Make Your Inventory Work Harder for You

Tracy Mayor -- Expert Business Source, 2/10/2007 12:18:00 PM

Ever since the first salesman tried stockpiling rocks to attract the burgeoning hunter-gatherer market, managers have struggled to get an eagle’s-eye perspective on just how hard their retail inventory is working for them.

One key metric to aid in your quest for better insight into your inventory – the top-performing items as well as the laggards – is Gross Margin Return on Investment (GM ROI, sometimes also called Return on Inventory Investment, or ROII).

GM ROI is a decision-making tool that can help you identify which products in your line of merchandise are delivering the highest dollar profits. The metric expresses the relationship among:

• Total sales.
• The gross margin earned on those sales.
• The investment in inventory required to generate those gross margin dollars.

Calculated as either a percentage or a dollar multiple, GM ROI tells you how many times you have received your original inventory investment back for a specific period of time. The higher the GM ROI, the better.

Best of all, GM ROI is scalable: you can apply it to an entire retail operation, to a specific department or to a single class of merchandise. This is a key consideration for small businesses looking to become bigger businesses by fine-tuning their inventory productivity.

To calculate GM ROI as a percentage, George Matyjewicz, publisher of E-Tailer’s Digest, suggests the following formula:

1. Calculate your gross margin percentage for the item or class of merchandise you wish to analyze.
2. Figure your average inventory at cost.
3. Divide your total sales by your average inventory at cost. This is your ratio of sales to inventory investment.
4. Multiply the result of step three by your gross margin percentage to get your GM ROI percentage.

Not everyone is a fan of these types of inventory metrics. Dave Piasecki, an inventory and operations analyst who also runs the inventory-themed web site InventoryOps.com, believes that metrics are often misused, misunderstood or offer too narrow a view of a company’s inventory situation.

“Determining inventory productivity just isn’t an easy process. There are no simple measures,” says Piasecki, who is writing a book on the subject.

That said, Piasecki does concede GM ROI can be useful in specific circumstances. “GM ROI is better than some other measures,” he says. “It does tell you something about the performance of your investment, particularly if you are comparing similar products. Then you can identify distinctive differences [between products] to determine what’s cutting into your profit margins.”

In general, Piasecki and other inventory experts remind managers that GM ROI should be used in consideration with other factors – such as freight costs, storage costs, display area required, and customer buying behaviors – to make merchandise decisions.

Tracy Mayor is a freelance writer based in Hamilton, Mass.