In This Chapter

After you decide who you want to buy your products from and what products you want to buy, you then must figure out the right quantities, at the right price points, and in the right assortment. Merchandise management is about deciding how much of each product to carry, making sure it’s exactly what the customer wants, when they want it, and at the price that they are willing to pay.

In this chapter, I review the basics of merchandise planning and how to determine the right mix of merchandise. I also discuss how to avoid over-or under-buying, as well as how to manage the goods when they arrive. Finally, I discuss markdowns and the lessons you learn from them.

First, you need to come up with a merchandise plan. A merchandise plan gives you a roadmap for profitably managing what your store will carry for the next season based on the six rights of retail:

To help you develop your merchandise plan, you first need to understand how to group the items you plan to sell into “departments” and “classifications,” also called “categories.” That’s the only way you’ll be able to manage your inventory in a profitable way. Computers make this management much easier today. To help you understand how departments and classifications evolved into what is used in stores today, let’s look at how we got here.

If you had started your business in 1950, you would have run it with little or no structure. With the adding machines that were used then, you would know that you made a total of $500 worth of sales, but you would have no idea what items you sold.

In the 1970s, things got easier. With the evolution of cash registers, you could track your sales by department. At the end of the day, you would know from the cash register tape that you had made a total of $1,500 in sales—and that you had sales of $500 in department one, $650 in department two, and $350 in department three.

As you think through the selection of merchandise you will offer in your store, keep in mind that you should have fewer departments rather than more. Each department should account for at least 10 percent of your business. Therefore, the maximum you mathematically should have in your store is 10 departments. Some successful stores have only one, whereas most have three or four.

Department totals, by themselves, do not provide enough information. You really need to understand what you are selling at a deeper level, as well as what is not selling. You may even want to see these numbers every hour.

Since the 1990s, retailers have been able to use computers to take charge of the merchandise management part of their businesses and structure their inventory to a very high level of detail. Using the right program (I discuss software programs in Chapter 19), you can know your numbers in detail at the end of the day—or whenever you want during the day. For example, your computer system would tell you that you made a total of $4,500 in sales. And that you had sales of $1,500 in department one, $1,950 in department two, and $1,050 in department three. You can even dig deeper into the details and find out what you sold. For example, an electronics retailer could find out that he sold 12 widescreen DVDs and 8 full screen DVDs of a particular movie title.

I often remind retailers that customers “vote with their wallets.” By this, I mean that the most valuable market research you will ever have is the behavior of your customers. You can do all kinds of research to ask customers what they would like to buy in your store, but their answers will all be “in theory.” The only answers that really count are the ones that customers give when they put their money on the counter to pay for their purchases.

The extra information you can get by using computers to manage merchandise is available as long as you develop your merchandise plan with an extra level of detail below departments. The detail can be called either categories or classifications. Both words refer to the same thing: a grouping or assortment of merchandise that the customer views as interchangeable.

Think about how your customers will shop in your store to define your classifications. For example, if you are a hardware retailer and sold out of hammers, a customer will not buy a can of paint and use that to pound nails instead. Paint and hammers would be in different product categories. Or, if you are a women’s fashion retailer and sold out of dresses, a customer will not buy a bathing suit and wear that to work instead. Dresses and bathing suits would be in different product classifications.

As you try to develop your product classifications, remember that when a customer comes into your store looking for a particular item, several items from the same product classification can often meet their needs, but never items from other product classifications. The same rule of thumb applies for a classification as applies for a department: each classification should account for at least 10 percent of your business in that department. Therefore, the maximum you can mathematically have in each department is 10 classifications.

The actual number you choose will be a trade-off between your need for accurate information and your ability to digest that information in a meaningful way. You may decide that different departments need to have different numbers of classifications.

The key here is to let the customer be your guide. If you have too many classifications, some will inevitably represent only a small percentage of your total business. The customers will be telling you clearly that they do not believe you are the right store at which to buy items in that classification.

Sub-classifications or sub-categories are further definitions of a classification or a category. For example, if you are a menswear retailer who does a good business in your dress-shirt classification, you might want to have two sub-classifications—one called long-sleeved dress shirts and another called short-sleeved dress shirts.

Within each sub-classification, you might want to divide things further into lines, items, and stock keeping units or SKUs—the finest level of detail at which you can define an item. For example, here is how a retailer would take a long-sleeve shirt down to the SKU level of classification:

To be a successful retailer, you need to recognize that you cannot be everything for everybody. “I am sorry, but I don’t carry that item,” is one of the hardest things you will ever say to a customer—but you must say it to certain customers. For example, if your business is a shoe store, you may decide that you will not carry shoes for children, not stock athletic shoes, or not offer wider sizes.

Assuming that you have a good point of service (POS) system, which I discuss in Chapter 19, it will be much easier to understand the exact merchandise that your store should carry after it has been open and operating for six months. You will then be able to start tailoring your inventory to match the votes that you got from customers during the first season.

Carrying what your customers want to buy is one of the most critical things you can do to become an important source of that merchandise for them. This is why structuring your business around classifications makes sense. By analyzing your sales at the classification level, you will learn that customers prefer some classifications to others, and that they want to spend a certain amount of money in each classification. Then you can buy accordingly and give them more of what they want the following season.

For example, if you were the menswear retailer selling dress shirts, you might learn that 80 percent of the votes in your dress shirt classification went to items priced between $50 and $60. You might also learn that 90 percent of those votes went to your long-sleeved dress shirt sub-classification. And that 50 percent of those votes went to the Arrow brand.

Here is how the math for that calculation works:

So looking at that calculation, where should you put 36 percent of your dollars when you buy dress shirts for next season? Arrow brand long-sleeved dress shirts would be a good place to start. Assuming the price for the shirts is in the $50 to $60 range and will probably increase to between $55 and $65 in the next season, that’s what you should plan to stock. If you tracked your information to the SKU level, you could take this analysis down to the size, style, color, and fabric that won the most votes from your customers.

Without this knowledge, you could easily put 50 percent of your dollars into shirts priced at $100 and face huge “markdowns” next season when they do not sell. Worse, you could put 50 percent of your dollars into shirts priced at $60 or below and face an entire season in which you can match your unit sales from the previous year but not your dollar sales.

While this level of detail is great information you could base your decisions on, there is a limit to this. You will sell thousands of different SKUs each day or week, and analyzing sales at the item, line, and sub-classification levels will probably be overwhelming. That is why I suggest that you just look at classifications.

In fact, if you manage the entire merchandise management side of your business at the classification level using the right technology, you will achieve a level of information and control that most owner-operated retailers only dream about. At the end of every day, you will be able to look at your sales by department to see if you are meeting your goals. If you are, everything is fine and you can go home to rest.

If you are not meeting your goals, you will be able to “drill down” to the classification level and find out why. Perhaps you will find that within a certain department, classifications one and two are performing well but classification three is nowhere near budget. Once you know that, you can go home—with a clear understanding of what you need to look at first when you come in the next morning.

In addition to picking the right products, you also need to carry the right assortment of those products. Assortment dimensions include sizes, colors, styles, price ranges, fabrics, and lifestyles. The process of assortment planning is complex. Most retailers take years to learn how to do it properly. The complexity is due to the fact that you are dealing with a process that has many dimensions or components. When buying merchandise for your store, not only must you select an appealing range of products to buy, you also need to make sure that there are choices of colors in each of the styles. In addition, you have to have low-, moderate-, and high-priced items for different customers. And you most likely need to have different materials or fabrics. Finally, you need the product to appeal to different lifestyles. When you take a total quantity of 1,000 different products and begin to break them down by all these dimensions, it gets quite complex.

In analyzing your sales to determine why certain items sell well whereas others don’t, you need to look at your stock based on the many dimensions that you used when you created the assortment in the first place. If you want to know why one item is not selling, you must look at last season’s sales and markdowns by size, color, lifestyle, and so on, and then decide to remove not the entire item from your assortment but only specific colors or sizes that do not sell.

Most retailers find they have winners in their inventory that customers buy a lot and they just did not have enough items in inventory to satisfy their demand. Similarly, they find that a majority of their inventory is not selling as well and is therefore unprofitable.

Assortment planning helps you focus on the 20 percent of your most profitable stock with the goal to increase it to ensure improved sales. In order to develop a well-balanced and profitable merchandise line, you must follow some important rules:

Looking at the past is key. However, it might not work every time. For example, if you are running a clothing store, last season’s markdowns on certain styles or fabrics might not have anything to do with this year’s performance of similar products. It might be that a style that will sell this season was bought too early last year and is just now catching on. Or a fabric like cotton will be back “in,” or denim will make a dramatic turnaround. You must look at the past but not be a slave to it. Customer behavior is just a rear view mirror. It does not always predict the future.

We all need to become better at identifying the true market value of the products we sell and understanding that there are customers who will generally pay more if the product is right, customers who will pay more at certain times, customers who will never pay more, and customers who simply are not influenced by price at all. I know that you are asking yourself where you can find more of the latter! But the truth remains, price is an important factor to many of your customers, and how you set your merchandise prices is critical to your business strategy.

If you don’t have a clear price policy, you are flirting with disaster. Whatever your price policy is, you must always be prepared to explain it to your customers.

If something doesn’t sell within at least three months of your putting it on the shelf, you do want to mark down the price and move it off your shelf so you can make room for items that are selling. When you take a markdown, not only must you learn something from the action, but you must also be able to explain to your customers why you are doing it. If you fail to explain to your customers that this is a markdown for the end of season, because products are damaged or defective and so on, then you run the risk of your customers not believing any of your prices and turning each interaction with your customer into a mini auction.

Can you imagine a return to the days when every transaction with a customer was a negotiation? What would your store be like if every item was open to negotiation by the customer? Yet this is what is possible and is already happening on the Internet today. You need to move your customers away from a price only concern. Here are five suggestions that will help keep you out of the price only game and will give you a strategy for your price policy:

Just as you plan and budget everything else in your business, you need to plan and budget your markdowns. Retailers use two kinds of markdowns: regular and promotional.

Regular markdowns are the ones you take to reduce permanently the book value of certain items in your inventory. For example, you might reduce a particular line in which you have only broken sizes, colors, or assortments from $49 to $39. You will actually cross off the old price on the price ticket and write the new price using a red pen.

Promotional markdowns are the ones you take for a specific event such as a “weekend sale.” You might, for example, plan to sell 50 of a particular item at $19 instead of $24 during that period. You need to include a promotional markdown of $250 (50 units × $5) in your plan, but you will only record a markdown for the items that you actually sell.

In the case of promotional markdowns, you do not permanently reduce the price of every unit you have in the store. After the sale, the remaining items are still in your inventory at regular price.

It is vitally important that you record and track every change from the original ticket price of every item you bring into your store. Computer systems can do this automatically if you change the price in the computer at the same time as you change the price of an item. If you do not have a computer inventory system, you must manually record each price reduction on a markdown form.

If the price change is only temporary and the item will return to “regular price” after that—such as a promotional markdown for the “weekend sale” described previously— you will only record a markdown when you sell an item. The promotional markdown list that you keep beside the cash register for those three days might look like this:

You can fill this in for each promotional markdown you take at the cash register. Most stores fill in the names and stock numbers of the promotional items in the morning and just enter the units sold with hash marks as they go through the day. I filled in a sample promotional markdown list below to show you how that looks:

To record regular markdowns—also called “permanent” markdowns because the selling price will never go back up—you should use what is called a “laundry list.” You use this list to record a batch of markdowns, completing one line as you change the price of each group of items. Here is what a regular markdown “laundry list” might look like:

By using both a promotional markdown list and a regular markdown “laundry list,” you can keep track of every markdown you take. You will constantly be updating your inventory value and tracking your reductions. You can then use this information to identify bad vendors, colors, materials, or sizes so that you do not make the same buying mistake again. In Appendix C, I include a “Regular Markdown Laundry List” that you can use to keep track of your markdowns.

When you take regular markdowns, you should ignore the cost of the items. Remember that your customers do not care in the least what you paid for an item. They only care about what they must pay for it. The whole point of taking regular markdowns is to adjust your inventory to “market value”—the price your customers will pay.

You should always take your regular markdowns on the first day of the month, so you have the maximum number of days in which to record a sale to offset the markdown. Because you record your regular markdowns by month and by classification, it is quite possible to have markdowns that exceed your sales in some months. This is not something to fear if you clean up a problem and learn from the experience.

As we mentioned earlier, “Your first markdown is the cheapest.” This suggests that when you recognize you have made a buying mistake, you should deal with it. Try to eliminate the problem with the first markdown instead of reducing the item’s price a little at a time, thus keeping your mistake “front and center” for weeks or months.

A number of formulas purport to tell you how much to take as a first markdown, but I do not really trust any of them. Instead, you should determine the appropriate price reduction by looking at your original quantity, your rate of sale, and your stock turnover goals for the classification. The idea is to calculate how long this particular item would likely be in your store if you did not take the markdown.

For example, if you originally bought 25 of an item and still have 17 of them left after eight weeks, the rate of sale is one per week. This means that you have at least a 17-week supply if you do not take the markdown and possibly longer because size, color, and assortment factors may slow the rate of sale even more. When you sell the last piece, that item will have been in your store for almost the entire 26-week season.

If you have a turnover goal in that classification of more than two turns per year—it should be at least three and preferably four turns per year—you should “bite the bullet” and cut the price. You likely paid for the item after 30, 60, or 90 days, so you are looking at your own money, including all of your potential profit, when you look at those 17 pieces.

If you choose the right markdown price and sell the 17 pieces in a week or two, do not second-guess yourself. Understand that you took the right action and chose the right price. Just be certain that you learn from the experience. Decide which of these mistakes you made:

You may determine a different reason for the mistake. Whatever the reason, be sure to note it on your markdown laundry list so you can avoid making the mistake again.

If you find yourself in a position where you have more items to mark down than you have markdown budget available to do it, this could be the result of many factors, including:

In an ideal world, owner-operated retailers would follow a “seasonal” philosophy when it comes to taking markdowns. This philosophy says that you should give merchandise in your store extended exposure at full price, taking markdowns only at the end of the season. In practice, this usually translates into a commitment to hold your price for at least 16 weeks.

By following a seasonal markdown philosophy, you will give your customers time to see your full merchandise assortment. They will be able to see how various items fit together and get comfortable with any new ideas. You will be able to tell them with confidence that it is okay to buy at full price today because everything will not be going on sale tomorrow.

In fact, under a strict application of the seasonal markdown philosophy, all of the merchandise from a season would go on sale at once—in the last six weeks of the season. This strict application would make sense if you could buy perfectly, but no retailer has ever been able to buy perfectly. That is why I recommend that you take regular markdowns.

And when you take these markdowns, you should move the items to a special rack or area near the back of the store. You should never contaminate your regular-price selection or highlight your buying mistakes by placing them at the front door. Customers who want discount prices will gladly walk through your regular merchandise to find the “bargains.”

To help make things clear for your customer, you should always adjust sale items to specific price points instead of to percentage discounts. This will let you create a $10 table, a $20 rack, or whatever. With experience, you will learn the “sale” price points that work best in your business and can work those into your plan.

As an owner-operated retailer, you need to build a reputation for quality. Which means that you need to protect your integrity and not play the sale game. Your prices should fluctuate based on a week-by-week plan that you create at the start of the season—although there will always be minor modifications due to competitive conditions.

Once you start moving toward the discount arena, you will find yourself competing against the category killers and big-box retailers, and you will almost certainly lose.

If you need to lower your prices in order to meet your weekly or monthly sales goals, something is drastically wrong somewhere in your business, and you should seek professional guidance immediately.

Once you know your departments and classifications, you’re ready to think about designing the layout of your store. In the next chapter, I introduce you to store design.