Multiply your retail profits : Focus on this Key Metric
One of the key reasons why a business exists is to make money i.e to make profits. Whenever we talk about profits, what comes to our mind and what gets normally discussed is the gross or net margins in %. Muliplying profits is not a marathon anymore. This post aims to look at how.
Let me start with a real life case. Few years back while working at an MNC retailer, in one of the review meetings we were discussing the sales and margins of various categories of the retailer. The attention of the audience went to a category that had very low margin. It was “tobacco”. The margin % was a very low single digit. As expected tobacco was selling very well and hence pulling the overall margin % of the store down. The concerned category head was questioned on why the margins were so low for that store and why would he sell more of tobacco? He was struggling to rationalise. In this context, tobacco was being compared against fashion products which were selling at 10% margin and 90 days average inventory.
A version of this argument continues to happen across the business review meetings of many retail organizations. In order to better understand the above problem, one needs to use a slightly different lens.
When we invest money in a bank FD, what is the return we get? We get say 8% in one year on the invested capital. Can we express this in a simple equation?
Return on invested capital (say USD 1000) = (profit after taxes) * (velocity) = (8%*(1-.3)) * 1=5.6%
Velocity in this equation is the rate of turn of the invested capital in unit time, in this case 1 year.
Let us now invest the same amount of USD 1000 in tobacco which has a margin % after taxes of say 2% , it turns 180 times in a year (average inventory of 0.5 days, turning twice in a day), what would be the return on invested capital in one year?
Return on invested capital (tobacco) = M (margin after taxes) X V (capital turn/year = sales/capital)
= 2 x 180
Return on invested capital (fashion) = M (margin after taxes) X V (capital turn/year = sales/capital)
= 10 x 4
Where would you invest if you were purely a financial investor between the two products? Which metric drove your decision, was it Margin% or Return on capital?
While it may look simple, many retail business managers and their dashboards do not capture this metric as a part of their decision making. While margin is a function of price and cost, velocity is a function of relevance of products and responsiveness of supply chain.
A great benefit of Velocity as a metric is its focus on consumer. There is no velocity if there is no consumer pull. A focus on this metric in any organization would automatically make the organization consumer centric. It is a movement from focussing on generic static metrics to relative metric. For eg. If there is a conversation around sell through’s , velocity is sell thro in unit time for eg weeks.
One exercise you could do quickly is to stack rank all your products on ROIC (return on invested capital) and see how you could strengthen the availability and rage of the top ones, while improving the low ROIC products. You would realise that some of your products which you thought were of low margins suddenly become cash cows. These products not only bring cash, they also bring more customers and existing customers more frequently. It is the “velocity” of products that brings velocity of “cash” , “revenue”,“return on capital” and “customers”.
Smart CEOs and managers understand this metric well, this is the metric (velocity) used by Dell to outcompete the rest in the computer market. In the world of fashion, Zara understood this very well. Velocity can be a sustainable competitive advantage particularly in a business where the traditional lead times are longer and the product life cycle is shorter.
High velocity value chains can be a great anti dote to the unpredictability of a rapidly changing business and product contexts.
Keep watching this space on “how an organization can build a high velocity value chain ?”. A hint is “A Ferari car has far fewer parts than many other cars, but each of the parts are super good”.
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Originally published at retail.economictimes.indiatimes.com.