Buying Systems

Staple Merchandise Buying Systems

• Staple merchandise buying systems are used
for the merchandise that follows a predictable
order-receipt-order cycle.
• This system doesn’t work well with fashion
merchandise because certain SKUs don't have
a previous sales history.
 Types of Buying Systems
Staple Merchandise Fashion Merchandise
Predictable Demand Unpredictable Demand
History of Past Sales Limited Sales History
Relatively Accurate Forecasts Difficult to Forecast Sales
 What the staple merchandising system
does?
• Staple merchandising buying systems contain a
number of program modules to show how
much to order and when. These systems assist
buyers by performing three functions.
– Monitoring and measuring average current
demand for items at SKU level
– Forecasting future SKU demand with allowances
made for seasonal variations
– Developing ordering decision rules for optimum
restocking
Considerations in Determining How Much to Order
• Basic Stock Plan
• Present Inventory
• Merchandise on Order
• Sales Forecast
– Rate of Sales of SKU (Velocity)
– Seasonality
 The Inventory Management Report
• The inventory management report provides
information of sales velocity, inventory
availability, the amount on order, inventory
turnover, sales forecast, and most important
the quantity to order for each SKU.
 Staple Merchandise Buying System

Monitor Compare
Forecast Order
Sales and Inventory to
SKU Sales Merchandise
Inventory Basic Stock
List
Inventory Management Report for Rubbermaid Merchandise
 Basic Stock List
• Indicates the Desired Inventory Level for Each SKU

• Amount of Stock Desired

• The basic stock list describes each SKU and summarizes the
inventory position. Specifically, it contains the stock number and
description of each item, how many items are in hand and how
much on order, and sales for past weeks.

Lost Sale Due to Stockout

Cost of Carrying Inventory

 Inventory Turnover
• The planned inventory turnover is based on
overall financial goals and drives the inventory
management system.
 Product Availability
• Determining the appropriate level of product
availability.
Relationship between Inventory Investment and Product Availability

600

500

400

300

200

100

80 85 90 95 100
Product Availability (Percent)
 Back up Stock
• Back up stock, also known as safety stock or
buffer stock, is inventory used to guard
against going out of stock when demand
exceeds forecast or when merchandise is
delayed.
 Cycle and Buffer Stock

150 -
Order 96
Cycle
Stock
Units Available

100 -

Buffer
50 - Stock

0-
1 2 3 4
Weeks
 Buffer Stock
• We need it so we won’t loose sales, complementary sales, and
customers
• Buffer stock is dependent on:
– Forecast interval variance (Forecast interval = lead time + review
time)
– Variation in Demand (actual demand - forecasted demand)
– Time to Get Product from Supplier
– Time to Get Product from Distribution Center
– Product availability requested of IM systems
 Forecasting Demand
• Forecasting -- Extrapolating the past into future using
statistical and mathematical methods
• Objectives:
– Ignore random fluctuations in demand
– But be responsive to real change
 Forecasting Sales

New Forecast = Old forecast + ά x (Actual demand –

Old Forecast)

• ά ranges for 0 to 1
 Order Point
• Order point = the point at which inventory
available should not go below or else we will run
out of stock before the next order arrives.
• Assume Lead time = 0, Order point = 0
• Assume Lead time = 3 weeks, review time = 1
week, demand = 100 units per week
• Order point = demand (lead time + review time) +
buffer stock
• Order point = 100 (3+1) = 400
 Order Point (continued)
• Assume Buffer stock = 50 units, then

• Order point = 100 (3+1) + 50 = 450

• We will order something when order point gets
below 450 units.
 Calculating the Order Point

• Order Point = (Demand/Day) x (Lead Time

+Review Time) + Backup Stock

• 167 units = (7 units x (14 + 7 days) + 20 units

• So Buyer Places Order When Inventory in

Stock Drops Below 167 units
Merchandise budget plan for fashion
merchandise
 Step I: Monthly Sales Percentage
Distribution to Season
• Determine the percentage distribution of sales
per month by historic records
 Step II: Monthly Sales
• Monthly Sales equal forecast total sales for
the six month period.
• First Column $130,000 multiplied by sales
percentage by month
2 Monthly Sales $130,000 $27,300 $15,600 $15,600 $24,700 $27,300 $19,500
 Step III: Monthly Reductions Percent
Distribution to Season
• Sale is the primary reduction in the
merchandise
• Value of inventory is also reduced by
markdowns , shrinkage and discount to
employees.
 Step IV: Monthly Reductions
• The buyer calculates the monthly reductions
in the same way as the monthly sales.

Spring 2002

Apr-02 May-02 Jun-02 Jul-02 Aug-02 Sep-02

Reduction % Distribution to
3 season 100.00% 40.00% 14.00% 16.00% 12.00% 10.00% 8.00%
4 Monthly Reductions $16,500 $6,600 $2,310 $2,640 $1,980 $1,650 $1,320
 Step V: BOM Stock to Sales Ratio
Step V (a): Calculate Sales to Stock Ratio
• The GMROI is based on an overall corporate financial
objectives
• Since this is a six month rather than an annual plan, the
sales to stock ratio is based on six month rather than an
annual basis.
GMROI = Gross margin% x Sales to stock ratio
122.72%= 45% X 2.727
• Step V (b): Convert the Sales to Stock Ratio to inventory
turnover

• Inventory Turnover = Sales-to-Stock RatioX(100% - Gross Margin

Percent)
» 1.5 = 2.727 X 0.55

• This adjustment is necessary because the sales to stock ratio defines

sales at retail and inventory at cost , whereas inventory turnover
defines both sales and inventory either at cost or sales
Step V(c):Calculate the average Stock to Sales Ratio

• Average stock to sales ratio = 6 months / Inventory turnover

4 = 6 / 1.5

• Thus to achieve a six month inventory turnover of 1.5 on an average

the buyer must plan to have a BOM inventory that is 4 times the
amount of sales for a given month.
 Step V(c):Calculate the monthly Stock to Sales Ratio

• The monthly stock to sales ratio must average the BOM

stock to sales ratio.

• The buyer must consider the seasonal pattern for

determining the monthly stock to sales ratios.
 Step VI: BOM Stock
• The amount of inventory planned for the
beginning of month equals:
Monthly Sales X BOM Stock to Sales Ratio
Step VII: EOM (End of Month) Stock
• The BOM stock from the current month is
same as the EOM stock in the previous month.
• We must forecast the ending inventory for the
last month in the plan.
Step VIII: Monthly Additions to Stock
• Additions to Stock = Sales (line 2)+ Reductions (line 4)+
EOM Inventory (line 7) – BOM inventory (line 6)
• Additions to stock for April= $27,300+ $6,600+ $68,640 -
$98,280= $4,260
Evaluating the Merchandise Budget Plan

• GMROI , Inventory Turnover and Sales

forecast are used for planning the
merchandise budget.
• After the selling season the buyer must
determine how the category actually
performed compared to the plan for control
purposes.
 Open to Buy
• The open to buy system is one that keeps the
track of merchandise flows while they are
occurring, Specifically open-to buy systems
record how much is spent each month and
how much is left to spend.
Six-Month Open to Buy
 Calculating open-to-buy for past periods
• For the month of May the BOM stock actual is $
59,500 but there is no EOM stock actual because the
month hasn’t yet finished.

Projected EOM stock =

Actual BOM stock
+ Actual monthly additions to stock (what was actually
received)
+ Actual on order (what is on order for the month)
- Plan monthly sales
- Plan reductions for the month
• Open-to-buy =
Planned EOM stock (from merchandise
budget plan)-Projected EOM stock (based on
what is really happening)
 Breakdown by Store of
Traditional $35 Denim Jeans in Light Blue

(1) (2) (3) (4) (5) (6)

TYPE OF NUMBER OF % OF TOTAL SALES PER SALES PER UNIT SALES
STORE STORES SALES, EACH STORE (TOTAL STORE TYPE PER STORE
STORE SALES X COL. 3) (COL. 2 X COL. 4) (COL. 4/$35)

A 4 10.0% $15,000 60,000 429

B 3 6.7 10,000 30,000 286
C 8 5.0 7,500 60,000 214

Total sales $150,000

 Allocating
Merchandise to Stores

Fewer Sales, More Sales,

More Inventory Less Inventory
Percentage of total sales 1 1.5 2.5 3.5 4 6 8 12
Percentage of total inventory 1.5 2 3 4 4 4 6 10
 Markup

• A shopkeeper buys an item at a certain cost.

He then adds the so-called markup to this
price to cover his expenses and to make a
profit. The selling price is then the sum of the
cost and the markup.
• In equation form:
• Cost +Markup= Selling Price
 Markdown
• Suppose an item does not sell. The shopkeeper then
lowers the price in an effort to sell the item at this
so-called sale price.
• The usual thing for a shopkeeper to do is to take a
certain percentage off the regular price. This
percentage is called the markdown or the discount
rate r.
• Regular Price- Markdown = Sale Price
 Retail Inventory Method (RIM)
Two Objectives:
– To maintain a perpetual or book inventory of
retail dollar amounts.
– To maintain records that make it possible to
determine the cost value of the inventory at any
time without taking a physical inventory.
 Advantages of RIM

• The retailer doesn't have to “cost” each time.

• Follows the accepted accounting practice of
valuing assets at cost or market, whichever is
lower.
 Advantages of RIM cont’d

• Amounts and percentages of initial markups,

additional markups, markdowns, and shrinkage
can be compared with historical records or
industry norms.
• Useful for determining shrinkage.
• Can be used in an insurance claim case of a loss.
 Disadvantages of RIM

• System that uses average markup.

• Record keeping process involved is burdensome.
 Steps in RIM

Calculate Total Merchandise Handled at Cost

and Retail
Calculate Retail Reductions
Calculate Cumulative Markup and Cost Multiplier
Determine Book Inventory at Cost and Retail
Retail Inventory Method
 Inventory Turnover
❑ Inventory (Stock) Turn is the most usual measure of the
efficiency of inventory control.
❑It is the number of times within a period, usually one year, that
the average inventory is sold.
 Weeks of supply

• The number of weeks that a wholesaler will

stock an item based on the product turns.
 Gross margin
• Gross margin, gross profit margin or gross profit rate
is the difference between the sales and the
production costs excluding overhead, payroll,
taxation, and interest payments.
• Gross margin can be defined as the amount of
contribution to the business enterprise, after paying
for direct-fixed and direct-variable unit costs,
required to cover overheads (fixed commitments)
and provide a buffer for unknown items. It expresses
the relationship between gross profit and sales
revenue. It is a measure of how well each dollar of a
company's revenue is utilized to cover the costs of
goods sold.
 How gross margin is used in sales
• Retailers can measure their profit by using two basic
methods, markup and margin, both of which give a
description of the gross profit of the sale.
• The markup expresses profit as a percentage of the
retailer's cost for the product. The margin expresses
profit as a percentage of the retailer's sales price for
the product.
• These two methods give different percentages as
results, but both percentages are valid descriptions
of the retailer's profit.
 Markup
• Markup can be expressed either as a decimal or as a
percentage, but is used as a multiplier. Here is an
example:
• If a product costs the company $100 to make and they
wish to make a 50% profit on the sale of the product
(sale dollars) they would have to use a markup of
100%. To calculate the price to the customer, you
simply take the product cost of $100 and multiply it by
(1 + the markup), e.g.: 1+1=2, arriving at the selling
price of $200.
• The equation for calculating gross margin is: gross
margin = sales - cost of goods sold
 Gross Margin
• Most people find it easier to work with gross margin
because it directly tells you how many of the sale
dollars are profit.
• The $200 price that includes a 100% markup
represents a 50% gross margin. Gross margin is just
the percentage of the selling price that is profit. In
this case 50% of the price is profit, or $100.
Converting between gross margin and markup
 Examples:
• Gross margin = 0.5 = 50%;
• Markup = [0.5 / (1 - 0.5)]
=1
= 100%
 Using gross margin to calculate selling price

• Given the cost of an item, one can compute the

selling price required to achieve a specific gross
margin. For example, if your product costs $100 and
the required gross margin is 40%, then
• Selling price = $100 / (1 - 40%) = $100 / 0.60 =
$166.67