By  on January 12, 2005

Retailers avoided a disaster this past holiday season. Despite generally weak sales in most sectors, executives and analysts say there was no major panic among retailers, in large part because of significantly improved management of inventory and markdown activities. While it may have appeared to consumers that there were endless sales at stores up to and after the holiday season, many of those sales were planned long before the holiday season began. 

The calm partially stemmed from the increasing use of optimization software, or at least elements of it. The hype of emerging technologies rarely matches the end results, as any executive involved in IT decision making and project implementation knows all too well. But optimization software may be one of those rare IT breeds that deliver the goods as well as, or even better than, promised. 

Optimization tools are designed to suggest best prices, determine when and how much to mark down product and fine-tune merchandise assortment and shelf-space allocation. For apparel retailers, especially, solutions that limit markdowns hold significant potential to enhance profits. Similarly, tools that maximize shelf-space allocation and, hence, sales per stockkeeping unit, can lift the bottom line by precious percentage points.

The move to what is broadly termed “optimization” tools represents a daunting shift for retailers who traditionally have relied mainly on historical data and instinct to make pricing and merchandising decisions. Optimization software calls for retailers to trust in science and technology to forecast demand and predict trends, and suggests changes to cash in on both. 

The trend is not yet widespread, but it has moved from the pilot stages among a relatively small group of retailers to an option almost all companies are aware of and are considering embracing.

Although retailers are typically shy about sharing perspectives on leading-edge technologies they believe give them a competitive edge, Marvin Hearn, vice president of planning and allocation at Burlington Coat Factory, shared specifics about that chain’s space optimization program and the paybacks expected as a result.

Burlington Coat Factory, which carries an average of 15,000 coats year-round as well as a healthy assortment of other apparel, shoes and accessories, wants to make sure that every inch of its real estate is performing at maximum capacity. Burlington Coat Factory operates 360 stores and generated net income of $68 million on sales of $2.8 billion for its 2004 fiscal year. Net sales for the first half of 2005, ended Nov. 27, hit $1.45 billion, a 10.7 percent increase over the same period a year ago.“We know we have to maintain the [optimum] space for our customers. There is a flexing that goes on. Every retailer flexes. But how they do it is another story. A lot of times what happens is done by emotion, with the gut,” Hearn said. For example, when it comes to space allocation, “everybody fights for their territories. Everyone thinks, ‘I’ve got to have that space, because if I don’t have that space, I’m not going to do the business I did last year, and it will go to someone else.’ It is a battle.”

The real question retailers should ask is how to evaluate what is the right amount of space for each product. What is the productivity? What are the facts? “Well, as you get into space optimization, you rely more on facts,” Hearn said.

Burlington relies on software to build plan-o-grams for its product assortment. But just as important as “building the plan-o-grams and doing the visuals is the analyzing piece. Do you really need all the sku’s you are carrying or fewer sku’s? What kind of margins are you making? And when you place product in one part of the store versus another, what is the sales and the margin increase or decrease?” Hearn added.

Burlington Coat Factory is currently putting in place a financial planning application and will very soon implement an assortment planning tool. The retailer will then integrate those applications with analytical and plan-o-gram modules. “We have started it in our luxury linens area and we are about to roll it out” into other areas, as well, he said.

While the project is not yet complete, “I can tell you what my expectation is and I don’t think I am too far off. My expectation is that our bottom-line gross-margin dollars will increase 10 percent to 15 percent. I think I can achieve that by utilizing the space in the store to make sure product is exposed maximally to customers.

“I think I can do that and I think I can pay for the whole darn package within the first-year maximum — if not more swiftly,” Hearn said.Hearn was among the speakers at the Better Management Live Worldwide Conference in Las Vegas. The event included several retail tracks covering revenue, markdown, space and merchandise optimization. The conference was sponsored by SAS, along with IBM, Intel, Hewlett-Packard, Deloitte, Accenture and several other major IT vendors and consulting companies.

Bakers Footwear Group, with more than 200 stores in 35 states, is another retailer heavily investing time and resources to create a merchandising decision-making environment that is much more “scientific” and “fact based.”

Stanley Tusman, executive vice president of information systems and inventory management at Bakers, explained that the process of optimizing product assortment and merchandising is crucial to maximize returns. Doing that, however, requires changes in technology as well as buy-in by all levels of the organization.

“Stores are becoming much more customer-centric. You can’t just do the cookie-cutter [thing anymore]. We have to balance the economies of buying globally and yet meeting the unique needs of individual stores,” he said.

For Bakers, it also necessitated an internal shift requiring employees in different departments to work closer together. “Before we implemented the assortment-planning process, we had product planners, allocation analysts and buyers. Now we have a new level, called store planners. It is a team approach: The product planners, store planners, allocation analysts and buyers over the four separate pyramids all work together as a unit,” he said.

The optimization effort further involved taking a detailed look at each item in every store, developing store clusters with similar customer and sales characteristics and trusting the optimization tools to forecast product demand and make decision based on those forecasts.

“We forecast the sales build — that means looking at the business trend rather than just replenishing by history. We are anticipating promotional needs and then pushing inventory as we approach the end of season. We take pricing action relative” to what our forecasts are predicting and what we want to achieve, he said. 

“We look at key items at a very detailed level on a movement basis by sales, inventory and receipts, in units by month [and other metrics], because these are driving the business. That is what gives us guidance on assortments. Based on the assortment plan, we issue allocations and build-in our sales plan,” he added.While claiming considerable benefits from leveraging optimization tools, Tusman did not share bottom-line results of Bakers’ efforts. But Bernard Brennen, senior venture partner of BV-Cornerstone Ventures LP, spelled out in detail what various optimization programs have produced for retailers with whom his group has worked. Brennan is former chief executive officer of Montgomery Ward and also past chairman of the National Retail Federation. His company, he said, is an investor in one of the optimization companies, though he did not say which one.

According to Brennan, his company conducted an intensive study of two retailers in the soft goods arena that implemented different optimization tools and realized highly significant gains as a result.

The first study involved markdown optimization software in a $2 billion chain whose products, on average, carried an initial markup of 55 percent, with an average promotional discount of 20 percent and a clearance discount of 30 percent. The average total margin at the end of the season was 32.5 percent, meaning the difference between markup and gross margin was 22.5 points — the largest single expense the retailer had, Brennan said. 

“We’re over here working on saving a nickel on the purchase order, or working on labor scheduling, which are all good things. But any movement [in this area] goes right through to the bottom line,” he said. By using optimization tools, the retailer reduced its promotion and clearance markdown and also the amount of product sold on discount. The results: The chain, on average, “moved from a 32.5 percent to a 35.2 percent margin — representing almost $100 million.”

Brennan cited a second example involving the use of size-optimization software. “If something doesn’t fit, that is a serious problem. If you have the wrong size shoes or wrong size garments in the store, you know what is going to happen.”

Size optimization, he pointed out, analyzes not only what sold through, but estimates what is out of stock and would have sold on the same basis. It also recommends size profiles by store, and continually updates product recommendations. “You may have a market where the demographics are changing, as in Southern California or in other parts of the country. Those changes in demographics will change your size scales instantaneously. If you are not continuously following those and looking through those, it is impossible to keep up with them.”This particular retailer improved its gross margin by one full percentage point in the first year alone, “just through size optimization, not tied in with anything else. That is a significant amount, especially when you consider the company’s pretax profit margin was 6 percent. So that change was about 20 percent of their pretax profit. Very compelling.”

While footwear, apparel and other soft goods — with high markdown rates — are prime candidates for optimization software, the forecasting tools are taking hold and undergoing testing across all segments of retail. 

Brennan pointed to a test involving the perishables food arena — though at a retailer also well known for its apparel offering. The chain he discussed is based in the U.K., is renowned for perishable prepared foods, though it is mainly an apparel retailer, and it has about 320 stores and does some $3 billion in sales.

Sixty-five percent of the fresh food it sells is prepared centrally every day. Before implementing optimization software, the retailer was doing manual planning, had high out-of-stocks and inefficient filling. In this case, the retailer decided to test the optimization program on a store-level — rather than store clustering — basis. 

The results of the program included less time in filling orders, greater customer satisfaction regarding the product mix, higher productivity and lower costs, said Brennan. “But most important, sales went up 8 percent the first year. That is the ultimate in optimization.”

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