Wednesday, December 9, 2009

Part 3 of 3: Effectively Overcoming Empty Shelves in the Indian Marketplace

The asset value of stores is set to surpass inventory as the biggest investment on the balance sheets for most Indian retailers, given the improving supply chain efficiencies. Optimal utilization of this investment implies minimizing empty shelves. Strategies for doing this in India are more fundamental than in a developed market.

Empty Shelves

Supply chain text books have traditionally pointed out that inventory is the biggest asset of a retailer. Well, that has changed, at least in the developed markets. The assets at stores (real-estate plus furnishings) have become the biggest investment, as a result of more efficient supply chains in developed markets. With organized retail still developing in India, many retailers have not optimized supply chain efficiencies. Once the efficiencies are achieved, CFOs will realize that stores and store space is the biggest investment on their balance sheets.

Some retailers, such as a certain leading department store chain in India, already have store assets as the biggest investment on their balance sheet. An extract from their 2007-2008 annual report is presented below:

(All amounts in Rs. Millions)
Assets at Stores
Leasehold improvements
Air conditioning and other equipment
Furniture, fixtures and other fittings
Computers (apportioned to stores)

For mature and near-mature retailers, the strategic focus should be on improving the ROI on this biggest asset – assets at store. Empty shelves imply an under-utilization of this asset and therefore affect its ROI adversely. Empty shelves also negatively affect a shopper’s store experience.

At the corporate level too, empty shelves lead to higher items costs (COGS) and therefore reduced net margin (the bottom-line). This impact will likely become more prominent as real-estate and associated costs continue to increase. This relationship is shown in the diagram below.

Empty shelves could also represent a process issue - that merchants under-estimated consumer preference for specific items, that store personnel had sufficient inventory in the back-room but have not replenished the shelf, that supply chain managers couldn’t effect proper service levels at store or that the visual merchandisers have under-allotted shelf space in the planogram. Empty-shelf situations also skew the historical data used for forecasting, which results in reduced forecast accuracy for later seasons.

The solution:

To solve this problem, retailers can obviously over-stock items. However, that would increase the working capital costs to an unprofitable level. The solution lies in first understanding consumer preferences and then planning to effectively supply the right amount of inventory to each store. We have devised a roadmap for the typical issues at an Indian retailer. This roadmap needs to be altered to meet the specific requirements of any situation. The solution for empty shelves is provided in steps two through four of that roadmap (see diagram below). These steps fall within the demand flow.

Retail Value Chain

The demand flow starts from customer touch-points and ends in customer orders with the resulting orders being placed on the higher echelons of the supply chain. However, the steps that are pointed out (two through four) are improvements that might suit most retailers in the Indian marketplace. Our recommendations are to first identify the customer decision tree, a tool to visualize how customer needs link to specific items. This tool is drawn out as a tree with the trunk starting from the customer’s high-level needs like hunger, entertainment, exercise, etc. It then extends through the branches of categories and sub-categories and ends in the leaf nodes of items. Since every retailer’s typical customer profile is different, this tree would differ for every retailer. It is important to understand the customers shopping at your various geo-demographic store clusters before drawing this. The result of this exercise is a deeper understanding of customer-visit scenarios, customer needs and consumer preferences. This understanding should then be used to redefine merchandise hierarchies. Redefining the merchandise hierarchy is a big change, but based on deep analysis of the customer decision tree, retailers would certainly benefit from the intuitive floor layouts, clearer category roles and effective promotions.

To make sure these objectives are met, it is important to execute these strategies properly at the store level. With store personnel in India having one of the highest attrition rates in any industry, this presents challenges in training costs and compliance for retailers. Simple technologies to capture random questionnaires could be used to encourage compliance and quickly identify training issues and opportunities.

Sunday, November 29, 2009

Part 2 of 3: Managing in an environment of rampant vendor short fills

Indian organized retail is still developing and currently does not contribute to significant revenue shares of consumer goods companies. The result of this is vendor shortfalls. While most of the optimization software builds its logic on firm vendor commitments, in India such commitments are seldom firm. This poses issues to most supply chain optimization software. The key to utilizing optimization software in such environment lies in using sourcing strategies for reducing shortfills and in using correctional algorithms on top of the optimization software.

Indian retail industry contributes to almost 1/3rd of the country’s GDP. However, this industry is dominated by single-store businesses. Some such businesses occupy as little space as 10 sq. ft (your local PAN DABBA!). These businesses are widely spread and usually serviced by wholesale distributors. The wholesale distributors in turn purchase in bulk from branded consumer goods companies. This arrangements essentially dilutes the power of the ‘last mile’ (‘last mile’ is a term more often used in the telecom industry. It basically means the closest value chain to the consumer). The power of the ‘last mile’ lies in consolidating the bargaining power; the dispersed single-store businesses don’t efficiently consolidate this. However, in recent decades, the emergence of organized multi-store businesses is challenging this status-quo. These organized retailers (multi-store businesses) hold the absolute power of the last mile in most developed retail markets like US and Europe. This power translates into heavier pressure on costs, driving down the overall prices to the consumer, and into higher service levels, driving up availability of products for the consumer. This is not happening in India, as yet, mainly because organized retail is not a large part of the Indian retail industry. We still have a seller’s market of sorts. Brands are the main driver of sales. All this creates an environment where short filling on a retailer’s order becomes ‘chalta hai’ (‘short filling’ means providing lesser than the quantity request on an order).

Plausible revenue shares
The key reason for this short-filling phenomenon appears to be the relative low contribution to revenue (revenue share) from any single organized retailer to the revenues of a top-brand consumer goods company (see diagram above). However, there are contract manufacturers who enjoy economies of scale (given today’s more efficient production technology). Some retailer’s source private brands (goods which are branded by retailer) from such contract manufacturers. There are chances that a retailer could, in the best case scenario, end up with a significant revenue share of the contract manufacturer. This significant share ensures service discipline (viz. lesser short-fills). However, the path to resolving short-fills is not just hiring a contract manufacturer. It is a path that is part of a roadmap introduced in the 1st article of this series (see diagram below).

Retail Value Chain and Roadmap

The path to lower vendor short-fills is given in steps five thru seven above. It starts from building a base on contract manufacturers. This base would not give immediate benefits but as the relation matures over time and as consumers become familiar with the quality overtime, the retailer might have enough volumes to launch private brands across various products lines and across larger store space. Assuring greater service discipline.
Some retailers in India, even today, handle most of their logistics through a manual or an automated system. Optimization technologies, if configured suitably, can help recommend more optimal solutions than a human can ever produce. These technologies don’t necessarily replace humans. They simply let human’s do more high-end tasks. These technologies, apart from enhancing the process maturity, help build a base infrastructure for the next step in the roadmap.

The next step in the roadmap is an unconventional step. It is about managing vendor short falls by using forecasting software to predict short-fills and late-deliveries. These predications could be later used to alter purchase orders. Though humans can do this too, systems can calculate to a precise level not just across key items but across all sub-items considering the various factors that might affect the consumer goods company – high-sales season, patterns in scheduled and unscheduled maintenance, new product introductions, etc. This step will help handle short-fills from the top-brand services companies too.

Tuesday, November 24, 2009

Part 1 of 3: Roadmap to improve inventory turns from 3 to 10

Organized retailing in India is still evolving in terms of reach and process maturity. One of the key metrics for process maturity for a retailer is Inventory Turns. The roadmap for improving this metric is a holistic effort covering demand and supply side functions.

Organized retail in India is rather young – the larger ventures in this space didn’t start until late 1990’s. We have made good progress since then. There has been thousands of crores invested in setting up retail businesses everywhere in India. These investments have gone into acquiring the most basic resources and capabilities to setup shop – trained workforce, suitable shopping space (suitable in size and location), distribution infrastructure, basic vendor agreements, etc. All of the large retailers today either have setup these basic resources and capabilities or have made definite progress towards these. It becomes imperative that the next round of investments should be in developing more advanced resources and capabilities.

Indian retail does certainly need more advanced resources and capabilities, especially since we still compare very bleakly to retailers in developed retail markets. One key metric to note in this regard is the inventory turnover. Inventory turnover indicates the velocity of goods movement in the retailer’s value chain. This velocity is not just a factor of distribution and procurement processes. It is also a factor on how well the retailer understands his customer and stocks his stores for it – if the customer doesn’t like the goods, they won’t move as fast in the value chain. Hence, inventory turnover is a key indicator of the maturity the retailer’s processes in doing the above (There is a more popular indicator in the retail world – GMROI – since retailer’s balance sheets today include their manufacturing operations, this is not considered here. The argument to be made in the article is the same with this metric as well).

Comparing the inventory turnover’s in the apparel retailing business of prominent players in India and a developed market like USA showed just how big the gap is – (see the diagrams below) US retailer was moving goods across 19,000 Kms +, across multiple nations and an ocean and across varied language/customs domains and yet achieved 3 times better inventory turnover than the Indian retailer.

Simplified US Retail Value Chain @ 10 Inventory Turns

Simplified US Retail Value Chain @ 3+ Inventory Turns

*Value chains are simplified to show only the prominent supply/consumption points in apparel; both the maps are to the same scale

An interesting note is that the US retailer’s value chain stretches into countries with evolving infrastructure in Asia. Therefore, the credit to better performance cannot only be conferred to the better roads in US. What other factors contribute to this performance? An analysis of the contributing factors yields the following roadmap (this is called as roadmap as there is a definite sequence to building these factors into a retail business).


The roadmap to building the process maturity, to achieve the level of performance of a US retailer, begins from not imitating the US retailer - US retailers face different regulations, different market conditions and different geographic features. The roadmap begins from building something more fundamental than mimicking the practices of a US retailer - it begins from building a culture of adaptation and innovation. Culture is often the first thing to be changed before a large change happens. Quality Management Strategies have often highlighted this to the Manufacturers. The cultural change required here is about empowering various sections of the employee base with suitable tools to analyze processes, establishing forums for evaluating ideas at various levels, encouraging talent acquisition with varied exposure and building a vision statement that clearly communicates this. However, this is just the first of the steps in the roadmap to higher inventory turns.

Retail Value Chain and Roadmap
The roadmap has to be more holistic as the metric of inventory turns, as noted earlier, is more holistic in nature. This roadmap touches demand and supply sides of the retail value chain as indicated in the diagram above. The next steps in the roadmap will be elaborated in the subsequent articles in this series. In brief the next steps involve planning the demand flow and supply flow, more efficiently.