EXERCISE HOMEWORK

To illustrate the use of the basic stock method, let’s look at the planned sales for Department 353 of the Two-Seasons Department Store shown in Exhibit 8.2. Assume that the inventory-turnover rate for the season is 2.0. (Recall that inventory-turnover rate refers to the number of times that inventory is sold in a season).

Average monthly sales for the season = Total planned sales for the season/ Number of months =$500,000/6 -$83,333

Average stock for the season =Total planned sales for the season/ Inventory turnover = $500,000/2 - $250,000

Basic stock =Average stock -Average monthly sales

=$250,000 -$83,333 -$166,667

BOM @ retail (Feb.) =Basic stock + Planned monthly sales

= $166,667 + $75,000 = $241,667

BOM @ retail (Mar.) = $166,667 + $75,000 = $241,667

BOM @ retail (Apr.) = $166,667 + $100,000 = $266,667

BOM @ retail (May) = $166,667 + $50,000 = $216,667

BOM @ retail (Jun.) = $166,667 + $125,000 = $291,667

BOM @ retail (Jul.) = $166,667 +$75,000 = $241,667

It is obvious that $166,667 of basic stock is added to each month’s planned sales to arrive at the BOM stock. In those cases where actual sales either exceed or fall short of planned sales for the month, the retailer can easily adjust the amount of overage or shortfall to bring the next month’s BOM stock back in line by buying more or less stock. Therefore, the basic stock method works best if a retailer has a low inventory-turnover rate (that is, less than six times a year) or if sales are erratic. A second commonly used method for determining planned stock levels is the percentage-variation method (PVM). This method is used when the retailer has a high annual inventory-turnover rate—six or more times a year. The percentage variation method assumes that the percentage fluctuations in monthly stock from average stock should be half as great as the percentage fluctuations in monthly sales from average sales.

BOM stock =Average stock for season x ½ [1 + (Planned sales for the month/Average monthly sales)]

Since the PVM utilizes the same components as the BSM, we can use the data from the previous example.

BOM (Feb.) -$250,000 x 1/2[1 + ($75,000/$83,333)] - $237,500

BOM (Mar.) -$250,000 x 1/2[1 + ($75,000/$83,333)] - $237,500

BOM (Apr.) -$250,000 x 1/2[1 + ($100,000/$83,333)] - $275,000

BOM (May) -$250,000 x 1/2[1 + ($50,000/$83,333)] - $200,000

BOM (Jun.) -$250,000 x 1/2[1 + ($125,000/$83,333)] - $312,500

BOM (Jul.) -$250,000 x 1/2[1 + ($75,000/$83,333)] - $237,500

A third method for planning inventory levels is the weeks’ supply method (WSM). Generally, the WSM formula is used by retailers such as grocers, whose inventories are planned on a weekly, not monthly, basis and where sales do not fluctuate substantially. It states that the inventory level should be set equal to a predetermined number of weeks’ supply. The predetermined number of weeks’ supply is directly related to the inventory-turnover rate desired. In the WSM, inventory level in dollars varies proportionally with forecast sales. Thus, if forecast sales triple, then inventory in dollars will also triple. To illustrate the WSM, let’s return to our earlier problem and use the following formulas:

Number of weeks to be stocked - Number of weeks in the period/ Stock turnover rate for the period

Average weekly sales - Estimated total sales for the period/ Number of weeks in the period

BOM stock - Average weekly sales x Number of weeks to be stocked

Thus,

Number of weeks to be stocked -26/2 -13

Average weekly sales -$500,000/26 -$19,231

BOM stock -$19,231 x 13 - $250,000

Having determined the number of weeks’ supply to be stocked (13 weeks) and the average weekly sales ($19,231), stock levels can be replenished on a frequent or regular basis to guard against stock outs. The final method for planning inventory levels, and the one used in Chapter 8, is the stock-to-sales method (SSM). This method is quite easy to use but requires the retailer to have a beginning-of-the-month stock-to-sales ratio. This ratio tells the retailer how much inventory is needed at the beginning of the month to support that month’s estimated sales. A ratio of 2.5, for example, would tell the retailer that it should have two and one-half (2½) times that month’s expected sales on hand in inventory at the beginning of the month. Stock-to-sales ratios can be obtained from internal or external sources. Internally, the statistics can be obtained if the retailer has designed a good accounting system and has properly stored historical data so that the figures can be readily retrieved. Externally, the retailer can often rely on retail trade associations (such as the Menswear Retailers Association) or on national groups such as the National Retail Federation (nrf.com) in the United States, the Australian Retailers Association (ara.com.au), the Retail Merchants Association of New Zealand (retail.org.nz), the Retail Council of Canada (retailcouncil.org), the Japan Retail Association (http://www.japan-retail.or.jp/english/index.htm), or the Hong Kong Retail Management Association (hkrma.org). These and other trade associations collect stock-to-sales ratios from participating merchants and then compile, tabulate, and report them in special management reports or trade publications. However, these ratios should only be used as a guide to determine how much inventory to have on hand at the beginning of each month. Successful chain store retailers have long known that even stores located near each other require not only different merchandise mixes but also different inventory levels per sales dollars. This is a reflection of the store’s trading area, layout, and competition. However, inventory turnover remains a key factor in a retailer’s financial performance. Planned average BOM stock-to-sales goals can be easily calculated using turnover goals. If you divide the number of months in the season by the desired inventory-turnover rate, then we can compute an average BOM stock-to-sales ratio for the season. For example, if you desired an inventory-turnover rate of 2.0 for the upcoming six-month season (4.0 annually), your average BOM stock-to-sales ratio would be 3.0 (6/2.0 ¼ 3.0). Once the buyer has planned for the dollar merchandise necessary for the beginning of each month (or season), it is essential that the buyer not make commitments for merchandise that would exceed that dollar plan. In short, the dollars planned for merchandise need to be controlled. This control is accomplished through a technique called open-to-buy (OTB). OTB represents the dollar amount that a buyer can currently spend on merchandise without exceeding the planned dollar stock discussed previously. When planning for any given month (or season), the buyer will not necessarily be able to purchase a dollar amount equal to the planned dollar stock for that month (or season). This is because some merchandise may be already on order but not yet delivered. To illustrate this point more succinctly, let’s compute the open-to-buy for an upcoming month. Assume that at the beginning of February the buyer for Department 353 of the Two-Seasons Department Store (Exhibit 8.2) has already ordered, but not yet received, $15,000 worth of merchandise at retail. Keeping planned EOM stock at $300,000 and planned reductions for February at 10 percent of planned sales, the buyer’s planned purchases for February will remain $157,500. However, the open-to-buy for February will only be $142,500 at retail since it is necessary to account for the $15,000 of merchandise already ordered but not yet received. The computations would look like this:

1. Planned sales for February + $ 75,000

2. Plus planned reductions for February + 7,500

3. Plus EOM planned retail stock + 300,000

4. Minus BOM stock - 225,000

5. Equals planned purchases at retail $157,500

6. Minus commitments at retail for current delivery - 15,000

7. Equals open-to-buy $142,500

The OTB figure should not be set in stone because it can be exceeded. Consumer needs are the dominant consideration. If actual sales exceed planned sales, then additional quantities should be ordered above those scheduled for purchase according to the merchandise budget; however, this should not be a common occurrence. If it is, then the sales planning process is flawed. Either the buyers are too conservative in estimating sales or they are buying the wrong merchandise. This chapter’s ‘‘What’s New?’’ box discusses an innovative way the front line employees at Best Buy aid their buyers in making decisions on new product ideas. In any case, the buyer, along with management, should always determine the causes of OTB adjustments. Some of the most common buying errors include

1. Buying merchandise that is priced either too high or too low for the store’s target market,

2. Buying the wrong type of merchandise (i.e., too many tops and not enough skirts) or buying merchandise that is too trendy,

3. Having too much or too little basic stock on hand,

4. Buying from too many vendors,

5. Failing to identify the season’s hot items early enough in the season, and

6. Failing to let the vendor assist the buyer by adding new items or new colors to the existing mix. (All too often, the original order is merely repeated, resulting in a limited selection.)

Merchandise planning is a dynamic process subject to many changes. Consider how planning your stock levels might be affected by any or all of the following: (1) Sales for the previous month were lower or higher than planned, (2) reductions are higher or lower than planned, and (3) shipments of merchandise are delayed in transit. Understanding the consequences of each situation illustrates the interrelationship of merchandising activities with the merchandise budget. Such occurrences, though, serve to make retailing a challenging and exciting career choice. The dollar-merchandise plan is only the starting point in merchandise management. Once the retailer has decided how many dollars can be invested in inventory, the dollar plan needs to be converted into an inventory plan. On the sales floor, items are sold, not dollars. The assortment of items that make up the merchandise mix must then be planned. Each of these dimensions needs to be defined; however, to do so, it is necessary that we first define a merchandise line (or category). A merchandise line consists of a group of products that are closely related because they either are intended for the same end use (all televisions), are sold to the same customer group (junior miss clothing), or fall within a given price range (budget women’s wear). Today, as was discussed in Chapter 5, more than 90 percent of grocery retailers use the term category management to refer to their management of categories as a strategic business unit. That is, a supermarket buyer using category management would no longer be concerned with GMROI for just the Tide or Cheer detergent. Instead, that buyer would be concerned with the GMROI for the entire detergent line or category. For that buyer, the line or category is his or her strategic business unit. If the buyer focused only on the items, problems could quickly arise. For instance, price promoting Tide might increase Tide sales, but how much of the sales increase would come from existing customers merely switching from other products not on sale? Similarly, the buyer in such a situation must also consider to what extent some customers will simply stockpile (buy extra now and less in the future)? Taking a category perspective, the retailer might choose to price promote an item that is above the average margin for the category. If done well, the increase in the discounted product could bring up the average margin, instead of lowering it. This isn’t always possible, but it’s one of several concepts that retail buyers think about when managing a category. The variety of the merchandise mix refers to the number of different merchandise lines a retailer chooses to stock in its store. For example, department stores have a large variety of merchandise lines. Some have more than 100 departments carrying such lines as menswear, women’s wear, children’s clothing, infant’s wear, toys, sporting goods, appliances, cosmetics, and household goods. Others, like Pet Smart, carry only one basic merchandise line: pet supplies. In the middle of these two would be a retailer such as Sports Authority, selling a complete range of sporting apparel and equipment. Breadth, also called assortment, refers to the number of brands that are found in a single merchandise line. For example, a supermarket will have a wide breadth or assortment in the number of different brands of mustard it carries: six or seven national or regional brands, a private brand, and a generic brand. The 7-Eleven convenience stores, however, will offer very little breadth by generally carrying only one or two brands in any merchandise line. The breadth might change with time. For example, many clothing retailers now have as much as three times the selection in the misses department over the petites department (as customer sizes6 and manufacturer product styles have changed). Breadth is particularly a problem for retailers selling private-label brands. Retailers seek a proper balance between their own private labels and the national brands they carry. This is because private-label brands, as noted in Chapter 4, offer the retailer lower costs and higher gross margins; however, the retailer also needs national brands to draw customers into its store. Yet sometimes a powerful manufacturer may try to tie some of its merchandise lines together. In other words, if the retailer wishes to carry one product, the manufacturer stipulates that the retailer must also carry its entire product line. When retailers are faced with such dilemma, a battle of the brands can occur in which the retailer, in determining the breath of its product assortment, has its own products competing with the manufacturer’s products for shelf space and control over display location. One consequence of such a battle of the brands is that many retailers now stock one or both of the top brands in a product line or category as well as their own private brand. Consequently, many so-called third-tier brands have been left off store shelves. Merchandise depth refers to the average number of stock-keeping units (SKUs) within each brand of the merchandise line. In the preceding example, the supermarket manager must decide which sizes and types of French’s mustard to carry. The convenience store will probably carry only the regular nine-ounce jar of French’s. Depth is an acute problem today because all too often retailers are constrained in the number of SKUs they can carry by specific constraining factors. Dollar-Merchandise Constraints There seldom will be enough dollars to emphasize variety, breadth, and depth simultaneously. If the decision is made to emphasize variety, it would be unrealistic to expect the retailer to also have a lot of breadth and depth. For instance, assume for the moment that you are the owner or manager of a local gift store. You have $70,000 to invest in merchandise. If you decide that you want a lot of variety in gifts (jewelry, crystal, candles, games, cards, figurines, ashtrays, clocks, and radios), then you obviously cannot have much depth in any single item such as crystal glassware. Some retailers try to overcome this dollar constraint by shifting the expense of carrying inventory back on the vendor. When a retailer buys a product on consignment, the vendor retains the ownership of the goods, usually establishes the selling price, and is paid only when the goods are sold. (This is different from the use of the word consignment to describe customers taking products to stores like Play It Again Sports to resell merchandise to other customers with the store taking a percentage of the profit). Pay from scan is a more recent term that some retailers are beginning to use when describing consignment. Pay from scan (or consignment) helps reduce risk for seasonal products such as greeting cards, books, magazines, or dated food products (e.g., chips or soda). The manufacturer usually sends a field representative to the retail store to pull the remaining product off the shelf when the sell-by date passes. One of the benefits of pay from scan is that a retailer can have a lot of holiday greeting cards or promotional displays and not worry about having to (1) put them in storage somewhere for a year or (2) spend precious markdown dollars on them. However, consignment doesn’t come free. Manufacturers usually pass along a higher initial cost to the retailer to cover the returns. Still, retailers don’t have to worry about magazines or chips expiring every month. It’s a trade-off that retailers must make product by product or category by category: higher initial margin or less risk. Another approach the retailer might try to get is extra dating (EX), where the vendor allows the retailer some extra time before paying for the goods. For example, most textbook publishers either sell their books on consignment or give the bookstores an extra 60 days in which to pay. In this way your campus bookstore orders its books in early July for an early August delivery. The bookstore then sells the books in late August or early September. However, because the books were sold on consignment, or with extra dating, the bookstore does not have to pay the publisher until October. The retailer must also deal with space constraints. If depth or breadth is wanted, then space is needed. If variety is to be stressed, then it is also important to have enough empty space to separate the distinct merchandise lines. For example, consider a single counter containing cosmetics, candy, fishing tackle, women’s stockings, and toys. This would obviously be an unsightly and unwise arrangement. As more variety is added, empty space becomes necessary to allow the consumer to clearly distinguish between distinct product lines. Most retailers have operation guides that tell how much space should be between each fixture, rack, display, and so forth. They also have to decide how tall they want their fixtures to be. A retailer could have taller shelf sections (gondolas) that hold more products; however, at some point, it would start to feel like a warehouse. Conversely, the retailer could use shorter shelves that customer’s find more visually appealing, but this tactic provides less space for products. For example, Walmart is taking out many of its risers in its stores to be more visually appealing. While this impacts store atmospherics, it also reduces how much inventory the total store can hold. It either has to give up products (go narrower in breadth or depth), go leaner on inventory (risking out of stocks) and requiring more trucks on the road, or have more trailers behind the store (in which there is usually more theft, product and package damage, and outside temperature changes that can freeze or melt some products) where permitted. Retailers, especially in the grocery business, have been able to turn this space constraint into an advantage by charging manufacturers slotting fees, which were discussed in both Chapters 6 and 8, to carry their products. As the depth of the merchandise is increased, the retailer will be stocking more and more variations of the product to serve smaller and smaller segments. Consequently, inventory turnover will deteriorate and the chances of being out of stock will increase. One does not have to minimize variety, breadth, and depth to maximize turnover, but one must know how various merchandise mixes will affect inventory turnover. Market constraints also affect decisions on variety, breadth, and depth. The three dimensions have a profound effect on how the consumer perceives the store and consequently on the customers that the store will attract. The consumer perceives a specialty store as one with limited variety and breadth of merchandise lines but considerable depth within the lines handled. An individual searching for depth in a limited set of merchandise lines such as formal menswear will thus be attracted to a menswear retailer specializing in formal wear. On the other hand, the consumer perceives a general merchandise retailer such as Target as a store with lots of variety and breadth in terms of merchandise lines but with a more constrained depth. Therefore, someone who needs to make several purchases across several merchandise lines and is willing to sacrifice depth of assortment would be more attracted to the general merchandise retailer. The constraining factors make it almost impossible for a retailer to emphasize all three dimensions. However, retailers can take some comfort in the fact that greater product selection does not necessarily mean that the consumer will get more enjoyment from the shopping experience. Research has found that retailers can cut SKUs without lowering consumer perceptions of selection. In fact, Procter & Gamble (P&G) claims that in the laundry category 40 percent of SKUs could be eliminated and 95 percent of consumer needs would still be met.8 Some consumers may even be more satisfied with the smaller selection.9 This is important for retailers using the category management system to remember. After all, category management, in its effort to increase profits, typically reduces the number of SKUs as it seeks to increase inventory turnover. Nevertheless, if you are going to lose customers, you should seek to lose the less-profitable ones by properly mixing your merchandise in terms of variety, breadth, and depth within the dollar, space, turnover, and market constraints. After deciding the relative emphasis to be placed on the three dimensions of the merchandise mix, you need to decide when to order and reorder the desired merchandise lines and items. Ideally, as shown in Exhibit 9.3, a retailer selling a basic stock item, one that should always to be in stock, would receive the reordered merchandise just as it is needed. However, a retailer selling a seasonal item, as shown in Exhibit 9.4, would want to be completely sold out at the planned out-of-stock date. Both Exhibits 9.3 and 9.4 recognize the fact that it annually costs the retailer between 20 percent and 25 percent to carry inventory. Some of these costs are direct, such as interest on the money borrowed to pay for the inventory or insurance and warehousing expenses, and other costs may be indirect, such as what the retailer could have made elsewhere when it uses its own money to pay for the inventory. The retailer tries to achieve the optimization of its inventory dollars by closely monitoring its inventory. One of the great difficulties many retailers face is that inventory figures, including ‘‘perpetual inventory’’ (real-time updating) are often wrong as much as 40 percent of the time. 10 One way to fix (or decrease) the problem is to use radio frequency identification (RFID) barcode data. An RFID tag consists of a tiny digital signal processor embedded in a product, package, or box. It allows retailers to account for merchandise without the use of hand counts, which often leads to missed items in the stockroom, on risers, on the wrong shelves, or in customer carts. They also allow for faster reorders (as the merchandise is being sold). However, with all their potential benefits, RIFDs still present some issues that are described in this chapter’s case. Managing inventory turnover is one of the most important things retailers do. It is not easy. Just when you think you have the forecasts correct, customers change their minds. For example, after nearly 50 years of being a top seller, Barbie’s worldwide sales have hit the skids, dropping double digits over the last few years.11 As a result of these sales decreases, Mattel is trying to reconnect Barbie, perhaps ironically, with older girls (‘‘tweens’’)12 and even trying to sell bridal Barbie wear to Japanese adult women, among other strategies. More information about how the vicious battle13between Barbie and Bratz affects retailers’ inventory management is found in this chapter’s ‘‘ Retailing: The Inside Story.’’ Another problem can arise when retailers use the wrong baseline in making their forecast. For example, Spiderman was a huge success back in 2002, not only at the movie box office but also for several retail merchandise categories (e.g., toys, activities, electronics such as video games, music, movies).14The next year, retailers were excited to jump on board the Hulk movie bandwagon. This author and several other buyers sat in on meetings with the movie studio and licensing and manufacturing company managers. They planned for another Spiderman; however, as the children’s song goes ‘‘down came the rain and washed the spider out.’’ The movie flopped.15 The heroic, patriotic, nostalgic effect of Spiderman on a still-traumatized post-September 11 America was lost in a psychotic, violent remake of the Hulk television series. In fact, the aftermath can still be seen in leftover Hulk punching gloves on many retail chains’ shelves years after the film. The lesson? Retailers that are unaware of changing market conditions when purchasing merchandise will not be profitable. Market conditions involve a lot more than just patriotism or nesting trends. For example, celebrities like Oprah can dramatically impact future sales and thus inventory planning just by mentioning the product in a show or interview.16 Similarly, changes in the overall economy can affect retailers’ planning processes. For example, prior to the recession that began in late 2008, oil prices of $140-plus a barrel forced many manufacturers to raise prices on their goods in order to cover the increased cost of fuel.17 However, when prices later dropped below $50 a barrel in early 2009, a majority of retailers neglected to see a corresponding drop in the price they paid for their merchandise. With a recession in full swing, many questioned whether their customers would or even could continue to pay the higher prices. As a result, many sought to control inventory levels by renegotiating with manufacturers, which led a number of grocery chains to drop hundreds of big brand names.18 These retailers simply felt that if manufacturers were unwilling to give concessions given the recession, then they’d drop the branded items and replace the inventory with an expanded number of private-label items not only helping their customers save money but also enhancing their bottom lines. Once a retail buyer has finished negotiating the purchase of an item, the buyer has to oversee the creation of the item in the retailer’s computer system. Creating an item in a retailer’s computer system may sound easy, but it involves several steps. For example, the buyer or assistants have to determine which subcategories and categories of merchandise the item will be assigned. When inventory of the item is purchased from the supplier or sales are made to customers, the item’s performance will be linked to that category on both the OTB and merchandise planner workbooks that the company keeps. The buyer also has to decide how many items to create in the system. For example, if a buyer purchases a striped T-shirt that comes in five sizes and four colors, there are as many as 20 items that could be created and cross-referenced in the system. Does the buyer want to track sales by size and color or just by the shirt style? Tracking at a very detailed level can lead to less average inventory needed to be in stock in order to meet customer demand. It can also lead to ‘‘analysis paralysis.’’ If the buyer has 20 items for the shirt and one or two of them are not correctly cross-referenced, then some of the items may get missed if the buyer creates a PO or sends a markdown, which can be costly at the stores. Further, the buyer has to decide if there are any existing items that the new item should be linked to. Continuing with the shirt example, if the widths of the stripe or patterns change throughout the season as they often do, the retailer has to decide how to track the new shirts in its inventory system. Will they use the same item umbers? If not, will the new item numbers be cross listed with the narrower striped shirts’ item numbers? Another way of thinking about it is, do all of the shirts get marked down at the same percentages off at the same time? If they are to be managed separately, then they need to be created as separate items. Further, was a similar shirt sold last year that the item should be cross-referenced to so that we can compare year-to-year performance? Maybe the prior year it was bought from a different supplier, so it needs to be created as a new item in the system (to reflect the different supplier and costs) but linked to the other item for comparison. It might sound easy to do this for one shirt, but the process has to be done for every item that’s going to the stores. Some retailers may decide the information gained from this type of item-level tracking isn’t worth the costs of doing so, and they simply place stickers with prices on the items. Most of the larger, national retailers use very advanced tracking software so they can reorder products for each store in a way that the stores stay in stock, but not overstocked. Some large-scale retailers have a corporate PO department solely to create and manage items and purchase orders in the retailer’s computer system. The other decision facing the buyer is, will the item be displayed everyday on permanent store fixtures (described in Chapter 13) or will the item be a ‘‘special buy’’—a display item featured on as tack base in the aisle, at the front of the store, or on end caps (displays at the end of aisles)? While both methods require inventory management, adding it to the shelf means another item has to be deleted and marked down to open up room for the new item. Making a shelf-space drawing (normally called a planogram or modular) takes several weeks of measuring product dimensions, uploading them, and adding the UPCs to the shelf-space software (i.e., programs like Prospace or Spaceman). Stores have to reset the shelves (which takes valuable store employee time and wages). To not overwhelm the store employees or customers, most retailers have an annual shelf-space review calendar. When possible, each department is assigned a different week or time of the year to physically reset the shelves in the stores Basic stock items then need to be replenished, which means setting up a forecast usually based on the history of a similar item. Buyers need to be careful in deciding which existing items to use for the new item’s history. For example, say a retailer decided to carry a new line of fashion-print bed sheets. If the retailer used an existing white bed sheet item for the sales pattern, then it might be in trouble toward the end of the year. At many retailers white sheets have a sales bump toward the end of October that fashion sheets wouldn’t have. Why? Because some customers buy the white sheets to use in homemade Halloween costumes. Using the white sheets as a history would result in an overstock of the fashion sheets in early November. Sometimes special buys might also be replenished to avoid sending too much inventory at one time. Replenishment (buying and selling inventory) affects the merchandise budget and, in turn, the retailer’s financial statements. Replenishment can be difficult because so many things can affect it—from weather to transportation problems (like dock strikes or backlogs in port inspections) to manufacturing problems. Manufacturing problems aren’t just related to assembly lines. Competitors are always trying to find ways to gain an edge over the competition, and they increasingly seem to be using the court system to impact competition. Remember, the story from the chapter’s ‘‘Retailing: The Inside Story’’ box described how the actions of a supplier’s competition can affect a retailer’s replenishment of a successful item. Stock planning is an exercise in compromise and conflict. The conflict is multidimensional because not everything can be stocked. Some of the more common conflicts are described below. 1. Maintain a strong in-stock position on genuinely new items while trying to avoid the 90 percent of new products that fail in the introductory stage. The retailer wants to carry the new products that will satisfy customers. If the consumer is sold a poor product; it hurts the retailer as much as, if not more than, the manufacturer. The problem becomes one of screening out poor products before they reach the customer. Any screening device, however, has error; the retailer might end up stocking some losers and turning down winners. Thus, a basic conflict arises, but even the best of buyers will make some mistakes and be forced to use markdowns to unload slow-selling merchandise. 2. Maintain an adequate stock of the basic popular items while having sufficient inventory dollars to capitalize on unforeseen opportunities. Many times, if the retailer fills out the model stock with recommended quantities, there is little if any money left over for the super buy that is just around the corner. But if the retailer holds out that money and cuts back on basic stock, then customers maybe lost and that super buy may never surface. For this reason, it is important that retailers realize that they should never be out of stock on staples and best-selling products. 3. Maintain high inventory-turnover goals while maintaining high gross-margin goals. This is perhaps the most glaring conflict. Usually, items that turn over more rapidly have thinner gross margins. Therefore, developing an inventory plan that will accomplish both objectives is surely challenging. 4. Maintain an adequate selection for customers while not confusing them. If customers are confronted with too many similar items, they will not be able to make up their minds and may leave the store empty-handed and frustrated. On the contrary, if the selection is inadequate, the customer will again leave empty handed. Thus, a delicate balance needs to be struck between too little and too much selection. 5. Maintain space productivity and utilization while not congesting the store. Take advantage of buys that will utilize the available space but avoid buys that cause the merchandise to spill over into the aisles. Unfortunately, some of the best buys come along when space is already occupied. At the end of the selling season, the buyer reviews the entire merchandise performance in what many retailers call a line review. The process takes a few weeks. The where they use the supplier performance card and reports showing how each item supplied by the supplier did over the selling season (as compared to the category average and total). They might try to renegotiate the vendor contract or simply jump right into item negotiations, including which items are going to be discontinued and marked down (and who will fund the markdown19), which items will stay, and which new items might be added to either the planogram or as seasonal displays. Hundreds of reports are run by the buyer. Some buyers will run an 80-20 report, showing which items do most of the business (20 percent of the items often do 80 percent of the business) and which items could be dropped. In dropping items, they need to consider the market basket—a given item may not be a top performer, but maybe it’s the reason that people come to the store. Line reviews involve taking a lot of data and trying to summarize it in a digestible manner. They also involve understanding trends and fashion. Thus, to be successful, buyers need to have both creative and quantitative analysis capabilities. If they don’t, they often are paired with assistants who can complement their strengths. As should be readily evident at this point, inventory management is no easy task. Equally challenging is the selection of vendors from whom to purchase merchandise. After deciding on the type and amount of inventory to be purchased, the next step is to determine where the retailer is to obtain its merchandise. All too often people have misconceptions about how retailers choose and negotiate with vendors. In reality, with proper planning and control, it can be a very rewarding experience, especially when customers react positively to merchandise selection. However, no matter how rewarding a buying experience is, it will also be grueling. Retail buyers must not only determine what merchandise lines to carry but also select the best possible vendor to supply them with these items while simultaneously negotiating the best deal possible with that vendor. Unless the retailer owns a manufacturing or wholesale operation or both, the retailer must consider many criteria when selecting a merchandise source. These criteria depend on the retailer’s type of store and merchandise sold. Generally, the following criteria, which may vary across merchandise lines, should always be considered: selling history, consumers’ perception of the manufacturer’s or wholesaler’s reputation, reliability of delivery, trade terms, projected markup, quality of merchandise, after-sales service (such as helping manage the retailer’s replenishment system or perform annual shelf-space reviews), transportation time, distribution-center processing time, inventory carrying cost, country of origin, fashion ability, and net cost. The retail buyer also has to consider the size of the vendor. Is the vendor large enough to provide product to all of the retailer’s stores? If so, is it big enough to replenish the items so they stay in stock without having too much inventory on hand? Is the vendor big enough to staff any support functions for the retailer? Pepsi and Coke can both send field employees into retail stores to restock and rotate soda products. A unique, local mom-and-pop beverage manufacturer probably couldn’t do that. Further, if the retailer decided to drop the item to pursue a different strategy, is the vendor big enough that dropping the item won’t hurt the vendor? For example, in 2005, nearly 12 percent of General Mills net sales were to Walmart. In 2007, as a result of Walmart’s growth in super centers, this concentration had increased to 20 percent of global sales (or 27 percent of U.S. sales), and no other retailer accounts for even 10 percent or more of the manufacturer’s sales. This situation is similar for Dial Corporation, Unilever, Procter & Gamble, Energizer, Kellogg, Gillette, and Kraft Foods. In fact, for some divisions of these large manufacturers, Walmart now accounts for more than a third of their business. Thus, there is truth to the story that when Walmart sneezes, the manufacturers get pneumonia.’’20 However, since these large vendors supply hundreds of items to Walmart and other retailers, if one item is discontinued by a large retailer, these manufacturers are not going to suffer major damage. However, if a larger-scale retailer started doing business with a small, entrepreneurial manufacturer who had a single blockbuster product, what would happen if the retailer needed to discontinue it? Would the vendor go out of business? Would the retailer be accused by the manufacturer, the media, or customers of putting the vendor out of business? Such an occurrence is covered in the chapter’s ‘‘Global Retailing’’ box. Country of origin is also becoming a more important issue every day as governments use trade agreements to limit the amount of merchandise that can be imported from various countries. In addition, consumers are becoming aware of sweatshops and the use of child labor in certain countries, and they are rebelling against the buying of products manufactured in these areas. While laws regulating country of origin have long applied to apparel, one of the many initiatives found in the Farm Security and Rural Investment Act requires country-of-origin labeling for beef, lamb, pork, fish, perishable agricultural commodities, and peanuts. This is increasingly important for buyers to consider given there were recently several situations in which dozens of manufacturers in China used melamine, a plastic derivative, in baby formula, chocolate, and pet food to make the products look like they had more protein in them. Many toys were also recalled over the last few years because several China-based manufacturers used lead paint beyond that permitted by law. (The lead-based paint is shinier and requires less primer.) The public outrage over the children and pets that became sick or died has resulted in a renewed and stronger call for labeling where products are made and testing what is in them. Although consumers say they want to know where their food comes from and what is in it, most are unaware of the costs associated with tracking and testing these products, the amount of record keeping needed, and loss of sales resulting from the higher prices. The Grocery Manufacturers of America claim such laws are unworkable and will do little to maintain the safety and purity of the U.S. food supply. Is the cost worth it? Are you willing to pay the extra nickel or dime on every product to know where your food, clothing, and purchases of electronics were made? And how do such laws apply to retailers in the resale markets? For example, the U.S. federal government recently passed a law that took effect in February 2009 in which all products for children younger than 12 (regardless of when they were made) have to be tested for lead and certain other chemicals.21 This means thrift stores, consignment shops, and online auctions and resellers (like eBay or Amazon) are going to encounter a lot of difficulty or need to shut down a big part of their business. However, some local manufacturers have used the situation to help their locally produced products. For example, they’ll have ‘‘Made in the USA’’ stickers on them when selling in the United States. Even something as seemingly minor as the number of units in a pack can also be a significant factor in choosing a vendor. Walmart, for example, once asked a vendor to ship some school supplies in packs of 10 instead of 80. Working with vendors in this way allowed there tail chain to increase inventories by only 4 percent while increasing sales by more than 12 percent. The $1.4 billion saved by such vendor negotiations was made available for other uses.22 In 2006, Walmart went a step further and changed the way store employees ordered merchandise. It pruned the assortment of merchandise available in stores to emphasize the items that sell best in each category. Thus, many consumers were surprised that some of their favorite products were no longer carried in the new streamlined Walmart. The retailer’s reasoning was that focused, ‘‘uncluttered’’ stores will produce more sales than those laden with merchandise. The resulting drop in inventory costs bolstered the retailer’s margins. Walmart’s decision has had a ripple effect across the industry. Taking the assortment reduction a step further, several retailers are rediscovering smaller stores.23 For example, Tesco has recently started putting in very small ‘‘Fresh & Easy’’ stores in the United States. Interestingly, Walmart, in response, is trying to compete with Tesco through its new Market side stores (about 15,000 square feet), which are half the size of the existing, small Neighborhood Market stores. These smaller stores have considerably less selling space than a 208,000-square-foot Supercenter store. (In addition, these stores don’t have any reference to Walmart in them as the giant retailer tries to position these units as a friendly neighborhood grocer.) With a lot less space, these retailers have to decide which few items from their long list of available items they will sell. Like everything else, tailoring merchandise assortments to each individual store involves a trade-off that the retailer must consider. By creating a ‘‘store of the community,’’ the retailer may successfully meet most local needs, but this tailoring of merchandise may increase the frustrations of tourists or other ‘‘out shoppers.’’ For example, when customers visit a McDonald’s, Kohl’s, or Targets tore in any part of the country, often they expect to have the same products across the chain. Further, at some point, the scale advantage (of buying for hundreds or thousands of stores) could disappear as each store assortment is customized. Part of the lower costs that large-scale retailers enjoy is due to their large purchases of each item. Likewise, in cases where a manufacturer offers to co-op some expenses—for example, advertising or display support—the amount of price reduction has been shown to have a significant effect on the purchase decision.24 Some retailers also check to see whether the same merchandise will be made available to a nearby competitor; in such cases, it may be advantageous for the retailer to use a private label. Another advantage to the private label is that some manufacturers will not sell a product to certain retailers. For example, some discounters which try to offer lower prices by carrying only the ‘‘hottest’’ toys, claim that some vendors will not sell them the hot toys for fear of losing business to smaller chains and independents that sell toys year-round and not just at Christmas. Recent research concludes that the use of private-label brands (1) increases as the perceived consequences of making a buying mistake decrease, (2) increases when the different brands in the category are perceived to have a wide variance in quality, and (3) decreases if the category benefits are deemed to require actual trial and experience rather than being accessible through a search of package label information.25 One of a retailer’s greatest assets when dealing with a vendor is the retailer’s past experiences with that vendor. Whether you are a small retailer doing all the buying yourself or a new buyer for a large chain, you should always approach vendors with two important pieces of information: the vendor-profitability analysis statement and the confidential vendor analysis. The vendor-profitability analysis statement (see Exhibit 9.5) provides a record of all the purchases you made last year, the discount granted you by the vendor, transportation charges paid, the original markup, markdowns, and the season-ending gross margin on that vendor’s merchandise. The confidential vendor analysis (see Exhibit 9.6) lists the same information as the profitability analysis statement but also provides a three-year financial summary as well as the names, titles, and negotiating points of the entire vendor’s sales staff. This last piece of information is based on notes taken by the buyer during and after buying trips in previous seasons. Based on the information obtained in the previous two reports, some retailers classify vendors into different categories (called class A, B, C, D, or E vendors) using both performance and brand-positioning information and the retailer’s opinion on the vendor’s other attributes. Regarding performance and positioning, if the supplier can produce very profitable items but doesn’t have a brand the retailer needs, then the supplier could make private-label products for the retailer. If the supplier has an important brand but not the best prices, then it can still fill an important niche. When the supplier doesn’t carry a needed national product and it doesn’t have the best prices, the supplier is not very valuable unless it can provide information, trends, or something else that the retailer needs. Currently, there is a big focus in many retailers on after-purchase service. In thinking about the service relationship, retail buyers usually think about both the vendor company and the vendor representatives. Retailers often have a certain level of trust toward the selling organization (S trust) and a separate level of trust toward the supplier’s sales representative (SR trust). Retailers depend on the supplier to make and ship products. They depend on representatives to keep their promises, inform the retailers about the latest sales trends and what they see going on in competitors’ stores (when walking through the stores, not divulging trade secrets), and occasionally help them manage the inventory and sales numbers. Sometimes a retail buyer might trust a supplier but not the supplier’s current representative (or vice versa). While working with several retailers, one of the authors has noted that in situations of high-supplier, low-representative trust, the retail buyer works with the supplier in using retail production-ordering systems (like Walmart’s CPFR—see Chapter 4) to produce inventory just in time for the retailer. In some circumstances, retailers might let very trusted suppliers write themselves purchase orders in co-managed systems without ever needing a signature from the retailer. In situations of lower-supplier, high-representative trust, a retail buyer seeks the sales rep’s input, but either doesn’t trust the supplier to co-manage the retailer’s inventory systems, or believes the supplier has a different business philosophy from the retailer (such as ‘‘we win, you lose’’). In situations of high-supplier, high-representative trust, a retailer’s buyers and manufacturer’s sales reps may sit down and discuss how to create a new product related to an upcoming movie’s release or special event, including what the shape of the product should look like, the wording (if any) on the product, the packaging, the advertising, and so on. However, when the retailer doesn’t trust either the supplier or the supplier’s representative, it is likely to engage in a ‘‘transaction’’ relationship. Here the retailer works with the supplier only because it is either unable to get a needed product from any other source or the supplier simply provides a price advantage that cannot be ignored. Even buyers who choose not go to market and instead have their vendors come to them, evaluate their vendors. For years, many grocers felt that firms like Procter & Gamble treated retailers poorly. These grocers needed the many products that P&G manufactured, but they did not appreciate P&G’s ‘‘We win, you lose’’ attitude, which forced retailers to purchase the complete line of P&G products in order to earn merchandising money. Over the last half-decade, however, P&G has developed a program in which it helps all its customers formalize their merchandising plans for the coming months and no longer requires grocers to purchase slow-moving products. This new attitude of ‘‘ Let’s both win’’ has seen many supermarket managers reclassify P&G as more of a collaboration relationship. With some retailers, P&G is even working together to design new products and advertising copy, building a co-creation relationship. P&G has obviously determined that it can only be as successful as its retailers let it be. Philips Electronics and many of its retailers are beginning to do similar activities.26 After selecting the vendors, the retailer still must make decisions on the specific merchandise to be bought. Some products, such as the basic items for a particular department, are easy to purchase; others, especially new items, require more careful planning and consideration. Retailers should concern themselves with several key questions prior to selecting a product for purchase:

1. Where does this product fit into the strategic position that I have staked out for my department?

2. Will I have an exclusive with this product, or will I be in competition with nearby retailers?

3. What is the estimated demand for this product in my target market?

4. What is my anticipated gross margin for this product?

5. Will I be able to obtain reliable, speedy stock replacement?

6. Can this product stand on its own or is it merely a ‘‘me-too’’ item?

7. What is my expected turnover rate with this product?

8. Does this product complement the rest of my inventory?

The climax of a successful buying plan is active negotiation, which involves finding mutually satisfying solutions for parties with conflicting objectives. The effectiveness of this buyer–vendor relationship depends on the negotiation skills of both parties and the economic power of the firms involved. The retail buyer must negotiate price, delivery dates, discounts, shipping terms, and return privileges. All of these factors are significant because they affect both firms’ profitability and cash flow. In recent years, both manufacturers and retailers have become increasingly aware of the cost of carrying excess inventory. Likewise, both parties have become more concerned with the time value of money and the resulting effect on each firm’s cash flow. Since both parties involved in the negotiation process are aware of these costs and are trying to shift them to the other party, most negotiations produce some conflict. However, a successful negotiation is usually accomplished when both parties realize that the other should serve as its partner during the upcoming merchandising season. Both the buyer and the vendor are seeking to satisfy the retailer’s customers better than the competition. Therefore, buyers and vendors must resolve their conflicts and differences of opinion, remembering that negotiation is a two-way street and that a long-term profitable relationship is the goal. After all, the vendor wants to develop a long-term relationship with the retailer as much as the retailer does with its customers. What can be negotiated? There are many aspects to the terms of a sale (prices, freight, delivery dates, method of shipment and shipping costs, exclusivity, guaranteed sales, markdown money, promotional allowances, return privileges, and discounts), and life is simplest when there are no surprises. Therefore, the smart buyer leaves nothing to chance and discusses everything with the vendor prior to signing the purchase orders. The buyer and seller must together work out future plans using the buyer’s merchandise budget and planned turnover. Therefore, the buyer and seller should seek to make negotiations a win–win situation or collaboration in which neither side feels like a loser. The essence of negotiation is to trade what is cheap to you but valuable to the other party for what is valuable to you but cheap to the other party. The smart buyer puts all the upcoming areas of negotiations and previous agreements in letter form and distributes it before going to market. This helps to eliminate any misunderstandings afterward. Price, of course, is probably the first factor to be negotiated, but it is always smart to begin negotiating on factors where agreement can be reached the most easily. Negotiations that tend to focus too much on the ‘‘difficult’’ terms early tend to become more problem a tic and leave each party feeling as though it’s in a battle rather than a partnership. Consequently, the new buyer would be smart to remember the old adage ‘‘First you get along, then you go along’’ when entering into negotiations. As price is often a hot topic on many buyer’s minds, they should attempt to purchase the desired merchandise at the lowest possible net cost, yet not expect unreasonable discounts or price concessions. Buyers must be familiar with the prices and discounts allowed by each vendor. This is why past records are so important. However, the buyer must remember that his or her bargaining power is a result of his or her planned purchases from the vendor. As a result, a large retailer may be able to purchase goods from a vendor at lower prices than a small mom-and-pop retailer. Five different types of discounts can be negotiated: trade, quantity, promotional, seasonal, and cash. A trade discount, sometimes referred to as a functional discount, is a form of compensation that the buyer may receive for performing certain wholesaling or retailing services for the manufacturer. Because this discount is given for the performance of some service, the size of the discount will vary with the type of service performed. Thus, variations in trade discounts are legally justifiable on the basis of the different costs associated with doing business with various buyers. Trade discounts are often expressed in a chain, or series, such as‘‘listless40-20- 10.’’ Each figure in the chain of discounts represents a percentage reduction from the list price of an item. Assume that the list price of an item is $1,000 and that the chain of discounts is 40-20-10. The buyer who receives all these discounts would actually pay $432 for this item. The computations would look like this:

List price $1,000

Less 40% -400

600

Less 20% -120

480

Less 10% -48

Purchase price $ 432

To see how the various chains of discount permit a vendor to compensate the members of the supply chain for their marketing activities, let’s look at the preceding example. Assume that the manufacturer sells through a supply chain that includes manufacturer’s agents, service wholesalers, and small retailers. The purchase price of $432 is accorded to the manufacturer’s agent, who negotiates a sale between the manufacturer and the service wholesaler. The manufacturers’ agent then charges the service wholesaler $480 for the item, thus realizing $48 for rendering a number of marketing activities. The service wholesaler, in turn, charges retailer $600 for the item, thus making $120. The retailer then sells the item at the suggested list price of $1,000, thus making $400 in gross margin to cover expenses and make profit Trade discounts are legal where they correctly reflect the costs of the intermediaries’ services. Sometimes, large retailers want to buy directly from the manufacturer and pay only $432 instead of $600. This action would enable the large retailer to undercut the competition and is illegal, unless one of the three defenses of the Robinson-Patman Act explained in Chapter 6 can be applied. A quantity discount is a price reduction offered as an inducement to purchase large quantities of merchandise. Three types of quantity discounts are available:

1. A noncumulative-quantity discount is a discount based on a single purchase.

2. A cumulative-quantity discount is based on total amount purchased over a period of time.

3. Free merchandise is a discount whereby merchandise is offered in lieu of price concessions. Noncumulative-quantity discounts can be legally justified by the manufacturer if costs are reduced because of the quantity involved or if the manufacturer is meeting a competitor’s price in good faith. Cumulative discounts are more difficult to justify since many small orders may be involved, thereby reducing the manufacturer’s savings. For an example of how a quantity discount works, consider the following schedule:

Order Quantity Discount from List Price (%)

1 to 999 0

1,000 to 9,999 5

10,000 to 24,999 8

25,000 to 49,999 10

If a retailer that had already purchased 500 units wanted another 800 units, it would have to pay list price if the vendor uses a noncumulative policy. However, the retailer would receive a 5-percent discount on all purchases if the vendor uses a cumulative pricing policy. Quantity discounts might not always be in the seller’s best interest and should always be viewed by the buyer as an invitation for further negotiations. Consider the following price schedule published by a computer manufacturer:

Quantity Unit Price ($)

1--19 795

20--49 749

50--149 699

150--249 659

Let’s say that you, a buyer for a retail chain, want 19 of these computers, and your cost is $15,105 (19 Â $795). But 20 would cost only $14,980 (20 Â $749). What do you do? You actually have four choices:

1. Tell the manufacturer to ship 20 computers for $14,980 and you keep the extra one.

2. Tell the manufacturer to ship you 19 computers at $14,980 and have it keep the other one.

3. Order 20 but tell the manufacturer to ship you only 19 and to credit you for the other computer at $749.

4. Negotiate a purchase price.

Whenever quantity discounts are offered, buyers should always check to see if the total purchase price may be lower if they order more. Many times, retailers can make a quick profit from utilizing quantity discounts by selling the extra merchandise to a diverter to sell in a gray market. The diverter, who is not an authorized member of the marketing supply chain but still functions as an intermediary, will be able to purchase these goods cheaper from the retailer than it can from the manufacturer and will then sell this excess merchandise to other retailers. Also, such discounts allow the manufacturer to have its products sold in discount stores without offending all of its authorized retailers. However, many authorized retailers are upset when diverters provide discounters with such merchandise. Some department stores have dropped cosmetic lines when discounters, most of whose cosmetics are diverted, started to carry the lines. Costco acknowledges that it will try to buy directly from manufacturers, but in instances where the manufacturers refuse, Costco will make a legal purchase through a third party. Little wonder that Costco has a vice president of ‘‘diverting’’ who purchases more than $200 million worth of merchandise from unauthorized vendors.28 Consider the previous retailer who needed only 19 computers and purchased 20. Here the retailer sold the extra computer to a diverter for $600. As a result, the retailer was better off by $725 (the $125 difference in price between ordering 20 versus 19 units plus the $600 from the diverter) than it would have been had it bought only 19 computers at $795 each. The diverter could now profit by selling the computer to another retailer for something more than $600. Today, diverters are important members of the retailer’s supply chain, especially in the grocery and computer fields. However, despite the problems discussed in Chapter 5 that some manufacturers have with diverters, not all manufacturers or retailers feel the same way about them. In fact, some manufacturers develop their pricing policies to enable diverters to function economically. By doing this, they can increase sales by reaching markets they can’t enter under normal operating conditions. A third type of discount is a promotional discount, which is given when the retailer performs an advertising or promotional service for the manufacturer. For example, a vendor might offer a retailer 50 extra jeans if (1) the retailer purchases 1,250 jeans during the season and (2) runs two newspaper advertisements featuring the jeans during the season. One of the main reasons manufacturers offer such discounts is that the rates newspapers charge local retailers are often lower than the rates charged to national manufacturers. These discounts are legal as long as they are available to all competing retailers on an equal basis. Retailers can earn a seasonal discount if they purchase and take delivery of the merchandise in the off-season (e.g., buying swimwear in October). However, this does not mean that all seasonal discounts result in the purchase of merchandise out of season. Retailers in resort areas often take advantage of these discounts since swimwear is never out of season for them. As long as the same terms are available to all competing retailers, seasonal discounts are legal. The final discount available to the buyer is a cash discount for prompt payment of bills. Cash discounts are usually stated as 2/10, net30, which means that a 2-percent discount is given if payment is received within 10 days of the invoice date and the net amount is due within 30 days. Although the cash discount is a common method for encouraging early payment, it can also be used as a negotiating tool by delaying the payment due date. This future-dating negotiation may take many forms. The following are several of the most common:

1. End-of-month (EOM) dating allows for a cash discount and the full payment period to begin on the first day of the following month instead of on the invoice date. End-of-month invoices dated after the 25th of the month are considered to be dated on the first of the following month.

2. Middle-of-month (MOM) dating is similar to EOM except the middle of the month is used as the starting date.

3. Receipt of goods (ROG) dating allows the starting date to be the date goods are received by the retailer.

4. Extra (EX) dating merely allows the retailer extra or free days before the period of payment begins.

5. A final discount form to be considered, but which is not widely used today, is anticipation. Anticipation allows a retailer to pay the invoice in advance of the expiration of the cash discount period and earn an extra discount. However, anticipation is usually figured at an annual rate of 7.0 percent, which is near the current cost of money.

Many vendors have eliminated the cash discount because retailers, especially department stores, have been taking 60 to 120 days to pay and still deduct the cash discount. In fact, many vendors require new accounts to pay up front until credit is established Delivery terms are another factor to be considered in negotiations. They are important because they specify where title to the merchandise passes to the retailer, whether the vendor or buyer will pay the freight charges, and who is obligated to file damage claims. Retailers will often be quoted a different cost or price from a vendor if the free on board (FOB) is the vendor’s factory versus the retailer’s factory versus the retailer’s stores. Both the location of title transfer and who pays transportation can be negotiated together or separately. The three most common shipping terms are

1. Free on board factory. The buyer assumes title at the factory and pays all transportation costs from the vendor’s factory.

2. Free on board shipping point. The vendor pays the transportation to a local shipping point, but the buyer assumes title at this point and pays all further transportation costs.

3. Free on board destination. The vendor pays all transportation costs, and the buyer takes title on delivery.

For consignment (pay-from-scan) merchandise, the FOB is at the retailer’s cash register. Consignment is not usually discussed as an FOB point because there is no specified time of transfer (it could be purchased by a customer one day after arriving in the store or several months after sitting on the self). The other FOB points usually have explicit dates or windows of time printed on each purchase order. While delivery terms (including consignment) may not appear to be a big deal at times, the author saw 10-percent to20-percent differences on vendors’ price quotes to a major mass merchandise retailer across products in home furnishing, apparel, and household products. Most retailers don’t take advantage of price differences in logistics because the buyers normally don’t get rewarded for it on their annual performance evaluation (e.g., a buyer would be better off with a vendor warehouse FOB that has a higher gross margin but lower net margin than selecting a store FOB with a lower gross margin but a higher net margin). While not a discount, packaging is becoming a hot negotiation point, especially with many retailers asking for more PDQs (cardboard display boxes that often have to be painted by manufacturers to match store marketing guides) and for more sustainable (i.e., environmentally friendly) packaging materials. Whether the product is shrink wrapped or in a clam shell, a blister pack, or a solid paperboard box, each packaging display method changes the cost and is usually negotiated as part of the price. The retailer must have some means of handling incoming merchandise. For some types of retailers (e.g., a grocery store), this need will be significant and frequent; for others (e.g., a jeweler), it will be relatively minor and infrequent. Frequent and large deliveries entail considerable planning of merchandise receiving and handling space. For instance, consider that a full-line grocery store must have receiving docks to which 40- to 60-foot semi-trailer scan be backed up. Similarly, space maybe needed for a small forklift to drive between the truck and the merchandise receiving area to unload the merchandise. Subsequently, the merchandise will need to be moved from the receiving area, where it will be counted and marked, to a storage area, either on the selling floor or in a separate location. The point at which incoming merchandise is received can be a high-theft location. The retail manager needs to design the receiving and handling area to minimize this problem. Some thefts involve the retail employees themselves; others involve outsiders. In 2007, the National Retail Security Survey found that the average shrinkage rate for the nation’s largest retailers was 1.4 percent of their annual sales; the lowest percent in the 17-year history of the survey. This translates into an industry-wide net loss of $34.3 billion.29 The survey claims that the decrease in shrinkage is due to retailer investment in deterrence technology. (Shrinkage, which is calculated ‘‘at retail,’’ is the loss of merchandise due to theft, loss, damage, or bookkeeping errors.) One growing problem area appears to be in organized crime. In response, many retailers have formed their own special organized-crime-prevention units. Therefore, several types of shrinkage caused by theft will be mentioned in the following discussion. Most discussions of shrinkage attribute theft to one of three culprits—vendors, employees, and customers. Vendor collusion includes the types of losses that occur when merchandise is delivered. Typical losses involve the delivery of less merchandise than is charged for, removal of good merchandise disguised as old or stale merchandise, and the theft of other merchandise from the stockroom or off the selling floor while making delivery. This type of loss often involves both the delivery person and the retail employee who signs for delivery and the two splitting the profit from the collusive activity. Employee theft occurs when employees steal merchandise where they work. Although no one knows for sure how much is stolen annually from retailers (since all shrinkage statistics are based only on apprehensions), as many as 30 percent of American workers admit to stealing from their employers, even if they take only small items like a pen or pencil. Although some of the stolen goods come from the selling floor, a larger percentage is taken from the stockroom to the employee lounge and lockers, where it is kept until the employees leave with it at quitting time. Employee theft, which amounts to more than $800 per apprehension, is most prevalent in food stores, department stores, and discount stores. Considering that these types of stores are usually larger in size, sales volume, and number of employees, the lack of close supervision probably contributes to this problem. Exhibit 9.7 shows 50 ways that an employee can steal from a bar. Customer theft is also a problem. In fact, more than a dozen shoppers are caught for every case of employee theft, although the average amount of merchandise recovered is less than $50. Stealing merchandise from the stockroom and receiving area may be easier than taking it from the selling floor for several reasons. First, much of the stockroom merchandise is not ticketed, so it is easier to get it through electronic anti-shoplifting devices. Second, once the thief enters the stock area, there is very little antitheft security. Most security guards watch the exits and fitting rooms (and even grandmothers’ stuffing clothing into a stroller do get caught—as witnessed by one of the authors). Third, there is usually an exit in the immediate area of the stockroom through which the thief can carry out the stolen goods. Some retailers have wired these exits to set off an alarm when opened without a key, helping to reduce thefts somewhat. Another innovative retailer, after determining that employees were hiding merchandise in the compressed and discarded boxes that were left out as trash, started using a special spiked baler that punched holes in boxes to damage any stolen merchandise. The retailer must be aware that there are numerous opportunities for receiving, handling, and storage thefts. Therefore, steps should be taken to reduce these crimes. The retailer cannot watch the employees every minute to see whether or not they are honest, but some surveillance is helpful. However, the retailer must consider the employees’ and customers’ rights to privacy versus the retailer’s right to security. Legislation is currently being considered by several states that would, if approved, allow the use of electronic monitoring by video and audio systems only when advance notice is given. In effect, workers and shoppers must be informed when they are being monitored. They also have to decide which theft is worth prosecuting. Walmart just revised its rules to allow prosecution of 16-year-olds (it was18 or older before) and call police regardless of the child’s age or theft amount if the store cannot reach the child’s parent within 30 minutes or the parent doesn’t show within 60 minutes after contact.30 For example, a man in Florida was charged with shoplifting (valued at $2) and trespassing when an off-duty sheriff’s deputy confronted him over 10 raspberry jellybeans he had sampled in the candy area.31 The man said he just wanted to try them to see if he wanted to buy them. This customer had been shopping at the grocery for 30 years, and assuming he has another 20 or so years of shopping, the store probably lost his customer lifetime value over the $2 shoplifting and trespassing charge. Further, it probably got a lot of other people mad who read about it in the local papers. Retailers obviously have a right and a need to protect their investments. Sometimes, though, they need to think about the reasonableness of it—and the total impact on future sales. The amount of storage space the retailer needs is related to the physical dimensions of the merchandise and the safety stock level needed to maintain the desired rate of stock turnover. For example, furniture is bulky and requires considerable storage space; grocery items turn over frequently, so more merchandise is usually needed than can be displayed on the shelves. This excess inventory causes retailers to stack boxes and cartons on the floor of the stockroom. In most cases, however, this scenario is inefficient and costly given that the retailer is probably paying employees anywhere from $5 to $15 per hour to keep the store-room in order. Thus, in most cases, some type of mechanized equipment will be used to increase productivity. For instance, rather than simply hand carry incoming merchandise, employees might use one of the numerous types of carts made for this purpose. Also, instead of stacking the cartons and boxes directly on the floor of the stockroom where they must remain packed and risk being damaged, the merchandise can be unpacked, checked, inventoried, ticketed, and then placed on shelves or in bins until needed. By doing this, one can increase the amount of merchandises to red per square foot by decreasing the amount of packing material. A tidy, well-ordered stock area is less tempting to dishonest employees. Although much theft results from in-store merchandise handling, retailers must also be aware of how theft in transit may influence their ability to have the appropriate amount of merchandise on hand. Therefore, retailers must not only plan to have the appropriate amount of merchandise on hand for customers but also ensure that the merchandise purchased for the store shelves actually arrives. Whether a retailer outsources its logistics or employs its own transportation force, ensuring that the merchandise makes it from the warehouse to the retail floor is critical for success. So what can happen to merchandise in transit? Hijacking. A significant amount of shipment hijacking does occur in the United States, but the global playing field can be truly fraught with peril. Consider, for instance, the case of a truck carrying a load of consumer electronics bound for Paraguay. Deep in the heart of the Brazilian jungle, the driver sees that the road ahead is blocked. As he comes to a stop, the driver realizes that his truck is about to be hijacked. Luckily, he has brought an off-duty Brazilian police officer with him to help protect the shipment. The police officer exits the cab of the truck, and the driver immediately senses the feeling of familiarity between his security officer and one of the bandits. It seems that the band it is also a police officer. After a brief discussion, the truck is allowed to move on with its shipment. This may sound like fiction but it is a true story. And even though the shipment was consumer electronics, other high-value products such as apparel, perfume, cigarettes, and alcohol are also subject to hijacking. Whether on land, sea, or air, hijacking is a relatively common occurrence in the retail supply chain. The probability of theft in transit varies considerably from region to region. Although relatively few shipments are hijacked in Canada, the United States, and Western Europe, regions such as Eastern Europe, Latin America, Russia, and Southeast Asia are the most dangerous. Deteriorating economic conditions in these region shave increased organized-crime activity, resulting in increased theft of cargo. For many people in these regions, hijacking one shipment of consumer electronics can generate more cash than the average person in the area makes in a lifetime. Although statistics related to the theft of cargo is difficult to obtain because few companies want to publicize their security problems, losses due to hijacking and the resulting disruption to retail operations are a major concern. However, losses due to hijacking are avoidable to a degree. Here are some tips that retailers and their supply-chain partners can employ to minimize the threat of hijacking.

1. Eliminate the retailer’s name from the side of containers carrying the cargo. For a consumer electronics company such as Best Buy, putting its name on the truck signals to all that a shipment of consumer electronics is inside. It’s tantamount to saying, ‘‘Steal me.’’

2. Install electronic monitoring devices on all shipment vehicles. Whether shipping via land, sea, or air, being able to track the container in which the merchandise is shipped can help determine its location when hijacked.

3. Carefully screen all internal transportation personnel as well as third-party logistics personnel in each global market. Given the nature of their jobs, these personnel are under loose supervision, and higher security standards are therefore critical.

4. Hire security personnel for each shipment. It is much easier for a single person to collude with others than for multiple people to conspire.

As retailers continue to expand globally, the risks involved in international hijacking will continue to grow. As mentioned earlier, RFID also poses a problem here because anyone with an RFID scanner could sit on the side of a road or go through a shipping dock and immediately know exactly what is inside any truck or container. However, by implementing a few security measures, retailers can minimize disruption to their supply of merchandise, thus increasing the level of satisfaction to customers by minimizing out of stocks.

WRITING AND SPEAKING EXERCISE

As the newly hired intern in the shoe department for a mid-sized apparel chain operating in six Northeastern states, you have been invited to attend your first buyer’s meeting. Teresa, the new junior and misses buyer stood up during a weekly merchandise meeting at the retailer’s corporate office to show off the newest trend in fashion junior clothing: sweatpants and shorts with words like ‘‘hottie,’’ ‘‘angel,’’ and ‘‘devil’’ printed in bold letters across the seat of the pants. At the time, a few other retail chains were just beginning to sell similar pants and shorts with writing across the seat of the pants. She showed the crowd of other retail buyers and operational heads several examples of the product. She highlighted the high margin and strong chance of market success. When she asked if there were any questions, another buyer raised his hand. He asked, ‘‘I wonder if we should be selling this to teenage girls? Do we have a moral responsibility to not sell a product like this that could increase promiscuity or simply decrease girls’ self-worth or self-esteem?’’ An executive vice president of merchandise then stood up and responded, ‘‘Retailers don’t have a moral responsibility. That’s the media’s role. We just sell the product.’’ Just then your boss asked you, ‘What do you think Theresa should do?’’ Explain your reasoning