It is not uncommon for a manufacturing company to enjoy a profitability of around eight percent when the gross contribution is about thirty percent. However, it is rare for a retail chain enjoying a gross contribution of forty percent to have a consistent profitability of three percent (if they manage to make a profit at all).
It is relatively easier for retail chains to show rapid sales growth by opening new stores, however if there is no profit then continuing on this path of growth jeopardizes the very existence of the company.
As per a study by Harvard University professors, retailers with consistent high inventory turns have high profitability, resulting in higher share prices and vice versa.
Deciphering the correlation
Factors that affect inventory turns negatively are surplus and shortages, a reality for retailers across categories. It is not uncommon for stores to be stocked out of popular items while they hold slow moving stock of other items.
The impact of these factors on profitability is as follows:
- Money is blocked in excess inventory, thus preventing buying of required fast-moving items (due to OTB controls) resulting in lost sales.
- Surplus and slow-moving inventory occupy precious shelf space meant for fast-movers.
- Slow-moving items often require discounts resulting in loss of profitability.
- Write-off due to obsolescence or deterioration of inventory.
- Stock outs may result in loss of sales as customers may not buy alternative items.
- Even when stock outs are addressed through expedited supplies, it disrupts normal operations and increases costs.
- Repeated experience of stock outs can lead to buying in excess which in turn can impact inventory.
- Both excesses and shortages have a negative impact. Each factor can result in a future instance of the other! The only way to improve inventory turns, consistently, is to eliminate shortages and surplus.