I am going to describe a process by which your retail store can make money. Not just money that shows up on your income statements, but money that shows up in your bank account. Good, hard, spendable cash. Sounds like fun, doesn’t it? I hope so. After all, retail is supposed to fun, especially in the wellness market. Your customers are coming to you to improve their health and well-being, and the last thing you want to be is grouchy because you have no cash flow.
This is not some obscure economic theory. The process is actively in use at every major chain store, department store and larger specialty store chain. Yet the concepts are completely applicable to independent retailers. In fact, many specialty stores and boutiques use this to ensure cash flow and profitability for their stores.
It’s called Open-to-Buy. Now before you roll your eyes and think to yourself “I’ve heard it all before, it’s just budgets,” let me clarify something. OTB, when properly implemented and executed, is not just a budget. When done well, it creates an integrated buying and merchandising approach that ties together your marketing, customer service, point of sale, accounting, and operations and focuses all of them on one thing: great cash flow. It is the process of developing a great sales forecast and combining it with a sales and inventory plan to create cash flow. Let’s break that down into its components so you can really understand and apply it to your business.
Forecasting is Not Guessing
OTB starts with a great sales forecast that breaks your business down into mini businesses that each have their own demand curve. For example, the rate of sale for candles is way different than the rate of sale for books, body care, or apparel. Your point-of-sale system should help you break your business down into these mini businesses, and each one deserves and requires its own forecast. Further, if you have multiple locations, each location should have its own forecast for each classification of merchandise.
Too often we hear about bad forecasting techniques. Lots of specialty retail stores plan their business by “buying what we sold last year” or “we expect to be up 2%.” These are not forecasts. They are stabs in the dark and lead to lost sales and missed opportunities. If you buy only what you sold last year, then the most you can sell is what you sold last year, or less. Why? Because you are bringing in less inventory in classes that could grow. As such, you won’t have enough inventory to capture the growth, and you will lose sales. The method of buying what you sold last year has one sure outcome: You are guaranteed to do less than you did the year before.
Great forecasts also are built from the bottom up, not from the top down. If you find yourself forecasting your business by saying, “we will be even with last year” then you will make the mistake of generalizing all your mini businesses into one number. That means you’ll miss sales in the classes that could grow, and you’ll have too much inventory in the classes that are declining. Both consume cash flow like an army of college kids at a pizza-eating contest. Over the top, but you get the idea.
Your business’s forecast should be broken out monthly and should be adjusted for seasonality. Your forecast should accurately represent the sales of winter clothing, but should also identify when winter clothing stops selling, and spring clothing takes over.
Great forecasting does take into account what you did last year, but that is not the most important factor. Forecasting must also take into account current trends, both inside your business and outside your business. Your OTB forecasts should react properly when trends emerge and enable you to take advantage of those trends by buying into them (or getting out of them if they are trending down) and squeezing out as much cash as you can.
We spend a great deal of time enhancing and focusing our sales forecasts. Good OTB systems do that, because it is an important part of planning your inventory. Big retailers have very expensive systems (read: more than a million dollars) that do this for them. Independent retailers often hire companies that bring that technology to their stores, but those companies must invest in and deliver that technology to the specialty retail market.
Okay, But What Do I Buy?
Once you have a great forecast in place, it should be easy to buy, right? If I know I’ll sell $1,000 of essential oils in January, I just need to have a little more than $1,000 of essential oils on the floor, right? Sorry, it doesn’t work that way. You need to put a sufficient level of inventory on the floor so that you present an appealing assortment from which to choose. (This is exactly where stores lose a ton of money. Read on carefully so you aren’t one of them.)
Knowing how much inventory to put on the sales floor to achieve your sales forecast is the key to making money in retail. If you put too little inventory there, you’ll miss sales. Put too much, and you’ll have to take big markdowns to sell through the merchandise, which eats up all your profits.
So how do you know? You apply something called a stock-to-sales ratio, which is defined as the number of units you need to have on hand to sell one unit. For example, if your personal care department is operating on a three stock-to-sales ratio, that means you have to have three items on hand for every one you sell in that department.
Once you have your sales forecast, you then determine the proper stock-to-sales ratio. That will tell you how much inventory you need to have on hand, without overbuying, to meet your sales forecast with maximum profitability. Just like forecasting, there should be a different stock-to-sales ratio for each mini-business, for each location. By determining how much inventory you need to have on hand, you will know how much you need to buy, month after month, to achieve the best level of inventory for your business.
If you do this, mini-business by mini-business, location by location, and diligently follow that plan (adjusting where necessary), you will have cash. Businesses that we work with that follow the plan have cash. Businesses that don’t follow the plan run out of cash, and eventually fail. It is that dramatic a difference.
Is That it? Really?
Mostly, yes. Of course, there are lots of nuances to this, such as achieving the proper profit margins, planning your markdowns, and ensuring that your inventory is fresh and new. The Open to Buy plan should become the centerpiece of evaluating your business. If you are on plan, then you should be achieving cash flow. If you aren’t, figure out where you’re not adhering the plan, and adjust your business accordingly.
In large retail operations, the planners are in a separate department from the buyers. It is rare that a buyer is also a planner. I am not sure why that is. I think it’s sort of like letting the fox guard the henhouse, in that the planner should be challenging the buyer to do more, to achieve more sales, more profitability, and more growth.
In an independent retail store, it can fall to the same person, but better retailers realize that the most objective planning will get them the highest profits. That is why there are external open-to-buy planning companies (like mine) for specialty retail. The good ones bring a vast array of outside knowledge and expertise that helps customers grow their businesses.
Most importantly (and a key tenet in what we do), it should be fun. We always try to make planning a fun and enjoyable part of the business. Further, it should inspire you. It should give you focus, direction, and excitement for what you do. If all that happens, then you’ll have cash flow, and you’ll be as happy and giggly as the customers who walk through your door.