Saturday, October 17, 2009

Turning Inventory

Several years ago I was introduced to the writings of Roy H. Williams. Every Monday he sends out a newsletter that gets you to think about business, life, marketing, etc. Click here to go to his site and register for his weekly Monday Morning Memo.

Here's what he sent me last week:

Turn, Turn, Turn
The Mark of a Remarkable Business

Business midgets focus on profit margin, “I can sell these for double my cost!” But business giants focus on turn, “How many more would I sell if I lowered my price?”

Retailers call it “inventory turn.” Restaurateurs call it “table turn.” Either way, it’s a measurement of how efficiently a business uses its assets.

Inventory turn tells the retailer how many times he sold and replaced his inventory over a period of time. Table turn tells the restaurateur how many times he emptied and filled his restaurant during a single mealtime.

Turn is Sales divided by Inventory.

Bob and Samantha are competitors. Bob makes a 100 percent markup on everything he sells. Samantha adds only a 50 percent markup. Which of them has the better business?

Your instincts tell you Bob makes more money but actually, it’s Samantha.

Bob carries an average inventory of 6 million dollars and sells each of his items an average of once a year at twice the price he paid for it: 12 million dollars in sales with an annual gross profit of 6 million dollars. Bob “turned” his inventory once.

Samantha carries an average inventory of just 1 million dollars. She sells and replaces each item an average of 12 times a year, adding only a 50 percent markup each time. Samantha does 18 million dollars in sales and her annual gross profit is 6 million dollars, exactly the same as Bob’s.

But Samantha turned her inventory 12 times.

Both retailers made 6 million dollars but Bob is slowly going broke. Samantha is quickly becoming rich and powerful.

Bob invests 6 million to make a gross profit of 6 million a year. This means Bob has to make a 6 million dollar investment every time he wants to open a new store. And Bob’s inventory is getting out-of-date because he has to sit on it for a whole year before he can replace it. This problem compounds itself each year.

Samantha invests just 1 million dollars to make 6 million. She can open a new store with just a million dollars invested in inventory. But wait, it gets better.

Bob bought only 6 million dollars worth of product last year. Samantha bought 12 million. And Samantha is opening new stores. Lots of them. This is what makes Samantha powerful. Soon the suppliers will be charging Samantha lower prices than they charge Bob because Samantha is a much better customer. And the suppliers will give her 90 days to pay but Bob must continue paying immediately.

Do you realize what just happened? Not only can Samantha open a new store with an investment of just 1 million dollars in inventory, she can sell that inventory for 1.5 million dollars each month for 3 months – putting a total of 4.5 million into her bank account – before she has to pay the first million dollars for the first month’s inventory. This leaves 3.5 million dollars sitting in Samantha’s bank account, allowing her to inventory 3 new stores, each of which will be able to fund 3 additional stores in just 90 days.

Samantha has opened 12 stores in just 6 months. If she keeps it up, she’ll have 432 stores at the end of the year. And Samantha started with just 1 million dollars in inventory while Bob started with 6 million.

Bob likes to boast that he offers “6 times the selection,” but the public knows Bob charges $100 for the same item Samantha sells for just $75.

Care to make a guess how this is going to turn out?

The moral of the story is this: you can’t get a high inventory turn without offering the public what they really want. In my opinion, the person who selects a company’s inventory is the most important person in that company. I could be wrong.

But I don't think so.

Roy H. Williams

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