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March 3, 2003. Inventory-centralized Retail™

Author: Dr. Augustine Fou, Marketing Science Consulting Group, Inc.

This article examines several current trends and economic forces that are converging to change retail as we know it. We extrapolate into the future and take a look at what retail might be like down the line.

Current Trends In Retail More and more stores have recently been increasing the number and variety of their product offerings in an attempt to attract a wider customer base and potentially to keep them in stores longer. For example, Wal-Mart continues to add grocery and gasoline offerings to more and more of their store locations in an effort to bolster their “one-stop shop” value proposition. But there is a corresponding increase in redundancy, inefficiency, and waste. As Wal-Mart continues to encroach upon the domain of local grocery stores and gas stations, all retailers in the area are hurt. Having redundant inventory in the same geographic location means greater inventory costs and waste because consumers are not going to buy more or change their typical purchase patterns. Consumers suffer too because these increased costs and inefficiencies are ultimately passed along to them as higher prices.

Another trend in retail is that low-cost providers such as Target and Wal-Mart are expanding further into categories like branded clothing. Older retail brands or department stores which have not connected well with trend-conscious consumers will continue to lose business no matter what inventory they stock. Informal surveys of today’s young people reveal that they “never” shop or shop very infrequently at department stores like JCPenney’s, Kohl’s, Nordstrom’s, Foley’s, or Federated; in fact, some have never even heard of these store brands.

Single-line retail stores like Tower Records (which sells music) and Sports Authority (which sells sporting goods) are also being forced to change the way they do retail. They must move beyond the traditional definition of retail and expand their value proposition to become “destinations” for entertainment or sports, respectively. Music stores can no longer be merely stock rooms for thousands of CDs because today’s consumer can easily browse thousands of CDs online, listen to samples, and make purchases at better prices from the comfort of their own home. Physical retail stores have to deal with the extra costs of real estate, inventory management, and labor. One striking example, however, of a store which continues to innovate new in-store value propositions is Barnes & Noble. Their in-store CD-sampling stations allow customers to sample ANY music CD or get more info on any DVD simply scanning the UPC barcode at a sampling station; the samples start to play instantly and information about the product is displayed on the small 6-inch flat panel display. While sampling is already widespread online, the immediacy, efficiency, and “user-friendliness” of the Barnes & Noble system provides enough incremental value to make a trip to the store worthwhile.

Another entire category of retail, namely malls, are also being forced to reevaluate their value proposition to consumers. In the ’70s and ’80s malls became popular because they centralized many small stores under one roof and added conveniences like food courts and movie theaters to make a trip to the mall something of an excursion. They also quickly became places for teens to hang out for free (as opposed to bars or restaurants, where they felt obliged to buy something). But most often visitors to malls are just that — visitors — and not buyers; they hang out, socialize, browse the merchandise, and leave. Furthermore the individual stores that have been aggregated inside malls are still not able to compete with Wal-Mart on price for commodity goods; centralization of stores for one-stop shopping is no longer unique to malls since Wal-Mart already does a better job of it; and the food courts and movie theaters are no longer enough to make malls destinations.

Economic Forces There are also strong economic forces at work to reshape retail as we know it. While there can be dramatic fluctuations of economic condition, there are always downward pricing pressures from the competitive environment which continue to reduce margins or eliminate them altogether. There are inherent inefficiencies built into traditional retailing because displaying a large number of items on physical store shelves or racks and allowing customers to browse through, to try on, or to otherwise handle these items is extremely inefficient way to sell. In other words, the sale of one item is the convergence of several relatively small probabilities — e.g. the probability that a consumer has a need and is actually ready to buy, the probability of that consumer takes the time and trouble to go to a retail store, the probability that the item of the right size, color, or feature set is in stock at that time, the probability that the price is “right,” and potentially even more factors. These probabilities combine to make the chance of an item being purchased very small indeed. Retailers have to essentially be “fortunetellers” to purchase and stock the right products and product mix in anticipation of consumer demand; retailers have to have the foresight to locate a store near enough to consumers for them to actually make the trip; and, of course, retailers have to play the pricing game. While in the past, sufficiently large margins allowed for such inventory and pricing games, razor-thin margins of today’s retail mean that inefficiencies of traditional retail will no longer be viable.

On the demand side, consumers are continually gaining power through technology, more efficient sharing of information, and alternative retail channels. For example, online shopping bots and price comparison engines help to consumers find the best price anywhere. This dramatically increases the speed at which prices are driven down to bare-minimum commodity prices. Mass consumer feedback on particular products or manufacturers can be shared with millions virtually instantaneously online; this means that positive reviews of popular products will drive rapid spikes in demand while negative reviews can send sales of a particular product spiraling down. Finally, online stores provide consumers a convenient alternative to making a trip to a physical store and often offer better prices and hard-to-find items, too. People go into stores like Best Buy and Circuit City and play with products, but then go home and buy online cheaper.

Consumers have also been conditioned to make purchases only when there are “sales” going on. And in response, retailers have been conditioned to put on “sales” more frequently or even continuously. Not only do such sales annihilate margins for retailers, but they also make consumers wary and jaded to these so-called “sales” that go on all the time, and even then they usually don’t think the sale price is all that good. This is a devastating cycle which leads to further concentrations of demand, centered around calendar-based holidays like Valentine’s Day, birthdays, and most especially Christmas. Such concentration means that retailers have fewer and fewer chances to “get it right” — in other words, it is imperative that they get the right product mix and inventory for these small number of occasions; otherwise they won’t make the sales numbers. But in recent years, it is well-publicized that popular items are always in short supply and not-so-popular items remain on shelves and must be “disposed of” in often below-margin fire-sales after the holidays.

The economic forces of continuous downward pricing pressure, increasing consumer power, and demand concentration are combining to make retail ever more Darwinian. The inefficiencies and “slowness” of traditional retail is no longer economically viable. This calls for a new way of looking at retail and executing it.

Inventory Centralized Retailing We propose a new concept called “inventory centralized retailing.” Unlike traditional retail where individual stores or chains of stores purchase, distribute, stock, and sell specific inventory at specific geographic retail locations, in “inventory centralized retailing” most of the inventory is left in highly automated regional distribution facilities — extremely common and efficient having been refined and streamlined since the advent of Internet shopping. The individual retail stores then become highly specialized showcases of products, where consumers go to experience or “try on” products. They can also make the purchase in the store, but the item will be delivered directly to their homes from the regional distribution facilities. The retail stores will no longer stock aisles and aisles of product; they will no longer need to use large amounts of real estate for inventory storage; and they will not need to handle large numbers or variety of products. Retail stores can instead spend money on showcasing products in their “natural environments” and allow people to experience these products in the proper context, thus increasing the probability of making the sale.

“Inventory centralized retailing” also means that existing retail stores can selectively increase the variety of their product offerings to attract new customers and retain existing ones without an associated increase in inventory related costs. For example traditional music stores can now offer consumer electronics such as stereo systems, home theater systems, and even TV’s without having to manage such inventory themselves. They can set up a showcase of these selected products which complement their primary product lines and are on-brand, on-theme, or generally related to the same target consumer that visits the store. The consumer can try out or experience these relevant products in the retail environment and in association with other relevant products such as the music being offered for sale. And, if appropriate, they can even make the purchase in-store. They will then receive a card with a unique code on it or some other form of proof of purchase. The product will be then drop-shipped directly to their homes or an address the customer specifies, which could be particularly convenient for larger items like TVs.

The economics of “inventory centralized retailing” are also attractive to retailers, manufacturers, and consumers. There are many components of a retailer’s cost structure that can be attributed to inventory — 1) capital costs of acquiring the inventory, 2) logistics costs of getting the inventory to stores, 3) real estate costs of warehousing the inventory, 4) labor costs of stocking and restocking inventory, and finally 5) costs of inventory risk — i.e. not all retailers can predict demand with 100% accuracy which means that popular items will inevitably be understocked and “dud” items will be overstocked. With inventory centralized retailing, retailers can do away with most of these costs or significantly reduce them. For example if a retail store did away with the costs of moving large TV’s to particular store locations, warehouse them until they are sold, or disposing of unsold inventory, they could probably significantly lower the price of such TVs and still make more money. The economic argument for inventory centralized retailing is that for particular categories or types of products the cost of drop shipping individual items to individual consumers is still less than the combined costs of capital, logistics, real estate, labor, and inventory risk attributable to such products. In this scenario retailers can earn more profits; manufacturers can potentially achieve higher wholesale prices; and consumers might get better prices and a better retail experience.

Another benefit of inventory centralized retailing is real-time sales data. Historically, manufacturers don’t have timely sales data to do accurate forecasting. In other words, while they may have data on large, aggregate shipments of product to retail stores or chains, they typically don’t have detailed consumer sales data from the point-of-sale or they get such data many months after the fact, again in aggregate. Their lack of timely data leads to oversupply or undersupply, and thus adds to the inefficiencies of traditional retail. With inventory centralized retailing, manufacturers can have detailed and real-time to information about individual consumer sales as they happen. Such data leads to more accurate forecasting, manufacturing, and even better products or product mix.

Conclusions Given the known inefficiencies of traditional retail, the general trends which are making retail ever more Darwinian, and other economic arguments, inventory centralized retailing might become a significant new way of doing retail which has benefits for all parties involved — manufacturer, retailer, and consumer. If a retailer can increase the variety of their product offerings without an associated increase in inventory-related costs, then they have a chance to attract more customers into their stores, and perhaps keep them there longer. The other macro benefit is that these inventory related costs are not passed on to the consumer in the price of the item. Increasing efficiency through the use of technology and other methodologies can help retailers survive and gain a competitive advantage while giving consumers better value — i.e. lower prices and better shopping experiences. And finally the manufacturer makes sales with better margins and gets real-time data for more accurate forecasting and planning, thus completing the entire cycle to increase the efficiency of the retail cycle.

___________________________________________________________________ 2003, Dr. Augustine Fou

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Fou Bio

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inventory-centralized retail