Thursday, May 5, 2011
The Case Against Category Management – Prelude to Exercise #4 -2
Another thing you should keep in mind before you venture into Exercise #4, is just as there are profitable and unprofitable items, there are profitable and unprofitable customers, suppliers, employees, promotions, managers and locations… and yes, even CEOs. In fact, every company may have a mixture of all of these. Once you’ve accepted these principles, you may begin to think differently and it’s been my experience, our assumptions are what determine our value to the company we work for. To paraphrase an old proverb, “Be careful what you ASSUME. You just might get it.”
In the book, “Islands of Profit in a Sea of Red Ink,” L.S. Byrnes, leading MIT lecturer, told of an interview with a leading grocery retailer. He said, a top executive for the chain stated of all the customers that come into their stores, 25 percent cost them money and 25 percent accounted for all of their profits, and well over half of that profit came from only 10 percent of the base. In a busy convenience store, that equates to around 1,500 transactions per day; and using the same figures, out of 1,500 transactions, 375 are probably losses, 375 may be profitable, and what of the other 750? You’re lucky if you break even. If this comparison is only partially accurate, there is a great deal of work that needs to be done.
As for items within categories, we found 35 percent are unprofitable, 25 percent are profitable and as far as the other 40 percent… hopefully they’re a wash. However, never forget the 40 percent that are producing neither gain nor loss. They’re actually unprofitable too, because they occupy space where profitable items could be sold.
In Exercise #4 we will be using the following two sets of formulas:
1. Retail = Cost / % Cost
2. Cost = Retail * % Cost
3. % Cost = Cost / Retail.
Here’s a test: If you want to retail a $3.50 (cost) item for 36.8765% profit, what’s the formula, and what is the answer? (See bottom of page)
To help me remember the formulas, I use the triangle method when dealing with two known factors and one unknown. Draw an equilateral triangle, put ‘COST’ at the top, “RETAIL’ goes on the bottom left and ‘% COST’ to the bottom right. Draw a horizontal line (-------) between ‘COST’ and the two items below, and insert a vertical bar ‘|’ between ‘RETAIL’ and ‘% COST’. Whenever you need to compute any single value from the other two, just look at the chart. I have taped mine on the wall so I can find it quickly, because I’m always forgetting how it goes. Test it: Retail = $1.00 / 70% = $1.4286; Cost = $1.4286 * 70% = .99999 (rounding error); % COST = $1.00 / $1.4286 = 69.9999% (rounding error).
REMEMBER: To make 30% profit on an item, multiply the cost by 1.4286 and not 1.3, OR even better, refer to the formulas above. Nevertheless, marking up items is the wrong way to retail your inventory. You may understand why I say this pretty soon.
Here’s the second set of formulas:
1. Profit % = Profit / Retail
2. Profit = Profit % * Retail
3. Retail = Profit / Profit %
Write these down, or better yet, draw them in a triangle (see above). They will always come in handy down the road.
And one more:
TURN_RATIO = ITEMS_SOLD_DURING_PERIOD / NUMBER_OF_SELLING_DAYS_IN_PERIOD
Answer from trick question above: Retail = Cost / % Cost = $5.54
$3.50 / (1 - .368765) = $5.54. Note: Cost % = (1 – Profit % as decimal)