FIRST IN A SERIES ON RETAIL OPERATIONAL EFFECTIVENESS

O P E R AT
EFFECT

IONAL
S

IVENES

golden egg forretail

a

VPI DELIVERS A BOOST TO MARGINS

ABOUT THE RETAIL OPERATIONAL EFFECTIVENESS SERIES: McKinsey's Retail, Apparel and Hospitality Practice developed this series of articles to help retailers enhance their performance by utilizing optimizing tools and novel operations approaches. This is the first in a series of occasional articles.

ABOUT THE AUTHORS: The authors are leaders of McKinsey’s Retail Vendor Performance Improvement initiative. Laura Meinke is a consultant in McKinsey's Cleveland office, Elizabeth Mihas is a consultant in the Chicago office, Michelle Moorehead is a consultant in the Dallas office, and Nick Semaca is a principal in the Chicago office.

COPYRIGHT © 2000 MCKINSEY & COMPANY. ALL RIGHTS RESERVED.

The disciplines and organizational processes that comprise VPI allow merchants to think beyond individual buys to develop a strategic view of their business while driving dramatic increases in growth and profitability. The Internet. This article will: • Show how VPI can lead to substantial profit improvements through cost reduction and top-line growth Examine the barriers to capturing maximum value from VPI Define the five key practices retailers must adopt to seize the VPI opportunity • • V P I : A G O L D E N E G G F O R R E TA I L 1 . and logistics. Vendor Performance Improvement (VPI). Yet a powerful optimizing tool.golden egg forretail etail earnings are feeling the squeeze. remains little used and poorly understood. a VPI DELIVERS A BOOST TO MARGINS R VPI is a rich process that enhances retail margins by deepening buyers’ knowledge of their category’s economics. buying. It embraces vendors as partners in the systematic assessment of vendors’ capabilities — existing and potential — and retailers’ opportunities to improve in category management. industry consolidation and changing demographics are all applying pressure to the top and bottom lines.

VPI leads to the Exhibit 1 THE VPI PROCESS Tasks Create fact base Assess opportunities and potential impact Finalize recommendations End products • Clearly articulated category strategy • Vendor and productspending database • Total cost of merchandise • End-to-end supplychain flow • Supply-market assessment • Key opportunity levers • Segmented vendorsourcing strategy • Request-for-proposal (RFP) • RFP evaluation criteria • Negotiated pricing terms and conditions • Detailed implementation plans with actions. manufacturing processes. Depending on the character of the retailer’s business. objective examination of poorly performing elements of a business. Such a comprehensive look allows a retailer to identify its largest and most compressible costs and provides comparison points across vendors. the levers that will most enhance profitability vary with supplychain and selling-cycle characteristics. supply chain. Source: Team analysis 2 © M C K I N S E Y & C O M PA N Y 2 0 0 0 . While every category requires a systematic. payment flows. Time invested varies with the category’s complexity. and product merchandising and servicing on the store shelf. VPI examines all aspects of the business and all aspects of vendor relationships (Exhibit 1). Ultimately. retailers and vendors explore a comprehensive set of opportunities to improve profits. fact-based approach. VPI also requires internal. VPI can vary widely in its application. responsibilities. and timing • Monitoring and tracking mechanisms • Modified budget • Key learnings It takes 16-20 weeks to execute VPI. including the supplier’s purchase of raw materials.The size of the prize validates VPI In the VPI process. A critical element of VPI is an end-to-end analysis of the total cost of merchandise.

We’ve seen overall costs as a percent of sales reduced by 7 percent. Repositioning product to be more on trend or to address strategic gaps in assortment can result in a significant sales boost. Exhibit 2 VPI DRIVES COST SAVINGS NO MATTER THE CATEGORY Category VPI outcomes Results Grocer – cheese • Centralized purchasing organization • Consolidated/standardized vendors and SKUs • Created regional distribution centers 1% gross margin increase Catalog retailer – • Developed and enforced standards across all apparel groups private label apparel • Developed supplier cost model to reduce purchase price • Reduced vendor base 5% gross margin increase Mass merchant – • “Unbundled” product costs to negotiate better terms do-it-yourself • Changed distribution flow from DSD to through DCs Source: Team analysis • Identified product cost/quality inconsistencies 6% gross margin increase VPI also produces significant top-line revenue growth. hardline. By taking our VPI Savvy Quiz (on following page). It’s common to see improved access to proprietary product.identification of vendors with capabilities and product assortments that will maximize a retailer’s business — both bottom line and top line. V P I : A G O L D E N E G G F O R R E TA I L 3 . better in-stock performance.and softline-focused retailers alike. The VPI approach is equally valid for large and small. which translates into better than 40 percent improvement in net contribution margin. and hardlines yield 1 to 7 percent (Exhibit 2). softlines yield 2 to 6 percent. and enhanced product features or packaging resulting from VPI. McKinsey experience affirms that profit improvement from VPI can be significant no matter the category. The savings range varies principally by the retail category and skill level of the buying organization: consumables and grocery typically yield savings of 1 to 3 percent. you can determine whether your merchant organization has room to improve its skills to drive bottom-line improvement and top-line sales growth.

from gross sales to net contribution after store direct expense? Do you conduct a full category line review. 1 2 3 4 5 6 7 8 Do your merchants understand their key suppliers’ product economics i.e. and logistics to evaluate a category’s fully loaded. VPI will certainly help you achieve your goals. including vendor composition assessment. total cost of merchandise? Is your activity-based cost information widely used and trusted as accurate for decision making within the organization? SCORING: 7-8 yes responses 5-6 yes responses 1-5 yes responses Congratulations! You’re probably already implementing VPI to your advantage. do your merchants develop formal requests-for-proposal from the supply base and optimize both top-line sales attributes and total cost of merchandise? Do your merchants meet regularly with your distribution and logistics organization to identify profit-improvement opportunities? Do your internal information systems enable merchants.What’s your VPI SAVVY quotient? Can your merchant organization improve its skills to drive bottomline improvement and top-line sales growth? Take the VPI Savvy Quiz to find out. You may be missing opportunities to reduce costs and increase top-line growth. planners. Consider VPI.. each year? Do your merchants have clearly defined vendor segmentations and objectives by segment? For significant categories. 4 © M C K I N S E Y & C O M PA N Y 2 0 0 0 . suppliers’most significant cost drivers and their overall margin size? Do your buyers understand the total cost of merchandise.

Consequently. suppliers often do not properly understand the true cost of serving different retail accounts. most retailers pride themselves on executing this role well. buying is often seen as the most important role in retail operations. or experience to re-engineer the cost of their key products and to ensure that product pricing across lines is consistent and rational. Our work with retailers suggests that five barriers impede buyers’ ability to maximize value: 1 2 3 4 5 Incomplete knowledge of supply-market opportunities Disproportionate focus on short-term performance Unwillingness to switch lines and vendors Misaligned incentives Limited availability of information to support decision-making BARRIER 1: Incomplete knowledge of supply-market opportunities Buyers rarely grasp their key suppliers’ margin structure and the profit distribution between retailers and vendors. Likewise. Few buyers have time.Leap these hurdles to capture VPI value Why then haven’t more retailers seized the VPI opportunity? After all. resources. and without having the knowledge needed to truly optimize the deal. Our research indicates vendors sometimes offer significant differences in cost and deal structures to their V P I : A G O L D E N E G G F O R R E TA I L 5 . But it should be no surprise that buyers fall short given the scale of the barriers they often face. many buyers focus simply on bidding the business without a structured process. And.

to maximize consumer appeal at minimum cost. VPI provides the opportunity to step back and take a longer-term view. but invariably uncovers opportunities to improve short-term performance as well. BARRIER 3: Unwillingness to switch lines and vendors New vendors can seem risky to buyers who have established vendor relationships.multiple retail accounts. For hardlines businesses. In this environment. and frequently have a deeper understanding of the competitive dynamics shaping an industry. but this often results in short-term planning. vendor pricing is often hugely variable. Buyers prefer incumbents on the better-the-devil-you-know principle and avoid investing time in testing and piloting new lines and products. especially those with slow turns. This not only improves the strategic health of the business. In the noise of allowances. The success of this month’s advertisement often overwhelms buyers’ ability to step back from day-to-day assortment management to think strategically about overall category direction and anticipate transitions in consumer needs. BARRIER 2: Disproportionate focus on short-term performance Making the week’s sales targets and constantly showing good comps are top priorities for all buyers. Often. co-ops. Or. and distribution costs. This is particularly relevant to fashion-driven businesses such as home furnishings. vendors often are more knowledgeable than retailers about category and consumer trends. vendors and retailers can cooperate to optimize specifications for private-label goods. For example. 6 © M C K I N S E Y & C O M PA N Y 2 0 0 0 . vendors and retailers can fine-tune assortments by testing new product in pilot stores before rollout to evaluate order quantities and optimal assortment mixes. switching product lines can be expensive and messy. program fees. VPI provides value to retailers and suppliers who work through these issues and then share the savings discovered. this deters buyers from exploring alternate suppliers or pushing existing suppliers to collaborate to reduce costs. As a result. it is challenging for both buyers and suppliers to know if a better structure or price exists.

buyers may not challenge themselves to investigate potential supply-chain opportunities such as: • Reducing cycle times to better align with emerging marketplace trends Shipping direct-store-delivery versus to distribution centers Optimizing inbound order quantities and shipment modes to improve trade-offs between inventory. transportation costs. Buyers also need a good grasp of the internal economics of their business. in-store managing costs. its strengths and its weaknesses. and instock status • • By taking a look at a category’s total economics. Such information would allow buyers to V P I : A G O L D E N E G G F O R R E TA I L 7 . and a deep understanding of their vendors’ capabilities. Without incentives to optimize their products’ total cost. where the costs of handling. and net profitability compared across vendors. buyers aren’t motivated to look for cost-reduction opportunities in such areas as distribution centers. retailers assess these risks objectively. and often find that vendors can help reduce or eliminate them to capture joint opportunities. VPI highlights where incentives may need restructuring to enhance overall goal alignment. So. Gaining a complete understanding often requires working with multiple vendors to build a market profile. VPI also provides the quantitative information needed to create a new incentive plan. BARRIER 4: Misaligned incentives Buyers’ incentives typically are limited to sales and gross-margin performance. BARRIER 5: Limited availability of information to support decision-making Buyers rarely receive adequate external information — on consumermarket and supply-market trends — to fully comprehend their marketplace. shipping. It’s rare for buyers to have access to data that clarifies the true cost of shipping and handling. and logistics can represent up to 20 percent of product cost.Through VPI.

The absence of user-friendly desktop systems that link activity-basedcosting logistics and distribution-cost systems.identify opportunities for supply-chain savings and joint buyer-vendor cost reductions. and different accounting methodologies for advertising allowances. also represent significant hurdles. accounts-payable systems. For many retailers. 8 © M C K I N S E Y & C O M PA N Y 2 0 0 0 . the VPI process represents the first time they have assembled all the information needed to optimize their merchandise strategy.

most companies start with a handful of target categories and expand over time. collaboration with vendors. Often. and how the retailer will select merchandise. critical shopping occasions. VPI builds on and enriches a category strategy. price. making the transition is a learning process.Seizing the VPI opportunity The good news is that these organizational barriers to VPI are surmountable. A clearly defined category strategy identifies the target consumer. It is the roadmap that defines the must-have strategic brands and the assortment V P I : A G O L D E N E G G F O R R E TA I L 9 . and decision-making processes to support and sustain VPI results K E Y P R AC T I C E 1 : Clearly articulate a category strategy To enable maximum value from VPI. High performing organizations combine smart negotiating. merchants should establish clearly articulated category strategies. performance metrics. We’ve seen success with VPI when merchants adopt these five key practices: 1 2 3 4 5 Clearly articulate a category strategy Rigorously develop and use external and internal information Segment vendors and apply tailored sourcing strategies to each segment Aggressively coordinate all profit improvement levers in vendor negotiations Realign skills. and a willingness to make tough internal tradeoffs to drive significant bottom-line profit improvement. and service to meet consumers’ needs.

The process led to the identification of a clear set of preferred brands. color. and availability of substitute products. 10 © M C K I N S E Y & C O M PA N Y 2 0 0 0 . co-ops. The retailer identified gross margin improvements of 2 percent from reduced returns. VPI can be an effective way to rethink areas of weakness and fine-tune the strategy to best leverage market opportunities. and clear standards for size. industry reports. merchants must analyze SKU and vendor productivity to the net contribution level. A European catalog retailer developed its private-label-apparel strategy based on market research and a complex review of 700 suppliers. supply chain. and in-store service and display costs) can lead to insights into cost-reduction opportunities. Even when external information is not readily available. payment terms. and global sourcing offices. a rationalized vendor base. as well as associated buying and supply-chain processes. Valuable internal information includes vendor. To evaluate opportunities for substitution or expansion. and quality.and product-spending performance history. It sets category sales and contribution-margin targets. manufacturing capacity. If the category strategy falls short. a picture of the external marketplace can be developed from vendor visits. External information addresses the supply market — that is. Understanding the total cost of merchandise (net category contribution including the impact of allowances. competitive dynamics. and increased quality. a vendor scorecard based on logistical and financial measures.of branded and private-label options. K E Y P R AC T I C E 2 : Rigorously develop and use external and internal information VPI’s foundation is the rigorous development and use of external market data and internal cost-of-ownership analysis.

Using both levers. Concurrently. savings exceeded 7 percent of total cost.Exhibit 3 shows how a U. the retailer reverseengineered the product with the help of independent testing laboratories.S. The retailer then assessed whether to fund each component and also eliminated unnecessary service and support costs. retailer used VPI in a formal request-for-proposal to unbundle a vendor’s products from marketing services and support costs. Exhibit 3 UNBUNDLING COSTS REVEALS COST-SAVING OPPORTUNITIES DISGUISED CLIENT EXAMPLE RETAILER Percent 100 7 Freight 5 POP and National in-store equipment brand support 5 6 2 Sales force Cash discounts 7 68 Advertising allowances VPI revealed that bells and whistles comprised 16% of total invoiced costs to retailer Total invoiced cost (fullyloaded cost) Source: Team analysis Net product cost (unbundled cost) V P I : A G O L D E N E G G F O R R E TA I L 11 .

and businessassortment strategy (mix of promotional versus basic SKUs). Exhibit 4 shows how the retailer plotted all vendors on two dimensions. Exhibit 4 SEGMENTING VENDORS ACROSS TWO DIMENSIONS ALLOWED A VENDOR TO TAILOR STRATEGIES DISGUISED CLIENT EXAMPLE DEPARTMENT STORE Vendor Improve financials or trim from base Develop partnerships Logistical score (fill rate. as well as total cost of merchandise). etc. based on performance. vendor capabilities (lead times and supply-chain flexibility). The retailer sorted out profitable vendors from those that needed to be pruned.K E Y P R AC T I C E 3 : Segment vendors and apply tailored sourcing strategies to each segment The third aspect of VPI combines category strategy with external and internal information to create a high impact vendor sourcing strategy. Vendor sourcing strategies vary along many dimensions and address the desired number of vendors. Overall this resulted in a 2 percent improvement in net contribution. A North American department store using VPI segmented its apparel vendors along two dimensions: logistical capabilities (fill rates. mix of domestic and offshore sources. and then tailored a strategy for each. percent on time.) and financial impact (the gross margin percentage it brought the category. percent of time) Trim or justify testing longer Improve logistics or trim from base Financial score (GM%. TCM) Source: Team analysis 12 © M C K I N S E Y & C O M PA N Y 2 0 0 0 .

Exhibit 5 shows how a softlines catalog retailer used merchandise analysis to identify two cost elements with significant variability across vendors: merchandise returns and payment terms.K E Y P R AC T I C E 4 : Aggressively coordinate all profit-improvement levers in vendor negotiations The fourth element of VPI involves using all profit improvement levers.1 5. and reducing the basic cost of goods.6 67.0 9.4 0. This initiative led to a 3 percent increase in gross margin.5 POP 100. Exhibit 5 MERCHANDISE ANALYSIS REVEALS COSTS THAT VARY BY VENDOR DISGUISED CLIENT EXAMPLE CATALOG RETAILER Percent 21.Shipping scence Vendor's rates varied by 50% Product cost Total merchandise cost V P I : A G O L D E N E G G F O R R E TA I L 13 . minimizing transactional costs.6 5.8 3. not just product cost.4 Quality Advertising control allowances Inventory Returns Payment terms Obsole.7 3. Recent work with a discount retailer identified a 30 percent logistics savings accomplished by shifting product delivery from direct-to-store to just-in-time through the warehouse. eliminating unnecessary middlemen. The retailer then identified vendors with the least attractive returns and payment terms and renegotiated higher performance standards. This includes improving supply-chain flows.9 1.

Such incentives encourage cooperation among merchandising. and decision-making processes to support and sustain VPI results To maximize VPI results. This shift resulted in greater attention paid to freight costs.and activity-based cost-measurement tools to support a thorough analysis of product costs and track overall savings. rather than are shifted to other cost centers. stores. retailers should: • Craft incentives that motivate buyers to take full ownership of the cost of merchandise and ensure that VPI savings make it to the bottom-line. and logistics. A large home-furnishings and furniture retailer recently changed its incentive system to one that includes the metric net-contribution-after-supply-chain costs. performance metrics. Develop systems. and decision-making processes. into the buying process and line review. such as formal vendor requestsfor-proposal. Build new analytical skills and tools. merchants must realign metrics. tools. Specifically. 14 © M C K I N S E Y & C O M PA N Y 2 0 0 0 . buyers evolve from shepherding a transaction to managing a strategy. buyers manage the business proactively — instead of reacting to supply-market fluctuations — which may make their role more professionally rewarding. With VPI.K E Y P R AC T I C E 5 : Realign skills. which reduced the total cost of the merchandise by 1 percent. • • By incorporating these five key practices into the retail organization.

the most promising categories are those with complex. When selecting which aspects of a business VPI will address first. We suggest launching VPI with three or four pilots to prove the overall approach and build internal skills.Executive endorsement eases the way Executing VPI may seem daunting. the scale of the organizational development required suggests a slow-build approach to prove the case for VPI with respected merchants in an organization. This may come in handy if incumbent-but-at-risk vendors feel threatened and seek to circumvent the formal process – even reaching to senior executives to disrupt it. diverse supply markets. Depending on your buyers’ experience. and bring supplemental resources to buyers. It also promotes buyers’ cooperation and enthusiasm for VPI. Organizations that require significant skill building must develop a tailored and disciplined process that establishes VPI capabilities. Senior management’s involvement empowers merchants in their communications with vendors. These success stories can generate demand for VPI across an organization. Developing a rigorous understanding of a category requires dedicated resources and a concerted focus on results. Two options exist for getting started with VPI: slow-build or immediate commitment. institutionalize learning. it also may make sense to add one or two analysts with complementary V P I : A G O L D E N E G G F O R R E TA I L 15 . Merchants should consider dedicating a VPI SWAT team to drive the process. and rightfully so. S TA RT S LO W LY If you need to build the case for change If your company scores low on the VPI Savvy Quiz. some brand flexibility. and turn rates that allow the merchant to transition assortments without incurring prohibitive markdowns on obsolete merchandise. Senior management support is critical as the process involves tackling traditional organizational barriers.

SPEED IT UP If you have some VPI skills in place Retailers who score in the mid-range on the VPI Savvy Quiz and have access to internal financial performance data and sophisticated systems can move more rapidly with VPI. eventually covering all critical elements of the business. can you wait? VPI can create 16 © M C K I N S E Y & C O M PA N Y 2 0 0 0 . These retailers may consider a multiwave VPI program with five to six categories in the first phase of the program. is the challenge. When the VPI process is complete. Once the case is built. both top-line growth opportunities and drive bottom-line savings for retailers. VPI provides better strategic control of the business and can generate 5 percent or more in net margin improvements. it requires developing crossfunctional incentives that align buyers and supply chain alike and. however. VPI can be finetuned and rolled out in broad waves every four to five months.financial and strategic skills. Getting there. The faster a retailer can ramp up a VPI program the quicker significant profit improvement will be achieved. With results like these. and take a cross-functional view of margin opportunities. a dedicated SWAT team to provide analytical support to the merchants. It requires merchants to rethink traditional attitudes to managing vendors. the size of the prize is significant. build analytic skills. usually. VPI is a detailed and rigorous approach to developing a profitable advantage. When VPI is executed successfully. Organizationally. the buying team should repeat it every two to three years to confirm category knowledge and sharpen the strategy.

.

AMSTERDAM ANTWERP AT H E N S AT L A N TA BANGKOK B A R C E LO N A BEIJING BERLIN B O G OTA B O S TO N B R U S S E LS BUDAPEST BUENOS AIRES CARACAS C H A R LOT T E CHICAGO CLEVELAND C O LO G N E COPENHAGEN DALLAS DELHI DETROIT DUBAI DUBLIN DÜSSELDORF F R A N K F U RT G E N E VA G OT H E N B U R G HAMBURG H E LS I N K I HONG KONG H O U S TO N I S TA N B U L J A K A RTA JOHANNESBURG K UA L A LU M P U R LISBON LO N D O N LO S A N G E L E S MADRID MANILA MELBOURNE MEXICO MIAMI MILAN MINNEAPOLIS MONTERREY MONTRÉAL MOSCOW MUMBAI MUNICH NEW JERSEY N E W YO R K NEW ZEALAND ORANGE COUNTY OSAKA O S LO PA C I F I C N O RT H W E S T PA R I S PIT TSBURGH PRAGUE RIO DE JANEIRO ROME SAN FRANCISCO SANTIAGO S Ã O PAU LO SEOUL SHANGHAI S I L I C O N VA L L E Y SINGAPORE S TA M F O R D S TO C K H O L M S T U T TG A RT SYDNEY TA I P E I TO K YO TO R O N TO VIENNA WA R S AW WA S H I N G TO N . D C ZURICH .

Sign up to vote on this title
UsefulNot useful