Monday, June 6, 2011

The Case Against Category Management – Exercise 5 -2

I have gathered some information regarding costs and profits, tracking the costs and markup rates from suppliers, through retailers, to the consumers. For this exercise, I have chosen a Snicker’s bar (UPC 040000001027). IMPORTANT: You will have to take my word that this can easily be done with our current technology and read to the end; else, you may never get through the first section.

We are going to assume the grocery supplier’s markup on this item is 1.26, yielding a gross profit for the supplier of around 21 percent. The current arrangement is, the retailer receives the merchandise and the inventory is marked up for a 52.762 percent gross profit, resulting in the selling price for the candy bar at $1.09. To get a better understanding, you should follow along using the links below.

Supplier’s Cost: $0.40873
Sells to Retailer: $0.515
Supplier’s Profit: $0.10627

Retailer’s Cost: $0.515
Retailer’s Selling Price: $1.09
Retailer’s Profit: $0.57500

Supplier Cost: $0.40873
Sells to Retailer: $0.20437

Retailer’s Cost on purchase: $0.20437
Retailer’s Price: $1.09
Retailer’s Profit: $1.09 - $0.20437 = $0.88563
Retailer’s Profit Split with Suppler: $0.88563 * 50 percent = $0.44282
Retailer’s Gross Profit: $1.09 - $0.20437 - $0.44282 = $0.44282

Supplier’s Profit: $0.44282 - $0.20437 = $0.23845

It is clearly obvious, by selling the candy bar for half of what he paid for it, then taking 50 percent of the retailer’s profit after the sale, the supplier’s profit has more than doubled, from $0.10627 to $0.23845; so, why is this a good deal for the retailer?

There are several reasons: For one thing, it is an enormous advantage to the retailer because, the supplier has just transferred most of the risk back to himself, he manages the retailer’s inventory for him, and the retailer’s investment in inventory drops from $0.515 to only $0.20437… a whopping 60.3%; in other words, checks written to suppliers drop by less than half. Imagine how this will affect the retailer’s cash flow.

Your knee-jerk reaction might be, ‘this is a disproportionate advantage to the supplier’. Well, you would be half right; but, not so fast. Let’s walk in the supplier’s shoes for a moment: If the supplier takes an item to a store that never sells, using the figures above, he loses $0.20437, because he paid $0.40873 for the item and only received half of that investment back on the transfer to the retailer.

So, what’s the supplier’s incentive? To pick the item up, credit the retailer and put it where it will sell; or lower the sales price on the item, so he and the retailer can make at least some profit on the deal.  It doesn’t take much imagination to see the supplier’s incentive is to take to the store, only the inventory that he can make a profit on, rather than making a profit on each and every item he delivers. The supplier also suddenly becomes very interested in what sells best in the store to maximize his own profits.

Of course, the supplier is floating the $0.20437 loss, but only for one week, because he is going to have a strong incentive to deliver only what the retailer can sell between delivery cycles. In addition, he is going to pay more attention to the pricing because the product is in effect, on consignment.

More about this coming on the next post……


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