The objective for any small retailer is to maximize profitability and cash flow. Carrying too much inventory can decimate both.
If there's one thing I've said to clients that have stopped them dead in their tracks it's that trying to maximize their sales can be one of the worst things they can do.
I have yet to meet a small retailer who is thinking about retaining my services who isn't focused on maximizing their sales. Of course, they're also struggling with profitability and cash flow. That's why they're talking to me. People generally don't talk to somebody like me unless they're feeling some pain, and there's nothing quite as painful to a small retailer as not having enough cash.
They're also almost always sitting on more inventory than they need. That's usually a big part of where all their cash has gone. It's tied up in inventory. And it's usually a direct result of trying to maximize sales.
I call this chasing the last sale. Most small retailers live in fear of a customer coming in to their store and leaving without making a sale because they couldn't find what they were looking for. Small retailers think of it as a lost opportunity that can never be recaptured, and are willing to do whatever it takes to assure that it never happens again. They think that's how you grow your business.
But think for a moment about what it takes to capture that last sale. When that "last customer" comes in, what are they going to be looking for? What merchandise are they going to want to buy? How much of it? And how will you know they are the "last customer" and that's the last sale?
These are obviously rhetorical questions, but that doesn't make them any less significant. How much cash are you going to have to tie up in inventory to be able to make that last sale? The question comes down to how much you can reasonably expect to sell of an item, collection or category over a given period of time. It comes down to sales planning.
Let me risk getting a little technical here. If we're working together on a sales plan for your business, and I ask you how many widgets you really think you'll sell in September, you'll give me a pretty straight-forward answer: "I'll sell 100." But what you're really telling me is that the most likely number of widgets you'll sell is 100; you might sell 98 or 99, or 101 or 102, but the most likely result is 100.
Think of a bell curve. At the peak of the bell curve is the most likely level of sales for that item, collection or category over the given period of time. As you move to the left of that peak, the sales level goes down, and those levels become increasingly less likely. As you move to the right of the peak, the sales level goes up, but those levels also become increasingly less likely. At the extremes of the bell curve you have the extremes of the possible sales levels, but those sales levels are also extremely unlikely. And at the far right of that bell curve is where you'll find the last sale!
If you're most likely to sell 100 widgets in September, perhaps the extreme of the bell curve on the high side is 120 widgets. Now the question comes down to how many widgets you're going to stock in September. If you're going to stock to sell 100, you'll likely carry a few extra, let's say 5 or 10, because there's still a reasonable likelihood that you'll be able to sell them. But if your focus is on absolutely never, ever disappointing a customer, you'll probably carry at least 120, perhaps 125 or even more.
If the widgets we're talking about are basic, non-seasonal, in-stock items you may think, well, okay, what I don't sell in September I can always sell in October. However, in the process you're carrying 10 to 20 more than you otherwise would, tying up 10% to 20% more cash than you otherwise would. Identifying a range of core, "A" items that you never want to risk being out of is one thing, but the more items you designate as never-out-of stock items, the more inventory you'll end up carrying to cover that last sale. When you factor in the annual carrying cost of basic, non-seasonal retail inventory (approximately 20% to 30%, depending primarily on the obsolescence risk), that last sale is not nearly as profitable as you might think.
If, on the other hand, the widgets we're talking about are seasonal items, those extra 10 to 20 units of inventory are clearance markdowns waiting to happen. Not only are they tying up cash, leaving you in a less liquid position, but when you do sell them at the end of the season you're going to sell them at a 25% to 50% or more discount, making those sales clearly unprofitable, after you factor in carrying costs and overhead costs.
Let's return to the idea that chasing the last sale is how you grow your business. Inventory, by itself, doesn't generate additional sales. Sales increases are the result of a well-planned and implemented marketing strategy, wrapped around a compelling value proposition. If you sold 100 widgets last year, there's nothing inappropriate about planning a 10% increase if that plan is grounded on solid marketing and business fundamentals.
Finally, we need to distinguish between chasing the last sale and chasing a hot item. Climbing on a hot item and riding it for all it's worth is one of the hallmarks of any successful retailer. Whenever a retailer places a re-order of a hot item, they are responding to current sales, and re-planning (in their minds, if not on paper) what they expect to be able to sell. That's far different from carrying inventory in excess of a reasonable expectation of what can be sold in a given period of time.
Think of it this way: the objective for any small retailer should be not to maximize sales, but to maximize profitability and cash flow. Carrying too much inventory can decimate both. Inventory is a double-edged sword, the necessary evil of retailing. You gotta have it, but too much of it can rob you of the cash flow you need to cover your expenses. Manage your inventories around well thought out sales plans, avoid chasing the last sale, and you'll see an almost immediate improvement in your profitability and cash flow.