Open to Buy Planning

The formula for open-to-buy (OTB, a financial budget for retail merchandising) planning is not difficult. To start, look at planned sales. Where do they come from? Most independents get into trouble right out of the gate, by getting this segment of the planning process wrong. A common, albeit incorrect approach, is to plan monthly sales volume based on last year. Using last year’s figures to project future sales is wrong on several levels. If sales last year were driven by markdowns and were thus unprofitable, there is a good chance that planning around that number for the upcoming year may render the same, if not worse results. If sales were off due to a downward fashion trend or poorly timed shipments, the classification (method used to organize and analyze sales and inventory data) would also falter and the store may in fact end up under planning the classification.

Sales planning, projecting, forecasting or whatever label you wish to assign to it, needs to be done at the classification level and not by brand. Most independents almost always want to plan for an increase in business, whether warranted or not. An unrealistic sales forecast will generally lead to an overbought situation, which in turn will lead to increased markdowns at best, and decreased turn and cash flow at worst. Classifications get planned up based on profitable sales and trends, and down when the reverse happens. Merchandise planning that originates at the class level and rolls up to the department and then store level is referred to as bottom-up planning, as opposed to top down planning, which emanates from a total company plan and works its way down to the class level.

Planning the needed stock level to support the sales plan is the next phase. This is accomplished by the use of stock/sales ratios. A stock/sales ratio is simply the relationship between stock and sales. It is related to the turnover and the proper timing of deliveries. Stock/sales ratios are different for each classification and for every month. This is perhaps the single most compelling reason for automating the planning process. For example, a classification that is planned to turn three times would have a stock/sales ratio of 4. This can also be viewed as a number of months of supply to have in stock. (12 months/3 turns = 4 months of supply). If a classification holds more than it can sell for a given period of time, the stock/sales ratio increases, and over time, turnover will decrease. In severe examples, this can lead to higher markdowns than usual, reduced margins and an overall reduction in gross margin return on inventory (GMROI) as well.

Suffice to say, getting the inventory planned correctly is vital. When using the retail method of accounting, as we are assuming in this discussion, stocks are planned at the current retail value. This means that markdowns are recognized when they are taken, as opposed to when the merchandise is actually sold. This reduces the “market” value of the inventory by the amount of the markdown, which increases turnover and generates additional OTB dollars to land new merchandise. Some systems do a much better job at handling this than others; you can trust me on that.

Sales and inventory forecasting are the two most important elements in the creation of an OTB plan. If errors are made in either of these areas, the OTB plan is going to be wrong. Results of poor OTB planning or no planning can be quite costly, and generally lead to inventories that are out of balance. Under planned classifications lead to lost sales, while over planned categories typically end up less profitable due to markdowns and slower turnover. Attention also needs to be given to reporting accuracy, since inventory variance can substantially alter the merchandise plan. The capture of markdowns and transfer reporting is a good first place to look if you encounter an inventory variance that is outside of industry norms. Not using an open-to-buy plan is like driving a car without insurance or building a house without a blueprint. It is dangerous and sometimes the outcome can be disastrous.

Ritchie Sayner is Vice President of Business Development for RMSA Retail Solutions