Monday, April 25, 2011

The Case Against Category Management – CM vs. Item Level Control -1


Beginning on page fifty-eight of our book, “Turning Convenience Stores Into Cash Generating Monsters,” available at Amazon.com, Jim and I talked about the advantages ‘Item Level Inventory Control’ offers over ‘Category Management’. We will touch lightly on just a few of those advantages here.

You may be able to find your ‘Last Cost Paid,’ but, what’s the true cost of the items on your shelves today? Lately, my clients have been calling me, confused as to why their fuel profits at stores are so high. The answer is simple, as of this writing, fuel cost are going up faster than retailers can get rid of the cheaper fuel stored in their tanks. 

As the prices the suppliers charge for their fuel increases, these increases are reflected almost immediately on the street. Generally, the reason is, most convenience store operators don’t know what their true cost of fuel is at any given moment in time. So, when the supplier’s cost goes up a nickel, the street price quickly follows suit. For example, let’s say you have one-million gallons of fuel in your tanks for which you paid $2.95654, and today, the trucks deliver 140,000 gallons which cost you $3.00 per gallon. Since the cost has jumped up nearly a nickel in twenty-four hours, the chances are everyone in your area heard of the new costs and your competitor across the way raised his street price by $0.05 per gallon. You of course, follow suit.

Now, let’s calculate the true cost of your inventory at that moment. The formula is (Old_Inventory_At_Cost + Received_Inventory_At_Cost) / Total_Gallons_On-Hand.

Using the above figures, your new cost of fuel would be ((1,000,000 * $2.95654) + (140,000 * $3.00)) / 1,140,000 gallons, or ($2,956,540 + $420,000) / 1,140,000 = $2.96188, an increase of only $0.00534 per gallon­— pretty startling right?

Now, if everybody in town raises their street price by $0.05 per gallon to compensate for the increase in supplier’s prices, in your case that would result in an increase in profits of $0.04466 CPG over and above the profit you would have made if the cost had remained stable. If inflation continued on like this indefinitely, in a few months you could retire; but what actually occurs is you give all of that money back again when the price starts going down. In fact, if the cost of fuel should ever drop by $1.00 per gallon in one day, within a month, listings for convenience stores would overwhelm the market and operators would be going out of business left and right, unless they invested that temporary fortune into something they could get their hands on fast when prices start to fall.

The long and the short of this lesson: We rarely experience this kind of volatility in the grocery market, but our time is coming… very soon I’m afraid. Increases in supplier prices on groceries may create a similar boom in temporary profits, but only if you possess the tools to handle it correctly.

If things remain as they are, my predictions go something like this. 1) Suppliers’ grocery prices will increase and operators will not take notice fast enough, and instead of making more money during inflation, they will suffer catastrophic losses.  2) If they can hang on long enough to wait for the period of deflation, they may be able to stay in business, however the chances are they will over compensate at some point during the inflationary period and drive their customers away.

Regardless of any of this, customers will tighten up on purchases and seek more economical alternatives. In order to survive this kind of environment, operators will need to be careful about raising prices and work hard to convince their customers their prices are not that much more than Walmart’s. Walmart on the other hand, will just build another twenty superstores.

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