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WeDo Technologies delivers Profit Optimization Platform for Retailers
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RAID: RETAIL - Protecting your Profits
Welcome
How WeDo Technologies Can Help
From the Gartner Files; Improving On-Shelf Availability for Retail Supply Chains Requires the Balance of Process and Technology
Issue 12
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Welcome
Executive SummaryWhat you can’t measure you can’t control. Although a cliché never has this adage been so true. In this newsletter you will learn how retailers across the globe are designing strategies and tactics to protect their margins by assuring and most importantly, controlling on-shelf availability.
WeDo Technologies has been at the forefront of this effort and can support retailers looking for solutions that will allow tighter operational and business control.
Challenges facing retailers today
Retailers today face many challenges: from trying to predict customer behaviour, grappling with global supply chains or reconciling multi-channel demand. This means that retailers need to control all processes and events related to revenue and costs, all customer, contract and service parameters and ensure their consistency in all platforms. If any problems arise they have to be warned very fast and have clear information on what the problem is and be able to pinpoint the cause. Yet many retailers do not have enough resources to effectively cover and control all of these factors.
In these tough economic times, defending margins is probably the most critical problem/challenge to be addressed. Thinking on the retail processes and metrics associated with margins, there are many aspects and areas where they are at risk. These can include price pressure (competition, discounts), increasing costs, shrink or leakage. Broadly speaking, the last issue – shrinkage - can encompass internal and external theft as well as inter-company fraud, but often an important factor is process failure. Products which are out of date, reduced or incorrectly priced, counted, picked or just simply damaged can account for as much as half of known stock loss.
Identifying factors such as theft and fraud as well as process issues are important elements in improving stock availability. Let’s detail some of them.
Example 1: On-shelf availability
Being able to have visibility on and proactively control on-shelf availability is a long term challenge for all retailers as not having the product available has a direct impact on retailers’ bottom lines and on their image (what if your customer goes to the store – brick&mortar or online- and the product he/she is looking for is not on the shelves?). Studies show that retailers can lose up to 4% of sales due to stores being out-of-stock. *Source: Retail Out-of-Stocks: A Worldwide Examination of Extent, Causes and Consumer Responses
Traditional mechanisms for measuring availability often deem a product to be available when in-store, as identified by receipt of delivery from distribution centre or supplier. This is not a measure of a customer’s perception of availability however. Delivery does not always translate into presence at the shelf, with the last few meters usually being the most difficult to manage. Ensuring transfer from back room to customer facing areas is critical to avoiding out-of-stock situations and increasing customer satisfaction.
As recognized by research and surveys, the market also dictates a number of competing trends which exacerbate the situation. For example, multiple and changing store formats create their own replenishment challenges, as does an expanding number of assortments and an increased importance of own-label products.
Although we assume that it’s impossible to control all events that cause out-of-stocks to occur there are many situations where out-of-stock reductions are possible simply by better controlling and monitoring the stock and being proactive in detecting potential situations that will lead to out-of-stock situations.
The controls should be used by different areas of the business as they address different business situations, namely:
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Here, one of the fundamental truths of retail, ‘Retail is detail’ has a particular relevance and the management of this detail is driven by data. The accuracy and timeliness of this data is important in identifying adverse trends and anomalies, but simply spotting these is not enough. Having determined the need for action, assigning responsibility and ensuring accountability of execution is pivotal, highlighting the need to operate in near-real time. Unfortunately, the data required is often locked in discreet systems developed in isolation over many years. Therefore integration, aggregation and reconciliation of transactions are required in order to reveal the trends and issues associated with maintaining stock availability. In order to address on-shelf availability, organizations must take new approaches to solving these problems; by aligning, planning and execution processes, supporting them with technology and ensuring that operations teams have the appropriate analytical and execution tools at their disposal.
Example 2: Availability of inventory in store to support a major promotion
For many retailers, a critical process is managing the availability of inventory in store to support a major promotion, such as a back to school initiative or black Friday.
FIGURE 1 Monitoring On-Shelf availability
Source: WeDo Technologies
Promotions require the coordination of many distinct store activities including re-merchandising, re-pricing, signage, new consumer packs, multiple location display and POS update. Often linked to external events such as advertising, timing is therefore an important element of promotion. Additional activities including increased stock monitoring, multi–location replenishment and allocations can all add to an additional burden on staff.
The chart below maps out the reasons why inventory could fail to arrive in store in time for the promotion and hence defines a process to manage promotional stock availability. A report is designed to highlight real problems arising from any of the theoretical causes. For example, a pick list may have been created for a store and the pick failed because the warehouse did not have enough free stock. A purchase order may have been delayed or never created in the first place. It may have been held up by lack of Open to Buy (OTB).
In this case, a promotional monitoring dashboard could be created highlighting a variety of situations that could result in stores not having the right stock. These would lead to drill down reports analyzing particular problem areas in more detail.
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Taking Profit Protection to the next levelProfit Protection and in this case, margin assurance, is about spotting issues early. Most people recognize that things that are addressed early are often cheaper to fix.
Retail management is based on tracking actual performance against key metrics and analyzing variances of concern. Tracking trends is also important to detect developing issues as early as possible. What to compare depends on whether you are analyzing company or departmental performance or the execution of key processes.
Source: WeDo Technologies
FIGURE 2 The Item Availability Management Process
At the process level, near real time alerting allows key issues to be addressed in a timely fashion. Being able to do this cost effectively is an important contributor to protecting or increasing profit.
But we need a way to close the loop and ensure that problems are not only identified promptly, they are dealt with and resolved. The most effective way to do this is to use two well-understood tools – case management and workflow management.
Source: WeDo Technologies
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How WeDo Technologies can help
Source: WeDo Technologies
FIGURE 3 Profit Protection Vision
At Wedo we developed a Business Assurance or Profit Protection vision that supports retailers to prepare their business for market challenges, operational risks and new business models.
Business Assurance or Profit Protection is about using systems to improve operational effectiveness and manage risk. This practice is focused on near real time data quality and consistency, on its financial value and on the implementation of controls on top of the business processes.
RAID:RETAIL is a complete Profit Protection solution tailored to cater and support retailers of all sizes, covering different areas. The solution imports and integrates information from different platforms into its central database, applies business validation and comparison rules to detect errors and inconsistencies and produces and manages alarms, dashboards and reports.
To implement this vision, WeDo developed a product that can address retailers’ needs to handle challenges like the ones described earlier.
RAID:RETAIL - Protecting your ProfitsRAID:RETAIL allows the transformation of business operations and suppliers data into valuable reporting information.
Retailers can also use the solution to respond to changes in their business and regulatory environment as well as take advantage of new opportunities by carrying out an end-to-end analysis of key business drivers.
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These final three functionalities in Figure 4, as well as alarms and alerts, are very important and not typically found in data warehouse solutions.
In terms of architecture RAID:RETAIL, is a centralized operational control platform that is independent of the IS architecture in place:
RAID:RETAIL operates as a proactive and continuous control and monitoring tool over information as transaction data, conditions, changes, processing integrity or error management.
Improving on-shelf availabilityThe identification of potential out-of-stock and low stock situations in near-real time requires the integration of data from disparate systems - RAID:RETAIL guarantees this. By allowing the reconciliation of stock movements, forecasts and sales against historical trends and operational benchmarks, it can identify potential out-of-stock and low stock situations in near-real time.
Source: WeDo Technologies
FIGURE 4 RAID:RETAIL main functionalities
Utilising case management workflow, issues can be assigned to those individuals responsible for rectifying the problem and alerts sent directly to them, for example via email or text message. Problems can be tracked and senior management can monitor progress via automatic escalation. Store staff as well as head office analysts can query status via role specific portals, all controlled by corporate security policies. RAID:RETAIL simplifies the management of on-shelf availability caused by the complexity of disparate IT systems
Profit Protection - defending your marginNot only can RAID:RETAIL assist stock control, it can also identify potential shrinkage issues such as fraud, as well as monitoring promotional performance, ensuring, for example, that associated financial credits are correctly identified and claimed.
Even those retailers that have made a strategic decision to standardize on ERP often find data
What our customers are saying about RAID:RETAIL:
Project Business Sponsor
“In our business the timely supply of information is essential, so it is very important to have a tool to pre-emptively detect and correct any anomalies. Business Assurance RAID:RETAIL will help us to reduce data transfer problems, control system configuration, and to optimize internal processes such as, for example, the consolidation of information for management. No less important is the fact that WeDo Technologies’ solution will improve the control of transactions and provide quality assurance of information.”
Project IT Sponsor
“RAID:RETAIL is a powerful tool, able to integrate in one product the management of business cases and alarms. It delivers us the opportunity to implement our own quality control rules, KPIs, reports and dashboards, with minimum effort. The gains are both effective and measurable on revenue assurance, cost control and productivity. From our perspective we can easily integrate the needs of the IT teams with those of the business teams.”
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Source: WeDo Technologies
FIGURE 5 RAID:RETAIL functional diagram
Source: WeDo Technologies
FIGURE 6 RAID:RETAIL benefits
needs to be combined from different platforms and applications in order to support decision making. However, many also find that the same data elements reported by more than one system produce different answers. Sometimes this is due to errors, but more often to assumptions being made about the way items are captured or derived. Another common cause for these differences is timing.
The ability of RAID:RETAIL to target most business processes allows retailers to take control of many of the components eroding margin, improve efficiency of operation and
directly contribute to their bottom line. Better control within the order-to-cash cycle creates the ability to maximise existing revenues and free up time and resources to create new ones. Profit Protection requires a strategic view of the goals and objectives of the business and detailed knowledge of the inter-related operational processes. Implementation, often achieved in phases, creates early benefits reducing the time to achieve Return on Investment (ROI) and funding further rollout.
To summarize the benefits provided by RAID:RETAIL :-
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About WeDo Technologies
WeDo Technologies is a worldwide leader in revenue and business assurance, providing software and expert consultancy to intelligently analyse large quantities of data from across an organisation, help to negate or minimise operational or business inefficiencies and allow businesses to achieve significant return on investment via revenue protection and cost savings.
WeDo Technologies works with some of the world’s leading blue chip companies from the retail, energy and finance industries, as well as more than 100 telecommunications operators from almost 80 countries, through 400 highly-skilled professionals.
WeDo Technologies is owned by the largest non financial Portuguese group – Sonae Group - with more than 40,000 employees in 29 countries.
Visit us at: www.wedotechnologies.com/en/industries/overview/retail
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Improving On-Shelf Availability for Retail Supply Chains Requires the Balance of Process and Technology
Utilizing availability measurement processes and more mature store-level inventory management, retailers can deliver a one-to-three basis-point improvement in on-shelf availability, without raising inventory targets.
Overview
Although retailers continue to embrace consumer-centric supply chain principles, their on-shelf execution remains disconnected, with more than 65% of out-of-stocks attributed to processes within the four walls of the store. Here, Gartner outlines how adopting demand-driven strategies can improve on-shelf availability and subsequently increase customer satisfaction.
Key Findings
• Nonpromoted, out-of-stock rates run between 6% and 10%. They run 18% to 24% for promoted items.
• According to SymphonyIRI Group, 70% of surveyed shoppers would shop for an item at a competitor or online if it was unavailable.
• Up to 4% of sales are lost because of out-of-stock items, which is an earnings per share (EPS) hit of $0.012, according to a Grocery Manufacturers Association (GMA), Food Marketing Institute (FMI) and Consumer Goods Forum (CGF) study.
Recommendations
• Recognize the difference between sales and demand by incorporating lost sales or out-of-stock information into your demand-planning activities.
• Ensure that your demand signal begins with customer point of sale (POS) data, and provides an integrated view of demand across channels, stores, distribution points, and trading partners, ideally through a centralized center of forecasting excellence.
• Reinforce space management disciplines at the store level to support perpetual inventory (PI) integrity and improve the ordering processes.
Analysis
On-shelf availability remains a significant challenge for retailers. Despite the focus on supply chain and inventory management initiatives, improvements still elude most retailers. Past and present Gartner research suggests that most retailers possess mechanisms to track on-shelf availability performance, but few turn this information into corrective actions.
Out-of-Stocks Force Consumers to CompetitorsAccording to SymphonyIRI Group, consumer shopping patterns continue to evolve over time. In 2003, shoppers visited an average of three stores to complete their shopping. This grew to five in 2007 and eight in 2010. Consumers switch shopping venues if three to four items are routinely unavailable. This means shoppers frequently visit multiple retailer locations and will pick up missing items on these trips.
SymphonyIRI Group data shows the first out-of-stock instance results in a consumer purchasing a substitute item 70% of the time. The second occurrence leads to a 50% substitution rate, with the other 50% representing consumers going to a competitor. By the third instance, there is a 70% chance the sale is lost entirely, in addition to the customer’s loyalty.
Organizations need to improve their abilities to recognize and respond to products not on the shelf. A joint study by the GMA, FMI and CGF found that only 20% of out-of-stock items were replenished within eight hours, with 36% unavailable for one to three days. Although most retailers capture the occurrence, few capture duration (see Figure 1). Understanding duration provides information to determine the root cause of out-of-stocks and create mitigation plans.
Operational Complexity and a Changing Marketplace Erode On-Shelf Availability
Although retailers aspire to improve their on-shelf availability levels, it’s often capabilities, or lack thereof, that limit making significant improvements. Today’s retailers can use technology advancements in forecasting, replenishment and optimization like never before.
From the Gartner Files:
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However, although technology alternatives are available, business processes remain disconnected and functionally focused. This is evident in four key areas:
1 Stock-keeping unit (SKU) proliferation – Many organizations still lack formal, consumer-focused SKU rationalization/optimization processes. As a result, their assortments grow to unmanageable levels. The unproductive items strain a retailer’s ability to effectively manage the demand, fulfillment and stocking of all products.
2 Poor data for promotional forecasting – As retailers increase the number and sophistication of promotions, a robust forecasting engine is required. Most organizations lack the required process to synchronize clean, foundational data throughout the extended enterprise (e.g., promotional offer type, price discount, store display location or advertising location) to accurately predict promotional demand. This results in promoted items being twice as likely to be out of stock as nonpromoted items.
3 Planogram challenges – The movement toward localized and store-specific assortments challenges a retailer’s ability
to effectively manage its selling spaces. Many retailers still establish planograms at a corporate level, which often leads to inaccurate space allocation decisions at the store level. Additionally, the constant introduction of new items and the removal of old items lead to misplaced or missing shelf tags at the store level, which hinders timely replenishment of the product.
4 Filling the channel with excess inventory – Intuitively, you would think that more inventory equates to higher availability. Unfortunately, it’s not that easy. Excess inventory causes congestion in the backroom, reduces the ability to replenish effectively, increases carrying costs and masks the real causes of out-of-stocks. Remember, most retail backrooms weren’t designed to be warehouses. They typically lack the fixtures, physical space and technology necessary to effectively manage large quantities of inventory.
Business processes aren’t the only challenge. The market dynamics within retail continue to evolve:
• Multiple and changing store formats, and growing channels – As retailers strive for customer relevancy, the size, configuration and focus of stores vary.
Source: Gartner (May 2011)
FIGURE 1 Retailer Methods for Tracking Out-of-Stocks
Manually capture availability information (e.g., associates count) 11%
Systemically capture availability information (e.g., statistical analysis) 47%
Use outside service or third party
8%
fo noitanibmoCany of the above
32%
Do not formally capture availability information
2%
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Multiple configurations create replenishment challenges, as retailers struggle to predict sales volume accurately. Operating multiple formats requires a keen understanding of the business model so that stores meet customer expectations, and do so profitably.
• Expanding and more specific assortments – Retailers are utilizing customer segmentation to better understand their shopper bases and identify the items they consider relevant. Unfortunately, many haven’t established a process for efficiently managing their assortments, nor have they automated the replenishment process for these items at the store level, which contributes to on-shelf availability challenges.
• Increased importance of own-brand products – Own-brand items provide retailers with a source of differentiation and bottom-line growth. Keeping them in stock requires a strong demand signal, which can be difficult to create, given the lack of historical sales movement. These items tend to build a loyal following with consumers, so shopper disappointment intensifies when these items are unavailable.
Although the home office should improve planning processes, our research shows that store execution, as well as the linkage back to
the merchandising planning process, has the greatest effect on availability performance. Table 1 outlines the typical root causes and locations of out-of-stocks.
Force a Consumer to Make a Decision and Risk Losing the SaleWhen faced with an unavailable item, consumers have five choices:
• Buy the item at another store.
• Delay the purchase.
• Substitute within the same brand.
• Substitute a different brand.
• Don’t purchase the item.
All have consequences for the retailer and manufacturer. Direct consequences include loss of a sale for both and smaller transaction sizes, as consumers tend to trade down if forced to substitute. The indirect consequences for retailers include poor consumer satisfaction and a reduction in shopping trips to their stores. When consumers delay or switch product purchases, it creates supply chain inefficiencies. Aligning potentially inaccurate demand signals with replenishment and logistics creates an inventory “bullwhip effect.”
Location Process Description Percentage
Upstream Warehousing • Poor replenishment policies• Data inaccuracies
12%
Planning • Last-minute price/promotion decisions 15%
Manufacturer • Capacity issues• Product availability
8%
Upstream Total 35%
Store Store forecasting
• Ineffective algorithms• Disconnected process
31%
Store ordering • Late or no order• Incorrect replenishment frequency
12%
Store stocking • Poor shelf management practices• Stocking frequency• Congested/disorganized backroom• Misalignment/lack of labor
22%
Store Total 65%
Source: Retail Out of Stocks: A Worldwide Examination of Extent, Causes and Customer Responses, University of Colorado (May 2002). Adapted by Gartner.
Table 1. Out-of-Stock Root Causes
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Consumers weigh three factors when making decisions among the previously mentioned five choices:
• Opportunity cost – The importance of using the product immediately
• Substitution cost – The value of using a less desirable alternative
• Transaction cost – The time and effort required to get the product someplace else
Retailers that classify items and categories across these three dimensions generate greater availability and increased customer satisfaction. For example, by linking an item’s availability performance with its cost factor, organizations can identify the high-priority items to keep in stock. As consumers blur their purchasing channels, retailers must recognize that these trade-offs vary by retail segment (see Table 2).
Connect Merchandise Planning and Store Execution to Improve On-Shelf Availability
Successful retailers are making a fundamental shift in the way they do business by implementing a demand-driven model that coordinates processes and technology to help them understand, shape and respond more
efficiently to consumer demand. However, many organizations continue to struggle with coordinating key promotion, pricing and inventory strategies, hindering their abilities to accurately sense, forecast and respond to consumer demand. One major barrier is that planning activities within the home office are often disjointed by functional and siloed processes, and represent the “average” store condition. We see this as the “Goldilocks” approach to space planning – stores with too much space, stores with too little space and very few with just the right amount. This also has a negative downstream effect on store execution.
Retailers have four opportunities to align the merchandise planning and store-level execution processes, which will lead to a reduction in out-of-stock duration and improved customer satisfaction:
1 Create an organization that oversees marketing, merchandising and space management responsibilities. This alignment provides a consistent view and use of consumer intelligence, as well as a common definition of the consumer for the organization. This definition helps merchants tailor their assortments to meet consumer demand and link the right assortment to the appropriate stores.
Substitution Cost
Opportunity Cost
Transaction Cost
CustomerWill …
Negative Impact Most Common Retail Segment
High High Low Buy item somewhere else
Retailer Fast-moving consumer goods (FMCG)
High Low Low Delay purchase
Retailer and manufacturer
Apparel
High High High Substitute – same brand
N/A FMCG
Low High High Substitute – different brand
Manufacturer Hardlines
High Low High Not purchase Retailer and manufacturer
Specialty
Source: Retail Out of Stocks: A Worldwide Examination of Extent, Causes and Customer Responses, University of Colorado (May 2002). Adapted by Gartner.
Table 2. Consumer Out-of-Stock Cost Trade-Offs
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2 Determine and define the role of store operations in the planning and execution processes. Typically delegated to execution, some retailers involve the stores in the assortment selection process because they have insights into local items requested by consumers. One retailer allows stores to select up to 10% of their ranges by selecting items from a corporate catalog.
3 Conduct a thorough review of the new and discontinued item process, which can represent up to 20% of retailer out-of-stocks. Establish a cross-functional review team to document the current process, identify the breakdowns and regulate the flow of new items. One retailer implemented a “one-in, one-out” policy: Merchants could not add an item to the assortment until they identified a candidate for deletion and had an inventory disposition plan.
4 Embrace workforce and task management, and share labor availability to downstream activities, such as receiving and stocking. Establish engineered work standards to determine duration of time for specific activities. Visibility allows organizations to coordinate the available labor resources with the demand from delivery and stocking tasks. This coordination leads to efficient product movement, available labor to replenish the shelves and uncongested backrooms.
Proactive Availability Management Requires Robust Root-Cause AnalysisOur research indicates that retailers approach availability measurement via physical counting at the store level and/or statistical analysis of POS data. Table 3 defines the measurement alternatives, and highlights the advantages and disadvantages of each approach.
Regardless of the measurement approach, there are five critical details to capture for each out-of-stock incident:
1 Rate – What is the number of out-of-stocks? This is typically measured as a number or percentage of items, and used in both physical counting and statistical approaches.
2 Duration – How long was the occurrence? This is typically measured in days and occurs more commonly in the statistical measurement approach.
3 Frequency – How often is the item out of stock? This is typically measured in number of occurrences within a given time period. It’s
used with both measurement methods, but more commonly with the statistical approach.
4 Breadth – How widespread across sales channels was the occurrence? This is used with both measurement approaches, but requires central visibility to the data.
5 Lost sales – What was the financial impact of being out of stock? This is calculated by multiplying the retail value of the item and the forecast sales movement for the duration of the occurrence.
These five dimensions begin to segregate out-of-stock incidents into problem areas. For example, breadth indicates how many stores had that item out of stock. One item out of stock across many locations could indicate a supplier or manufacturer problem. In addition to the dimensions of measurement, identifying what caused the out-of-stock is essential.
Detailed root cause analysis is lacking at most organizations. To help you incorporate root cause analysis into your existing measurement approach, we identify the leading causes of out-of-stocks (see Table 4).
Of course, not all organizations are positioned to classify their out-of-stocks at this detailed level. The retailers that provide this granular-level, out-of-stock information typically have implemented the following technologies:
• A master data management (MDM) structure to store item-attribute data, such as reorder point, minimum shelf presentation, authorization and store assignments, and warehouse or direct-store-delivered classification.
• PI and CAO or CGO to identify if orders were placed and determine if the order quantities were sufficient to support demand. Inventory management transactions, such as receipts, transfers and damages, must be captured to accurately reflect the BOH for an item.
• Turn and promotional forecasts to determine if the predicted demand supported actual sales. Best-in-class forecasts will separate turn and promoted forecasts to help isolate the cause of the problem.
• Predictive trade promotion management analytics to determine the most profitable means to shape demand and focus availability initiatives.
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Measurement Method Advantages Disadvantages
Physical counts at store level conducted by internal or external resources.
• Provides physical example of out-of-stocks
• Can be structured and scheduled to account for store activities
• Greater credibility for store associates
• Labor-intensive• Can be “gamed” by associates• Subject to priorities of the day
Leverage POS data to conduct statistical analysis on item movement to determine “likelihood” of out-of-stock condition.
• No store labor impact
• Unemotional analysis
• Runs in “autopilot” mode
• Data-intensive• To support the stats, usually a subset of items• No visibility to disruptive store activities
Source: Gartner (May 2011)
Table 3. On-Shelf Availability Measurement Alternatives
Description Definition
Delivery shortage (“scratch”) Computer-generated ordering (CGO)/computer-assisted ordering (CAO) items with delivery quantity less than the order quantity for delivery immediately preceding the out-of-stock scan date.
Insufficient vendor stocking Direct-store-delivered items that are vendor ordered, rather than via CAO/CGO.
Store stocking issue CAO/CGO items with a valid reorder point (ROP) (ROP more than one) and a balance on hand (BOH) more than three.
Turn forecast issue CAO/CGO nonpromoted items, with a valid ROP and BOH less than three, that sold more product than projected during the last order calculation. These items must not have an inventory adjustment or reclaim transaction that decreased inventory between the time the last delivery’s order was calculated and the time the out-of-stock scan occurred.
Promotional forecast issue Same as above, but for items with a promotional component to their forecast.
ROP too low CAO/CGO items having a BOH less than three and an ROP of one or two.
Item authorization issue CAO/CGO items that lack the necessary item attribute data. This includes appropriate authorization and ship-from-point association.
BOH adjustments CAO/CGO items with a BOH less than three and one or more negative inventory adjustment made since the last delivery.
Reclaim or return adjustments CAO/CGO items having a BOH less than three and one or more reclaim or return adjustments made since the last delivery.
Source: Gartner (May 2011)
Table 4. Out-of-Stock Reason Codes and Definitions
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Understand the Trade-Off Between Lost Sales and Service LevelService level is a supply chain metric that measures the ability of a distribution center (DC) to fill store orders completely. Since service levels are rarely 100%, the gap between the quantity ordered and what was shipped leaves stores vulnerable to out-of-stocks and lost sales. Ideally, safety stock fills this void, but manual inventory management processes often lead to inventory imbalances.
To better understand the implications of service level on lost sales, we have adapted a model from research completed at the Illinois Institute of Technology. It allows retailers to model the relationship between service level and lost sales. It also identifies effective service levels, which is a more accurate measurement of performance, as it accounts for lost sales and back-ordered (substituted) demand (see Table 5).
The model requires that retailers understand three variables:
• For an item (or another level of a merchandising hierarchy), the quantity requested from the DC (example number: 1,000,000)
• The existing service level for the item or level of the merchandising hierarchy (example percentage: 90%)
• An estimate of the percentage of transactions that are back-ordered or substituted at the store (example percentage: 60%)
The model shows that, using these three example variables, an organization would experience lost sales (units) of 66,667. While the organization may operate at a 90.0% service level, our effective service level is only 84.4%. Although this probably isn’t practical at the item level, the model provides insights into existing category supply chain performance, allowing retailers to model changing service levels and see the corresponding effects on lost sales. The percentage of back order or substitution also impacts the model. For example, a 10-point change in substitution – 60.0% to 70.0%, for example – lowers lost sales to 42,857 and increases the effective service level to 86.3%.
Because it’s difficult to measure opportunities with only internal demand data, consider using third-party data providers to better understand consumer substitution tendencies by category to enrich the output of the model.
Lost Sales as a Result of Service Level, Back-Order Performance
Known
sl Service level (percentage) 90%
pbo Unfilled demand: backorder/substitute 60%
dr Store demand requested to DC (orders placed to a DC)
1,000,000
Results
Variable Definition Calculation Results
df Shipments to store sl * dr 900,000
pls Unfilled demand that becomes lost sales 1 - pbo 40%
dbo Back-order demand dr - df 100,000
dls Lost sales (units) dbo * (pls/pbo) 66,667
du Unfilled demand dbo + dls 166,667
de Effective (total) demand df + du 1,066,667
sle Effective service level df / de 84.4%
Source: Stuart School of Business, Illinois Institute of Technology (2009). Adapted by Gartner.
Table 5. Service Level and Lost Sales Trade-Off Model
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Is It Possible to Collaborate on the Reduction of Out-of-Stocks?Although the term “collaboration” rolls off the tongues of both suppliers and retailers, true collaboration on out-of-stocks remains elusive for three primary reasons.
The Balance of Power Has Shifted to the Consumer (and, by Default, the Retailer)
Empowered consumers who know what they want and where they want to get it reinforce the importance of on-shelf availability, and the role suppliers and retailers play in the process. Collaboration occurs when two parties agree to work together on sustainable, win-win value propositions. With recent retail consolidation, the increase in store brands, and increased demand insight capabilities, such as the shopper loyalty programs at CVS Caremark, Kroger, Safeway, and Tesco, the retailer has more power than ever before. When retailers and suppliers meet today, it’s largely a brand discussion (i.e., supplier versus own brand), rather than a focus on improving the shopper experience.
The Gap Between Retail Aspirations and Capabilities Is Too High
Although retailers want suppliers to fix the problems within their span of control (25% to 40%, depending on the category and type of product), the problem is complex. The fix requires cooperation, but for retailers with PI, the inventory accuracy is worse than suppliers originally believed. Improving store-level inventory accuracy is an opportunity for both the retailer and the consumer products (CP) company to drive pull-based replenishment. This is a challenge, based on a Gartner research study of 62 FMCG retailers, which indicated that only 48% of respondents have had store-level PI systems for more than a year.
However, this doesn’t let suppliers off the hook. They need to more aggressively resolve their supply chain issues. Despite years of talking about out-of-stocks, CP companies have made little progress. Few have synchronized vendor-managed inventory (VMI) into the larger demand stream, and the sales account teams are primarily chartered with selling, not rethinking value chain issues. Consequently, when an out-of-stock occurs, the disruption is longer than originally thought, based on the CP company’s supply chain response.
Today’s CP processes for demand sensing and shaping take seven to nine days to correct an out-of-stock. Data from RFID pilots suggests that 80% of lost sales days are from out-of-stock
episodes that last more than seven days. With most out-of-stocks occurring in heavily promoted products and new product launches – products that are essential to the enablement of growth strategies – this is just too long.
New Problems Are Arising, and Execution Accountability Is Lacking
As suppliers try to institute more in-store programs to improve the shopper experience, there are three issues:
1 Promotion compliance – The largest issues for out-of-stocks occur in promotions. However, retail studies indicate that only 40% to 60% of store displays make it to the sales floor. RFID tagging of promotional pallets is a start, and CP companies are actively working with retailers to improve their promotional compliance. Tighter integration between merchandising and store operations can help ensure the merchants’ vision is executed by the store.
2 Feasibility of consistent execution – For suppliers, a major issue is the sell-in of a national campaign by a retailer’s corporate team that doesn’t reflect local capabilities. The gap between what retailers agree to corporately and what can be executed locally has grown in the last five years. Compounding the problem are changing formats and updated stores, as retailers strive to improve and localize the customer experience. What’s the supplier’s recourse for the sell-in of a program that cannot be executed consistently?
3 Inefficient backroom operations – Fast-moving, short life cycle products like ice cream, bakery goods, frozen meals, carbonated beverages and salty snacks utilize direct store delivery (DSD) to move the product to the store. Studies with the GMA DSD Committee indicate that 80% of DSD suppliers would deliver seven days a week, although this doesn’t match current retail policies. Most retailers restrict DSD deliveries to very narrow receiving windows that are five days a week and typically don’t include weekends. In this study, out-of-stock management is the No. 1 issue for both the 40 suppliers and the 35 retailers surveyed, but there’s no movement to change the archaic methods of backdoor delivery. Why are these policies so entrenched in history when it’s clear that major out-of-stocks occur on Saturdays?
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Suppliers beware: In the retail-supplier relationship for FMCG, the retailer has the power and will use it to its advantage. As a result, the focus for the supplier needs to move from collaboration to joint value creation, aligning with the retailer to improve on-shelf availability performance and enhance the shopping experience.
As the processes for joint value creation meetings evolve, suppliers will move from selling (talking), to listening, to analyzing and then to action. In parallel, the account teams will move from just selling products to owning the store experience for their brands. Account team incentives will change from a focus on revenue to a balanced system of metrics that include margin and growth objectives. This is a major change management issue for the supplier, but one that’s necessary to solve this problem.
Four Critical Factors to Improving Your On-Shelf AvailabilityLeading retailers recognize that technology alone is not the panacea. Solving the out-of-stock epidemic requires organizations to review current business processes, and embrace inventory and measurement technologies. Our research has identified four critical factors that, when understood and adopted, lead to improved on-shelf availability.
Recognize That Sales and Demand Are Different
Sales represent what the consumer purchased. Demand is what would have sold had consumers found everything they desired. Most forecasting products don’t account for lost sales and forecast based on historical sales.
Recommendation: Use out-of-stock data to calculate lost sales and incorporate that information into your forecasting processes. Since most forecasting algorithms don’t calculate lost sales, be prepared to do this manually (via Microsoft Excel), and export the results to your forecasting application.
Accurate PI Is Essential
Inaccurate PI is a problem that many organizations don’t know they have. Inventory problems come in two forms: hidden inventory (system BOH is less than actual BOH), which
triggers additional replenishment signals, and creates excess inventory and phantom inventory (system BOH is more than actual BOH). This delays the replenishment signal and creates out-of-stock incidents. Studies suggest that up to 25% of items on PI have phantom inventory.
Recommendation: Research shows that the more something is counted, the less accurate the results. Leading retailers establish counting criteria and provide directed lists to associates. Some examples of review criteria include items with negative or zero BOH, promoted items or items with excessive movement. Best practices also incorporate an algorithm that ensures that all items are counted at least once, with a defined period of time (i.e., once a quarter). Finally, pay special attention to items with multiple inventory locations. There’s a negative correlation between PI accuracy and the number of inventory locations for an item. Provide an indicator to associates, verifying BOH information if an item is in multiple locations.
Allocate the Appropriate Shelf Space for Fast Movers
Shelf space decisions are typically made based on case pack, not item movement. This leads to slow-moving items with too many facings and fast-moving products with not enough. In fact, many slow-moving items have a disproportionate amount of space based on their movements.
Recommendation: Identify fast-moving items and analyze their space allocations. Work with your space management vendor to understand the financial impacts of reallocating space to accommodate these items. Review their delivery frequency and method (warehoused versus direct store delivered). Their movements may dictate more frequent deliveries or alternative delivery methods. Finally, review the pack size for these fast-moving items. Work with the manufacturer to change it if a different one improves space utilization and availability.
Retailers can also work with suppliers and develop an innovation scorecard that governs new product introductions. Not all new products are successful, nor do they remain fast-moving forever. Yet they still remain on the shelf, causing forecasting and inventory management challenges, and negatively affecting on-shelf availability.
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What does good ultimately look like? Several leading retailers use their PI balances to drive their fiscal (financial) inventory reporting. For example, changing on-hand inventory levels at the store impacts the financial valuation of inventory at that location.
Understand Store Planogram Compliance, and Enforce Shelf Maintenance Disciplines
As planogram integrity declines, items important to consumers tend to disappear, leading to lost sales and decreased customer satisfaction. The influx of slow-moving inventory creates storage and organization issues in the backroom as well.
Recommendation: Create a planogram compliance business process. Be prepared to build your own, as most space management applications lack functionality to capture store planogram execution or provide a comparison to the required store set. Alternatively, engage a third party to survey the stores with some regularity. With either method, the compliance mechanism should measure item positioning and the number of facings. It should also offer exception reporting on missing or unauthorized items.
Reinforce shelf management disciplines. Ensure that stores don’t expand product facings to fill holes on the shelf or remove shelf tags. These practices disguise availability issues and make future ordering more difficult.
Recognize That Improving Availability Requires a New Paradigm“Death, taxes and childbirth! There’s never any convenient time for any of them,” wrote Margaret Mitchell in “Gone with the Wind” – and you can add out-of-stocks to this list. With little improvement in on-shelf availability during the past 10 years, organizations must take new approaches to solving this old problem.
The first step? Align your planning and execution processes, and support them with inventory management technology. Second, recognize and accept that the majority of availability challenges lie within the four walls of your stores. Third, ensure that your operations teams have the appropriate analytical and execution tools at their disposal. The retailer that solves this problem first will be rewarded with significant increases in sales and customer loyalty, and there’s no reason it can’t be you.
Source: Gartner RAS Core Research, G00212969, Mike Griswold, 26 May 2011
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