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Measure Gross Margin Return On Inventory

Furniture World Magazine


Track this inventory metric to understand your customer’s buying patterns, establish a more relevant product mix, satisfy more people and sell more.

Consumers’ tastes and the economy are constantly changing. Some vendors and categories that were once popular are not anymore. You cannot control your customers’ tastes or the economy, least of all, through general advertising. This is impossible. If you agree, ask yourself, “What can I control?” 

In this article, you will discover how to listen to what your customers want in order to make more informed purchasing decisions. If you can manage a process, you can influence and control it. So, by better understanding your customers buying patterns and establishing a more related product mix, you will satisfy more people and sell more.

First, take the guessing out of the equation. There is only one group’s opinion regarding the desirability of purchasing your products that matters. It’s not your buyers, your reps, suppliers or your competition. And, it’s not you or me. It’s your customers!

Buying is analytical. You need to know what your customers are purchasing and what they want to buy from you in the future. With any top industry Customer Relationship Management (CRM) software, this data should be readily available to you.

Crunching The Numbers

First, to find out what current tastes are, analyze your sales data over the last three to six months and rank your vendors underneath each category. By doing this, you will see what categories and vendors are your customers’ favorites.

  “In this case, IGMROI is $3.00 and should be compared to the company average GMROI and
the individual
category GMROI’s.”

Now, don’t forget to look at the Gross Margin Return on Inventory (GMROI) of each of these categories and vendors. GMROI is the amount of annualized gross margin dollars you make per dollar of inventory that you have invested ($GM/$IN).

With this data in hand you will see what your customers are buying and how profitable you really are. For example, Bedroom may be a top producing category with two vendors, say Ashley and Lane, accounting for similar sales and margins. If you are stocking significantly less of one of those vendors, your GMROI will tell you which vendor has a greater return.

Predicting the Future

Now, how can you listen to what your customers want from you in the future? You must ask them. No system predicts the future, but good ones can certainly help you understand what your customers are telling you. Businesses that excel at this, do it by recording Next Purchase Data in their CRM system and by surveying their VIP list.

If you want to track next purchase information, your sales manager should first teach your salespeople to discuss rooms with their customers. A home furnishings improvement is not a one-time fling for your customers and so it should not be seen as a one time UP for your salespeople. Few consumers buy everything for their home at once. If you can collect this information, you will be able to go to Market with your customers’ homes in mind and follow up with them by providing information relevant to their needs.

The other great way good business people determine their customers’ needs is via electronic surveys. The proper way to do this is through an email marketing system that is connected to your CRM system. This enables you to get more frequent and better data while making the best use of everyone’s time. This can be accomplished by sending a targeted email after an event, such as a store visit, a quote, a sale, or a delivery. At the bottom of your email, display a red button that says something like “Make your Home Even More Beautiful – Take Our Survey” or it could read, “Get a $50 Credit on Your Next Room – Take our Survey”.

You can ask questions like:

  • What room in your home are you
    furnishing next?
  • What vendors do you like? Why?
  • Would you like a complimentary room plan?
  • Would you like us to send you some related ideas?
  • How can we improve our service
    to you?
  • Do you have any special requests?

If you ask the questions properly, through the proper medium, you will get information back that you can turn into gold!

Now that you have taken some of the guesswork out of the equation and are armed with customer data, you can go to market with a better plan.

Providing that you have a decent inventory to sales ratio (15-17%), you should have some open-to-buy available for new merchandise.

Look to the areas that your customers have been pointing you toward. With that information, when you still can’t decide between two vendors, always go for the one that produced a greater GMROI for your business in the past. It is still a gamble, but you’re increasing your odds!

What’s next?

Tell your customers what you did for them. But, not all your customers. Tell the ones that were interested in Ashley Bedroom about that new group. Send them a personalized email with links to pictures on your web site. Tell those that wanted Lane Upholstery about that. This is real customer service and SMART marketing. One size fits all advertising is not a smart way to use your money or consumers’ time.

Finally, if you expanded your inventory level, did it work? Here again, analytics comes into play. To determine whether you actually produced a greater return on your investment in extra inventory, you should track IGRMOI. This stands for the Incremental amount of GMROI produced as a result of your buying. After two months of trying the new merchandise, look at your new GMROI in that area. Take the difference before and after, and then figure the GMROI on the increment or change.

The Formula
New Annualized Gross Margin Dollars Minus Old Annualized Gross Margin Dollars Divided by New Inventory Dollars Minus Old Inventory Dollars... Equals your IGRMOI.

For example: ($275,000 - $200,000) / ($75,000 - $50,000) = $3.00 IGMROI

In this case, was the $25,000 expansion a good idea for $75,000 in extra gross margin dollars?
Even though the GMROI of this area fell from $4.00 to $3.67, the answer is that it depends on how it affected your averages.

The Rule
If your incremental GMROI dips below your average GMROI, or below an attainable GMROI in another category, then you should not expand to the extent of the test.

So the IGMROI, in this case is $3.00 and should be compared to the company average GMROI and the individual category GMROI’s. If it is dragging either down, then further expansion should be stopped, and possibly reversed.

However, if the IGMROI is pulling your company averages up, the extra investment in inventory was a good idea.

The name of the game is making the most money from the least amount of inventory investment while satisfying your customers’ needs. Don’t dwell on external forces. Focus internally on your situation. Manage what you can control by analyzing your data and listening to your customers before you buy.

David McMahon is Director of e-Strategy and a business coach for PROFITconsulting. PROFITconsulting is a full service consultancy and marketing agency that specializes in retail furniture. FURNITURE WORLD Magazine readers can contact David to discuss this and other operations and marketing topics at david@furninfo.com.

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