Recently, I was working with a client to develop replenishment parameters for a new software package they were installing. One of the key components to building these parameters is vendor lead time; that is, the period of time it takes a vendor to deliver a purchase order once it's been issued. We were working vendor by vendor, when we got to their largest one. When I asked what their lead time was, I was told there really wasn't any. Sometimes, the purchase orders came in less than a week after they'd been issued; other times it took two to three weeks, and, if the vendor was out of stock, it might be four to six weeks.
Replenishment formulas typically set the minimum inventory level to cover the average daily sales rate during the vendor lead time, multiplied by a safety stock factor to cover variances in the average daily sales rate and the lead time. It makes great sense, at least in theory.
But what do you do if you are trying to manage your inventory and you have a vendor that can't seem to ship with any consistency, much less on time? Or seems to constantly be out-of-stock, which delays their deliveries to you? Do you factor in a one week lead time and live with the resulting out-of-stocks you're bound to have in your own inventories? Maybe a two week lead time, which will eliminate some of the out-of-stocks? Or maybe you go with a six week lead time, figuring that will completely protect you from unpredictability.
If you've been paying close attention, however, even if you know very little about replenishment management, you've picked up on the fact that the trade-off for factoring in longer lead times to cover the vagaries of vendor delivery is more on-hand inventory. That's quite a price you have to pay for a vendors inability to manage inventory correctly.
Many small retailers feel, however, that this is a cost of doing business that they have to live with, especially if the vendor in question is selling them high visibility, branded goods. The client I was working with had never given a second thought to the impact that the unpredictable lead times from this vendor were having on his business. He needed the goods!
It doesn't have to be this way.
For many small retailers, there are two types of vendors. There are vendors who are even smaller than you are and seem to be completely disorganized and underfinanced. They seem to have little understanding of customer service and what you need, and when you take the time to lay it out for them in plain English, they will quickly explain why it can't be done. If only they could deliver merchandise as quickly and consistently as they deliver excuses. Unfortunately, the one thing these vendors almost always have, in addition to excuses, is a killer item or line that you simply can't live without. Or so you think. They may try to tell you that they are a brand you must have, but if that was the case they wouldn't be a smaller vendor, they'd be a larger vendor.
Then there are vendors that are larger than you. They usually have a brand name that they say you can't live without, and are constantly reminding you of that. Whether you can live without their products may be another thing altogether. Their idea of customer service is that you will do it their way -- their minimum lead times, their minimum order quantities, their payment terms, their returns policies.
Larger vendors will spend a lot of money building their brand. Building a brand has a lot of benefits, the most obvious being that it helps pull sales through the sales channels. But just as importantly, it helps the vendor manage their inventory. How so? Branding enables a vendor to build market leverage with their customers. If you need a particular vendor's goods more than he needs you as a customer, he can dictate the terms of sale, including early booking programs, minimum quantities, and return policies. In this way, a vendor can stuff the channel, forcing inventory off of his books and on to yours. Whether the vendor is a manufacturer or an importer, he can manage his source of supply to his advantage, in order to minimize his costs, not necessarily to maximize his service to you. In any supply chain, inventory will pool with the weakest member of the chain.
So, with all that in mind, here are a few thoughts on managing your vendors:
- Your relationships with your vendors must be mutually profitable. It has to be a win-win. If its not, the terms of the relationship must be renegotiated. You can be sure that if the relationship were not profitable for your vendors, you'd be hearing from them. If it's not profitable for you, they need to hear from you.
- The profitability of your vendor relationships cannot be measured purely in gross profit percentage or gross profit dollars. The true profitability of each vendor is measured in gross profit return on inventory investment. There are a number of factors beyond sales volume and profit margin that determine this. What type of inventory investment do you have to sustain? How long are their lead times? How reliably do they ship on time? How consistent is the product quality? How frequently do they misship you?
- The only reason you are doing business with any given vendor is that you have been able to develop a market demand for their products in your store. The vendor may have spent bundles of money building their brand in the marketplace, but you have proven that customers will buy their products in your store. In your store! And the proof is in your purchase orders to the vendor. The vendor doesn't want to lose your account. You are a proven account in their eyes. If they lost your business and had to find another account to replace you, they have no assurance that they'll be able to do as much business with that new account as they've been able to do with you, despite their marketing budget. And they know it! When you're negotiating with a branded vendor, don't be shy about insisting on what you need. Most of the time you'll get it!
- A small vendor who can't perform is a small vendor who is likely to get even smaller. Whatever marketing initiatives they might have made to build a brand has likely been completely undercut by their operational failures, so their brand probably has a lot less value in the market than they'd like to think it has. What is special about their item or line? Can you get it elsewhere? When you are negotiating with a smaller vendor, don't settle for less than you need. Make it clear that you want to do business with them, that they are the vendor-of-record, but if they can't deliver what you need you know other vendors who can. And, if necessary, don't be afraid to move the business.
- Understand the difference between vendors who are pre-selling an item or a line before they manufacture or import it, and vendors who have goods on the floor or in the pipeline. Vendors who are pre-selling want to sell most, if not all, of an item or line before they have to commit to manufacturing or importing it in order to minimize their risk. A noble thing, but if you give them a purchase order for an item they end up not manufacturing or importing because they didn't take enough other orders, you'll end up not getting the goods, while tying up your open-to-buy dollars in a dead purchase order and not being able to buy other goods. When you are negotiating to buy goods that are being per-sold, ask how much has been already purchased by other customers, and how much more needs to be purchased before the vendor will commit to manufacturing or importing it.
- If you are working with small vendors, perhaps even a home-based business, your costs of doing business with them will likely be higher than with other vendors. For that reason alone, it's probably a good idea to limit the percentage of business you send the way of these vendors. Still, there needs to be a compelling reason to deal with them at all, and that reason will probably have a lot to do with the intrinsic value of their products. If that's the case, then be sure that you offset the higher cost of doing business with a higher than usual margin on their items.
Vendors that manage you, rather than the other way around, can be very expensive. They can slice several points of gross margin off your profitability, tie up valuable cash in unnecessary inventory, and chew up precious time trying to straighten out the problems. By proactively establishing your expectations, and holding each and every vendor to them, you'll have the time and energy to focus on the really important things, like working with your customers and growing your business.