Though the case studies center on the retailing and wholesaling environment, many of the principles apply to other industries equally well. Sharing information between business partners, placing product precisely where it is needed, and managing unproductive inventory levels are priority issues across a range of business sectors including health care, utilities, and automotive to name just a few. Put another way, the concepts presented here for controlling, tailoring, and executing extend well beyond the retail checkout counter.

Times are tough in retailing today. Statistics from KSA's Consumer Outlook^SM, our annual consumer survey, show that America is over-stored and people have less time to shop. Retail space has increased dramatically in the last 10 years, and more stores are being built. At the same time, stock-keeping unit (SKU) counts have ballooned throughout the supply chain. There is increased competition from direct marketers, such as print and electronic catalogs, as well as from wholesalers that are entering the retail venue to exert control over product assortment and price.

Time poverty only makes things tougher. As consumers struggle to balance the demands of work, home, and family, they have less time to shop. In fact, the time consumers spend in stores has decreased consistently over the last several years, both for apparel and food shopping.

The nature of the shoppers themselves is changing, too. Diversity is increasing throughout the country across lines of ethnicity, income, and age. As a result, consumer knowledge is more difficult to capture and manage than ever before.

For retailers and wholesalers, all of these factors intensify the pressure to maximize return on assets. Inventory turns and service levels must be high. Old wisdom held that retailers could choose between high in-stock positions and service levels, or high inventory turns—but not both. In the 1980s, it seemed retailers could "Stack it high and let it fly." But that environment no longer exists. To be successful, companies today must achieve both high in-stock levels and high inventory turns.

Given this difficult environment, organizations still can prosper through effective inventory management. A billion-dollar company with average inventory turns, in-stock positions, and growth projections can expect to improve results dramatically by focusing on inventory effectiveness. In KSA's experience, it is not uncommon to realize a one-time reduction in working capital invested in inventory ranging from $5 million to $40 million. At the same time, we've seen reductions in markdowns of anywhere from $10 million to $30 million as inventory is less likely to become obsolete. And it's not uncommon for revenues to increase in the range of $25 million to $75 million simply by having in stock the items that actually are selling. For a $1 billion retailer, the total financial benefit could range from $40 million to $150 million, simply by improving inventory effectiveness, achieving better turns, making smaller investments in inventory, and having the right items on the shelf.

For public companies, this financial benefit translates to improved earnings per share. After about four years, in fact, the improvement can be nearly a dollar per share. With today's average retail multiplier in the range of 20, one can quickly compute the potential effect on the retailer's bottom line, as illustrated in Exhibit 1. Note that the gap in performance actually widens over time. As performance improvement compounds, a company can gain 30 percent in earnings per share against the status quo. It is no coincidence, then, that the retailers leading the pack in performance are the ones doggedly pursuing inventory effectiveness. They are working to maximize the return on inventory investments without sacrificing sales revenues.

Technology is an essential piece of that comprehensive framework. Your information systems can have a positive or negative impact on inventory effectiveness. Many companies allow poor systems to become an excuse for idle work or for not taking action. Worse yet, some have invested millions in inventory-management systems in the belief that technology alone will improve inventory effectiveness. Sound business strategies—supported by appropriate processes, tactics, organization structure, and systems—are a better starting point. Technology then can be applied effectively to improve and automate these support mechanisms needed to execute the business strategies. Each of the case study examples presented below used technology in this manner.

At a high level, there is a simple model for the flow of inventory from concept to consumer. Product is planned, created, bought or manufactured, distributed, and sold. The challenge is to recognize that each step in the process affects others. This broad, integrated perspective is key to addressing inventory effectiveness. If this perspective is not maintained, the balance will be lost and the benefits will go unrecognized.

Supply Chain Management vs. Inventory Effectiveness

Before presenting the case studies, we need to make an important distinction between supply chain management and inventory effectiveness. Although the two concepts have somewhat overlapping frameworks, each has its own distinct emphasis.

Supply chain management typically addresses the efficient and effective physical movement of product from manufacturing source to consumer. A high degree of external focus is needed to streamline this flow as the company works with vendors, transportation providers, and other business partners. Cost savings are a typical bottom-line goal of supply chain management. The internal focus builds on the mantra: Have the right product in the right place at the right time. Supply chain management works to get product to that place at the right time at a lower cost.

Inventory effectiveness, on the other hand, is more strategic in nature. It deals with the underlying issues that drive the up-front decision making executed throughout your supply chain. Inventory effectiveness allows an organization to execute strategies, develop processes, structure the organization, and position systems to maximize the benefit of a physical supply chain. Inventory effectiveness addresses such questions as what are we putting into the pipeline, how much should I purchase, and where should I place my product? (Exhibit 2 summarizes the focus of inventory effectiveness.)

Four Real-World Examples

The four case studies that follow offer specific examples of companies that have acted aggressively to improve their inventory effectiveness. These organizations are increasing in-stock position and inventory turns—and at the same time reaping significant financial benefit.

The first case focuses on an overall channel strategy, addressing the issue of how to move product from plan to consumer innovatively and efficiently. The second case centers on demand planning and demand forecasting. The third examines conceptual assortment planning through this pivotal question: "What products are we going to offer to our consumers?" And the fourth case study focuses on advanced allocation techniques, or where to place product in a chain of stores to maximize the chances of selling at full margin.

The executives in each of the organizations profiled adopted a comprehensive framework for assessing strategies, operations, organization structure, and tools. Their assessments were linked across functional areas to answer the question, "How will we achieve the bottom-line benefit we're looking for?" In our experience, this kind of comprehensive approach facilitates development of innovative and beneficial solutions.

Case 1: Rethinking Distribution Channels

The first study comes from a slow-turn, SKU-intensive business. The case company is both a manufacturer and an outlet retailer of fashion footwear. The footwear business typically is characterized by low inventory turn because of the high number of SKUs associated with multiple colors and sizes in both length and width. And because this company sells product at wholesale as well as in its own retail outlets, inventory management takes on added complexity. On top of everything, this manufacturer-retailer was in the midst of expanding its company-owned retail outlets at the time of our collaboration.

Obviously, inventory management had become a top priority for this organization. Two specific issues demanded immediate attention. First, to keep space productive, retail customers could not effectively carry the full breadth of assortment. Second, re-orders were limited by open-to-buy dollars taken from slow-selling fringe SKUs.

The footwear manufacturer addressed both of these issues by developing an electronic kiosk system for retail selling floors. The kiosks provided access to the current warehouse inventory for use by the retailer or the consumer. Access was provided to inventory regardless of the assortment carried by the retailer. This inventory then could be shipped directly to the store or, more commonly, directly to the consumer for next-day delivery.

Results were impressive. In those retail locations where the kiosk concept was implemented, safety stock was minimized, especially for fringe sizes, colors, and styles. These items were pooled in one central location, which minimized inventory at risk for both the retailer and the manufacturer. Stock-outs were virtually eliminated as inventory could be sourced from the store, sister stores, or from the manufacturer's warehouse.

The bottom-line results were similarly dramatic. Sales increased by 20 percent. Half of that increase, or 10 percent, resulted from consumer access to product the retailer chose not to carry in the store. The other half of that sales gain came from product that was previously stocked-out at the time of consumer purchase intent.

At least four important lessons can be learned from this case example:

• To maximize inventory effectiveness, be willing to challenge the fundamentals of where, how, when, and why to hold and flow inventory.
• Maintain focus on the end consumer. Consumers want ease of access to the right product, at the lowest cost, at the right time.
• Be open to rethinking channels of distribution for your product. Distribution channels that may not have been possible five or 10 years ago now are open thanks to technological advances, partnerships, and collaboration.
• Finally, examine virtual inventory concepts. How do we provide inventory access to the consumer from anywhere in the supply chain? The company in this case example is working with its partners to do exactly that. Some other companies, such as CD-Now and Amazon.com, essentially have no inventory of their own. This is a direction in which many more organizations need to be moving.

Case 2: Buying for Demand, or Goodbye to Clearances

The next case study spotlights a specialty retailer of athletic footwear. The main issue for this company was aged inventory. It had a history of allowing inventory to build to higher and higher levels, and then bringing inventory down by holding a clearance sale. The markdowns taken during the clearance sale torpedoed profitability nearly every year.

The habits of the company's buyers compounded the problem. When planning purchase quantities, they used past information from similar styles they had bought. Basically, they relied on gut instinct to determine styles and the quantities to purchase. Additionally, the buying, planning, and allocation staffs were unclear about their respective responsibilities. Control and responsibility for inventory management in general was spread throughout the organization. Finally, company compensation structures were based solely on sales-related measures such as sales and gross margin dollars. Very little emphasis was placed on inventory measures—for example, turns, GMROI, and in-stock performance.

Recognizing the situation's seriousness, the company president commissioned a panel to investigate the causes of these problems that were leading to reduced profitability. The answer that came back was simple—they were buying too much. The amounts being purchased did not reconcile with true market demand. There was nothing linking market demand to purchase quantities. Aged and backed-up inventory sat in the distribution centers and in the stores' back rooms and sales floors.

For this retailer, the overriding priority was to align purchases with sales demand. Management correctly recognized that athletic footwear was fashion merchandise. And, as such, it followed a fashion demand curve. Typically, fashion sales start out very strong, then quickly drop off. Sales continue slowly and gradually decline as the inventory is sold out at a reduced price.

By looking at product demand curves and demand curves across the entire category, the company discovered how to better time key business decisions. It learned, for example, when to mark down merchandise and how to take "profitable" markdowns. This retailer also learned the right timing for consolidations and transfers, either mid-season or end-of-season.

In analyzing true demand and sales capacity, management utilized sell-through curves. (See Exhibit 3 for an example.) By reviewing indicators graphically, the company saw that after 180 days it was only reaching a 70-percent sell-through. This was yet another indication of excess inventory in the pipeline as athletic footwear typically has a three-month demand curve.

The company developed an analytical tool that let buyers tie attributes to a new product and then apply a filtering mechanism to pull history on similar styles. The buyers thus were able to leverage the tool to develop a suggested purchase quantity rather than relying on recollection and intuition. The suggested purchase amount did not replace the buyers' judgment about quantity, but was simply another consideration for them.

In addition to conducting the demand analysis, this specialty retailer reviewed purchasing patterns. It found that buyers were purchasing the same amount of product, regardless of how well they thought it was going to sell. They were afraid to take risks by purchasing more of the product they thought would do best.

To address this problem, the retailer mined its database of sales history to understand the best and worst sellers, and then reconciled purchase totals to a top-down financial plan. It found a consistency in the selling history—not on specific products, but rather in the way products performed. As a result, the company developed an intermediate checkpoint in the buying process. After the initial purchase quantities were determined, they were checked against historical rates of sale percentages to verify that basic ratios were upheld. The company challenged buyers to make adjustments wherever necessary and trained those needing help in this area. Top-down plans were used to confirm the link between quantities purchased and planned sales revenues.

What can be learned from this retailer's initiatives in forecasting and managing demand? One lesson is the importance of understanding demand patterns, including the timing of promotions and product launches. Another is the importance of integrating demand forecasting into the planning process. Buyers should not have vague answers as to why they bought a certain quantity of a particular item. The final lesson relates to the conventional practice of flat buying. You can't hit a home run if you don't swing the bat hard...at least occasionally.

Case 3: Finding the Missing Piece Through Line Planning

The next real-world example involves a manufacturer and retailer of children's apparel. Though this company worked hard to design and make a wide assortment of product that would meet consumer expectations, it suffered from declining turns and increasing inventory levels. Several problems had contributed to this situation; but the key factor was an assortment that had spun out of control. Poor performers were not being taken out of the assortment, and inventory-control points were not being applied.

Line planning happened only at a very high level and did not involve the design team or the market-strategy resources. The designers, in fact, did not conceptually agree to the line plan. Nor were they held to it. Meanwhile, line plans continued to reflect increasingly disappointing sales results.

For this organization, the mandate was to take line planning down to the product-category level. The company also needed to link the line plan with the brand strategy. This was a necessary step in grounding the plan in the lifestyle image the brand was established to represent.

The company invested in tools to support the analysis of selling history, using newly defined attributes across products and product categories. This analysis became the foundation for future line plans. A line plan would be developed and agreed upon by the marketing and design teams prior to concept development. The plan would provide guidelines for design, rather than specific direction.

The line planners thought through a series of questions as part of the strategy: What types of items should be in my assortment? What are the characteristics of those items? What basic body styles will be in the assortment? How should the assortment change from what sold well last season? How many colors should be in the assortment? What coordinated groups should be offered? What are the price points to target and the gross margin goals at the product category level?

This exercise yielded a clearer vision of the groups of items to be offered. In essence, the buyers created conceptual slots to condense and focus the line. For our case-study manufacturer, line planning had not been a structured, formal process. It tended to happen casually in conversations between merchants and designers.

Line planning helps ensure that you're offering the right product, including the right depth and breadth to the assortment. There are both qualitative and quantitative aspects to building such a balanced line plan. As you add items to your assortment, you gain incremental sales up to the point at which new styles cannibalize sales of existing styles. If you maximize total demand from a customer standpoint, your business can get so over-assorted that buyers lose focus on the image being conveyed—a major problem in itself.

Deciphering the exact point at which this occurs is difficult. As a company adds styles to the assortment, it inevitably increases inventory and markdown risk. Our case-study example developed relationships among sales, inventory, markdowns, and margin to create a productivity index. The index was useful in showing the minimum, maximum, and the target line plan—a "sweet spot" number of items across categories. (Exhibit 4 shows the productivity index created as part of the overall assortment analysis.)

Case 4: Allocating Product—The Right Stuff

The fourth case study involves a vertically integrated retailer of women's fashion apparel and accessories. In addition to the core business, the company was expanding its size assortment into petites, large sizes, and children's. The problem facing this retailer was a downturn in sales. Part of this could be attributed to the retail business, where there was an improper balance of allocations based on store demand. The other part was due to an inconsistency in allocation of product across retail customer accounts.

On the retail side, two issues called out for immediate action: (1) a lack of consistency in sizing and (2) the tailoring of product quantities going into the stores. Complicating the situation, the chain was undergoing rapid store growth, and with hundreds of stores, the allocation team was understaffed. There was not enough time to review each store's allocation on a particular product. Furthermore, the stores had short selling seasons. If allocations were not correct, little could be done to solve the problem.

Within this context, let's first examine how this company dealt with the sizing issue. Histories were pulled for the life of the product on the selling floor. Upon close review, it became apparent that out-of-stocks were disrupting the demand picture. To get the truest picture of demand, the retailer began reviewing early selling results for its fashion product—that is, prior to the likely occurrence of stock-outs. That selling period was a short 15 to 30 days. Analysis revealed that inventory for a particular product, by size, was too high in core sizes and too low in fringe sizes. Fringe-size selling in the first 20 days was 80 to 90 percent of on-hand inventory—an indication that stockouts were likely to occur in some stores.

The retailer used sell-through analysis and in certain cases actually created store-specific size curves. The manufacturing side of the business conducted a similar analysis across customer accounts, providing better estimates for production planning.

The second initiative was to improve the overall quality of the allocations by using more advanced tailoring techniques. Allocation systems attempt to send quantities to each store that will match customer demand for the product at that outlet. When supply closely matches true demand, higher sales and lower markdowns result.

In recent years, allocation systems have incorporated an increasingly sophisticated set of methods for forecasting and tailoring quantities to anticipate demand. But these advanced tools have not always been available. In the 1960s, for example, most retailers took a cookie cutter approach—every store received the same amount. In the '70s, companies recognized that some stores did better than others in different categories based on different volumes, and the concept of volume groups emerged. Moving into the 1980s, we realized there were distinct types of stores and customers: African-American, Hispanic, urban stores, street, suburban, high-income, low-income, and so on. Accordingly, we devised systems and techniques to develop store profile groups, using attributes as filters.

In the 1990s, however, stores have become multi-dimensional and reflect a unique blend of customers. The previous system of using attributes as filters is no longer good enough. Instead, those attributes must be used as dynamic influencers in our allocation calculations. Using attributes correctly not only means developing the relationships between product and store attributes, but also giving those attributes values. The values then can be used in the allocation calculations. This is a refinement technique that allows the system to do the work, taking advantage of what already is known about our customers and stores.

The retailer in our fourth case example still was using the techniques of the 1980s. So to address the allocation issue effectively, it first had to build product and store attributes and develop appropriate values. Then, it made modifications to the allocation system calculations. The results were allocations that better reflected the store's customer base. The technique also ensured that allocations making common sense actually happened—for example, stores with a less-affluent customer base would receive smaller quantities of the more expensive products.

Refining size scales and using dynamic attributes are only two methods of improving allocations. Other techniques include the proper use of detailed data, assortment planning criteria, and plan/trend orientation within the allocation methods. Companies using these advanced techniques often can improve allocation accuracy by 20 to 30 percent, or even more.

This article began by discussing the powerful financial impact of inventory effectiveness at every point in the distribution pipeline. It then went on to highlight four real-world examples of companies that had leveraged inventory effectiveness for competitive gain. Though the organizations profiled and challenges faced all were different, certain common mandates emerged from the case studies. These core mandates, which hold relevance for companies across a range of industries, include:

1. Adopt a broad perspective. Each of these companies completed a comprehensive assessment and developed an integrated strategy. Specifically, they looked across the entire inventory logistics process—strategies, operations, systems, and organizational pieces—to determine how to make real progress. This approach gave these companies a clear vision of how they wanted all of the elements to work together and allowed them to set priorities. It also ensured consistency. They did not optimize one piece of the puzzle only to cause dysfunction in another. Finally, a broad perspective allowed them to consider innovative approaches that could be pursued in the quest for inventory effectiveness.
2. Concentrate the effort. All of these companies imposed greater structure, discipline, and focus on how they approached inventory effectiveness. These qualities need to become an integral part of any organization seeking to manage inventory successfully. A concerted effort is required to attack the real causes of ineffective inventory, not just the symptoms. The company case studies also underscore the importance of striking a balance between the analytical techniques (the "science") and the qualitative methods (the "art") employed.
3. Take advantage of technology. Each of the case-study companies capitalized on available information systems and captured data to effect positive change. Good systems facilitate changes that will lead to inventory effectiveness. But at the same time, poor systems cannot be used as an excuse for lack of progress. Remember that many techniques, such as line planning, can be done effectively (though maybe not ideally) on spreadsheets or simply with paper and pencil.

Achieving inventory effectiveness is critical to the business success of your organization. Assess the situation. Where does your company stand in terms of inventory effectiveness? How good are you compared to the competition? What are the opportunities to leverage advanced inventory-effectiveness techniques? What would implementing improvements mean to your financial performance?

The answers to these questions call for a comprehensive review of your operations. Until you embark on that endeavor, you'll never know where the opportunities for inventory effectiveness lie—or the true magnitude of those opportunities. Ultimately it's about profitability. And perhaps even survival.