Understanding Open-To-Buy

Increase your inventory turns and youll increase your profit and diminish your risk. Heres how. By Roy Turner
In the past few months, Ive talked with retailers across the country and surf-shop owners reported an across-the-board increase in surfboard and hardgood sales. Everyone commented on the volume of surfboards sold and the fact that they were actually making money on what is generally a lost leader in our stores. The face value of these comments seems quite simple, sell more products, make more money. Yet a closer look flags a unique concept in the retail process: inventory turn or, more commonly called, turn rate. Those of you who have an open-to-buy system in place are familiar with the importance of turn rates and its correlation to profitability. For those who do not have an open-to-buy system in place and are still making purchases based on intuition, take a minute to consider a potentially lucrative alternative. All surf retailers need an open-to-buy plan! Better buying will allow surf retailers to improve cash flow, increase inventory turns, reduce markdowns, and increase profits. What if I could show you a way to make more profit without increasing sales, reducing payroll, or cutting daily expenses? Better yet, what if we can make all this happen and at the same time reduce your capital investments! Interested? Next we break down annual department sales into monthly figures:
Twenty-percent markdown of inventory = $20,000 Profit = $20,000 - $20,000 (markdown) = $0

Inventory Balance September Open To Buy Monthly Procedures

$ 12,000 $ 20,000

T-Shirt Department Sales (by month) January 10% $10,000 February 10% $10,000 March 3% $3,000 April 3% $3,000 May 10% $10,000 June 10% $10,000 July 10% $10,000 August 6% $6,000 September 10% $10,000 October 8% $8,000 November 5% $5,000 December 15% $15,000 100% $100,000
Project Turn Rates.
Once your departments and monthly sales are in place, we can proceed to establishing the turn rates for your inventory. Turn rates are your number-one key to profitability; remember, the more inventory you turn, the more money you make!

To recap the idea of turn rates, assume we become better buyers and can increase the turn of our inventory to 4x or 6x. Even with markdowns, were able to maintain profits and reduce the amount of capital investments needed to generate the same amount of retail sales. Better said, turn rates lower your bills, introduces fresh merchandise, and puts money in the bank!

Inventory Turnover
Now lets look at how to project inventory turnover. Inventory turn factors consist of three main elements: delivery time (the lead time needed for your merchandise to arrive), shelf life (or how long can the merchandise can remain on the floor), and item quantity (based on inventory cost versus projected sales). We can take the turn rate formula that we presented earlier and begin to calculate our ideal beginning inventories. Lets assume 200,000 dollars in sales and a beginning inventory of 50,000 dollars:

By adjusting your sales on a monthly basis, you can keep control of your inventory and cash flow more accurately. An open-tobuy plan will constantly allow you to see exactly where you are overbought or underbought and allow you to adjust accordingly. Being proactive to your open orders result in no excess inventories, less markdowns, and lower accounts payable. We can sum up the open-to-buy initiative in two words: Cash flow!

Ordering Merchandise
With projected inventories in place we can now concentrate on ordering our merchandise. Once again, a systematic approach to selecting your inventory will help with the opento-buy process. When viewing product, take consistent notes including item number, description, retail price (not just suggested price but what the item could really sell for), wholesale price, and a consistent grade. Your grading system need not be difficult. It could consist of a 1,2,3 scoring system, where 1 is a sure seller, 2 is a good product but nothing special, and 3 is a definite no-buy product. Arranging your notes in this fashion will help with only purchasing top items based on selection, style, and value. Be careful not to fall into the trap of duplicating last years orders with a vendor. Last years numbers may also create last years markdowns or a store filled with items ranked 2 or 3. Make sure your opento-buy dollars are filled with items ranked 1. Buying by the item rank will keep a fresher inventory and set your selection above the boxstore mentality of only presenting the basics. Your store will be able to develop its own style and your customers will love you for giving them something different! Better inventory selection leads to fewer markdowns, quicker inventory turns, and ever-changing selections for your customers.

$200,000 $50,000 = 4, or a turn rate of 4x Annual Turn Rate = Annual Retail Sales Annual Retail Inventory
Lets look to an example to see how increasing you turn is important to your overall profitability.
Turn Rate 1X 2X Sales Merchandise Cost Overhea Profit d $0.50 $1.00 $0.10 $0.40 $1.00 $2.00 $0.20 $0.80 $3.00 $6.00 $0.60

The Basics
Mort Haas, founder of OTB Retail Systems, is quick to point out that there are three important rules for formulating an open to buy strategy:

Now calculate our ideal beginning monthly inventories. By dividing the twelve months of the business cycle by the calculated turn rate, we can create an inventory factor that will assist in the projection of ideal beginning monthly inventories:

1. Always buy in retail dollars.

Since your sales are in retail dollars, your purchases should be made in retail dollars.

12 (months in year) 4 (turn rate) = 3 (inventory factor)

With monthly sales projected and inventory factors in place, we can now calculate our open to buy for the next twelve months. Lets refer back to our projected monthly sales for our T-shirt category.

2. Every purchase is by department.

Departments are developed in accordance with your ability to track the data; complete specificity is not mandatory. Now, lets go back to our example store with total annual sales of 200,000 dollars and apply our new idea of turn rate:

3. Everything is done on a monthly basis.

A week is too short to track a trend and does not account for matters like weather. A quarter will not allow you to react soon enough within the surf industrys buying patterns. Monthly reporting and updates fill all requirements and can be easily maintained without being to labor intensive. With these rules in place we can now set the open-to-buy process into a two-fold plan consisting of the setup and the monthly procedures.

Example Store
Turn Rate 2X Annual Sales Merchandise Cost Overhea Profit d $100,000 $200,000 $20,000 $80,000 $20,000 $100,000 $200,000

The Setup
Organize inventory into departments or categories that reflect your stores product mix. This can be handled by your existing point-ofsale system or even a basic cash register. When organizing, remember to make each department defined enough to show relevant data, including sales, markdowns, and returns. Its not a good idea to define categories down to the vendor level as vendors may come and go while your inventory mix will probably remain fairly constant.

Project a Sales Plan.

Your sales plans should consist of annual retail sales and monthly retail sales broken down by department. You can use historical data or projections if you have no previous data. Dont let the lack of data stop you from implementing an OTB plan, you can use projections and make adjustments on a monthly basis. Our sample store produces 200,000 dollars in sales a year and the breakdown by department in annual revenue is reflected in the example below. Remember all figures are in retail dollars. 1. Total Annual Sales = $200,000 2. Annual Department Sales a. T-Shirts 50% = $100,000 b. Surfboards 30% = $60,000 c. Accessories 20% = $40,000 100% = $200,000

Okay, the sales, cost, and profit look the same, so where does turn come into play? A closer look will make you a believer in the magic of inventory turns. In order to generate 200,000 dollars in sales with an inventory turn of 2x, a store would require 100,000 dollars worth of inventory, while a store with same sales volume that can turn its inventory 6x only requires an inventory of 33,333 dollars. The increase in turn has saved you more than 66,000 dollars in inventory or 33,000 dollars in invested capital! Wouldnt you like to have an additional 33,000 dollars next year to help increase your ad budget, increase your square footage, or open a new store? Who knows, there may be enough left for you to take that hard-earned trip to Indo. Another aspect of the magic of inventory appears when markdowns and discounts come into play. Lets look at our example:
Inventory Cost Overhea Profit Sales d $100,000 $20,000 $200,000

A store with a turn rate of 6x requires 33,000 dollars in average inventory to generate 200,000 dollars in sales. Now consider an overall markdown factor of twenty percent.
Twenty-percent markdown of inventory = $6,600 Profit = $20,000 - $6,600 (markdown) = $13,400

Even with a markdown rate of twenty percent were still profitable thanks to our lower inventory cost. But what if our turn rate was only 2x? Then our average inventory cost balloons to 100,000 dollars to generate 200,000 dollars in sales, and when you factor in the cost of the markdown, things get downright grim:

Never Buy Until You See Everything A deal is a good deal only if it works within your projected numbers. Try to buy through the customers eyes.If you are unsure about an item, take a second look and if you are still excited, make the purchase With orders in place, the process of monthly maintenance begins. Whether you have a sophisticated P.O.S. system or a simpler means of tracking sales, be sure to track receipts and the sales of your inventory by department in retail dollars. Tracking your sales will allow you to rank vendor performance, recognize trends and minimize markdowns. Monthly procedures should include Calculating Beginning Inventories moving projected sales up or down and Now project our ideal beginning inventories and begin the second part of our adjusting your turn rates up if necessary. Your overall plan by initiating our monthly process monthly adjustments should be reflected in of open-to-buy procedures. For this example either increases or decreases of your current lets just look at three months and calculate and future monthly open to buy dollars taking what our example stores beginning inventory into account weather, waves, or economic concessions. should be: An open-to-buy plan offers Inventory x Projected Sales = Beginning Inventory Month your store two major strengths. $18,000 $6,000 Factor = x August First, it offers a system to avoid $30,000 $10,000 3 = x September $24,000 $8,000 3 = x October overbuying and underbuying by specifying a relationship between stock on hand and projected sales. Secondly, it If our sales hold true to form we can expect: allows storeowners to adjust future purchases based on sales, markdowns, and trends. August Beginning Inventory $ 18,000 Remember to always allow a small portion of August Projected Sales $ 6,000 your open-to-buy dollars to remain open, so Inventory Balance $ 12,000 you can take advantage of special deals, react Based on our ideal projected inventory of to trends and fill in on items that are selling out. With an open-to-buy system in place 30,000 dollars for September, we would have an open to buy balance of 18,000 dollars. If youre on step closer to more profitability. Dont let your lack of organized data stop you. You our sales for August came in above can begin today. The time and effort you invest expectations our September open to buy can reap huge rewards. would be adjusted accordingly:

Department Sales (Department 1 T-Shirts) January 10% $10,000 February 10% $10,000 March 3% $3,000 April 3% $3,000 May 10% $10,000 June 10% $10,000 July 10% $10,000 August 6% $6,000 September 10% $10,000 October 8% $8,000 November 5% $5,000 December 15% $15,000 100% $100,000

August Beginning Inventory August Actual Sales

$ 18,000 $ 8,000

Roy Turner is the owner of Surf City Surf Shop and is the president and founder of the Board Retailers Association

TransWorld SURF Business

November 2003

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