Shortages & Surpluses - Consumer Products - IV

 

3. So what can a Consumer Goods Company do?

With long lead-times from Asia retailers have no chance of determining, in advance, which products will be successful and which will not. There is only one response that can be successful – the ability to react quickly when the consumer has started to tell us what he really wants to buy. We want to catch the avalanche as it starts. How can we do that?

Purchases for the season have already been made:

The business has decided what will be in its stores and warehouses before the start of a new season. To a very large extent such a business has committed itself and accordingly will benefit (or suffer) from the consumers’ actual demand. From the supply side the die is largely cast. However …

Even if fashion crazes tend to be global there are many smaller avalanches that are likely to be much more localized. Regions around the country, continent or World will have different avalanches involving different products. Demand is not likely to be uniform across a big enough region. We could react to the differences in demand by making sure regions of high demand for specific articles get what they really need while the other regions that have less demand get less (they will stock other products more heavily – those that sell well in their area).

What this means is 3 things:

• Maintain as much stock as possible in a central warehouse that can respond very quickly when regions show their cards – when the consumer has spoken. (An alternative is cross shipments between stores – which is probably more expensive and slower).
• Replenish each store according to what it has just sold – as close as possible to whatever was sold just yesterday! Only with such rapid response are we truly close to the consumer. The longer we wait the greater the chance the consumer has changed his mind again – which means the retailer should change with him. Effectively this says that what was sold just yesterday is the best possible forecast for tomorrow.
• Return the poor sellers to the warehouse and redistribute them to locations with real demand for them. Don’t block your valuable shelf space with ‘dogs’. If at the start of a season all products are equally represented then very soon – as the hot items are sold out – the dogs will take over the majority of your shelf space. At the same time these same dogs will take more and more of your sales peoples’ time. Instead of selling as much as possible of the popular items efforts are spent getting rid of the dogs, to find substitutes for missing items and, in the end, to sell the remaining slow movers for deep discounts.

Clearly a good salesperson will offer an alternative whenever a desired article is out of stock – and will be successful some of the time. However, substitutions are often disappointments (I did not get what I really wanted). Substitutions take more effort from a salesperson – will they try to sell a substitute when it is clear the store still has stock of the hot product and it is just as clear that a potential substitute is not so popular? Substitution probably takes place only when the ‘hot’ item is sold out. What happens to store traffic when consumers realize a hot item is no longer available?

Substitution is a valid tactic, but better still would be the ability to resort to it as little as possible.

What is the threat if someone finds the solution of how to do the above? What is your benefit if you find it?

Replenish stocks (from suppliers) during the season!

Why buy everything before the season? Why not buy during the season and, as market knowledge becomes available, adjust purchases to whatever is truly selling well. Re-order from suppliers when you can see the avalanche starting!

In many (if not most) industries production lead-times do not need to be many weeks. In fact, many times, the actual ‘touch time’ (the time it takes to physically make an article without considering any waiting time) is very short (measured in minutes?). With TOC (Theory of Constraints) methods it is usually possible to get a production unit to respond within very short lead-times – short enough to react very quickly.

BUT, there is still transportation time from Asia. Shipping is something like 6 weeks – a long time for a season of only 6 months. This transportation lead-time is a fact of life and can be dealt with only by more expensive transport (flying) or by sourcing from low cost regions closer to Europe.

The question is – what will be the impact of such a tactic on revenues and margin, and what will be the added cost of air shipments (or new suppliers)? The result of having to discount much less (we don’t buy so much of the slow movers) and selling considerably more of our hot items must have a much larger impact than the expense of air shipments (that should only be needed at the start of each season) and more frequent smaller shipments by sea – if our greater flexibility is to have a positive impact on our bottom line.

Lets look at a scenario. Instead of buying the forecasted sales for the entire season our retailer buys ‘only’ 2 months of stock delivered in time for the start of the selling period (suppliers that want to sell in huge batches are an obstacle, but technically small batches are possible with little, if any, penalty). Once sales start, the retailer immediately (and then every week) reorders what has been sold from his shops during the week just past. The following will begin to happen (the diagram can be used to help understand the effects):

1. If the retailers initial purchases were a good estimate of demand, then inventory levels will decline towards 2-weeks of supply and stabilize there. That is the point where new orders and deliveries will approximately balance.
2. ‘Hot’ items will deplete stock (much) more quickly. To avoid a stock-out some air shipments will be necessary. By increasing stock levels of these hot items the retailer will eventually also have a 2-weeks supply with weekly replenishments.
3. Since ‘hot’ items are being replenished (rapidly) they will sell much more – increasing sales for both the retailer and his supplier.
4. After the first few weeks some items will be clearly identified as ‘dogs’ or slow movers. These will not be replenished until they reach 2-weeks of stock, or they will not be replenished at all if they are that poor! Stock levels of slow movers will be one third of ‘current’ stocks at the start of a season so there will be many fewer surpluses. Season’s end discounting and outlet sales will be much lower (and maybe at higher prices!).
5. Since there is less discounting, greater sales (of all the hot items that are always in stock) the retailer’s margins must soar. There will be less pressure on supplier prices and margins – much better relationships will be possible. The solution can be fine tuned for even greater benefits for both partners.
6. How much more will a retailer sell? If hot items are sold out within the first 2-months (shops and warehouses) then it looks like as much as tripling sales is possible. Shoppers quickly become aware which shops always have the hot items in stock – traffic increases and even more sales can be made.

If a retailer’s purchase costs are 45% of expected full price sales, then halving surpluses and adding just 10% to sales due to less shortage then return on sales increases from currently 5% to 15%. (In the model fixed costs are 30% of base sales and discounted sales are 40% of base sales volume. Discounts during season end sales are 50%). Should a retailer consider some transportation cost penalty for such an improvement – especially if increases of 30% in sales are possible?  The financial example in the endnotes (in a following post) shows the impact of having the right inventory in stock – Key is being able to respond to actual current signals from the markets. I recommend you create your own model and assumptions.

A book recommendation: "Isn't It Obvious" by Eli Goldratt. Goldratt develops the solution starting from an emergency in 1 store of a retail chain - one that replenishes from the far east. Written as a novel, but it describes the solution and the possible results very well.

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Shortages & Surpluses - Consumer Products - III

 

• Actual Consumer Behaviour

How do consumers behave in reality? We all (every person) have interactions with other people – our family, friends, employees, bosses, sales clerks, TV personalities (even if the interaction is only one way) etc. etc. Over just one day we receive a lot of (mis-) information that in a large part guides us in our actions – including what consumer goods we end up buying. What our contacts tell us play a big role in our day-to-day buying decisions.

The human race is notorious for its herd-like behaviour. We all would like to believe we make rational and informed decisions; but do we? We are all unique, but isn’t there also strong pressure to conform? Look at the stock market – if all decisions were rational why does that market sometimes streak ahead to ever-higher values – values that cannot really be justified? Why, all of a sudden, will every stockbroker and investor turn his or her back on the market - causing a huge crash? Major shifts are relatively rare but definitely important?

Could it be that human behaviour is like the sand mountain children build on beaches around the World**? Watching such a sand mountain grow you see the peak rising towards the sky and then suddenly collapsing. If you watch the process for a longer time you will notice the collapses are not the same – some are smaller, some are huge. The huge ones, like stock market crashes are rare, smaller ones are more frequent. Either way you cannot predict when or where a sand avalanche will occur. You only know that these avalanches will occur and some will be big, many will be not so big. Look at the stock market and consumer buying habits and you can find similar behaviours.

Communication in stock exchanges is extremely rapid. People are close to one another and can see the result of everyone’s actions almost immediately. In retail markets communication may not be quite so rapid but still we see communication of preferred products spread very quickly. Certainly we experience something different from the way forecasters and buyers assume consumers behave – consumers buy in ‘avalanches’ and not at some sort of average. Sometimes a popular item is a huge success (assuming the supplier can maintain supply) and, much more often, popular items are smaller successes – but still large enough to cause shortages. (Could it be that many times we do not really know how big a success could have been – because our stores and warehouses have run out?)

What causes these avalanches of demand? I don’t think we will know the answer to that for a very long time. We can predict they will occur and statistical physics can model the situation and show the frequency of big and small avalanches, but determining in advance what product will get consumers’ blessing is not going to be possible any time soon. However, we do know they occur and that the herd-like behaviour of humans might well result in bigger avalanches –if the article in question continued to be available in our stores.

We know they (avalanches of demand) will occur for sure – we just cannot know when, what it will be, or where the avalanche will start. {Have you ever watched flocks of starlings flying in formation? There seem to be hundreds or even thousands of birds in such a flock – and they all turn almost at the same time – as though there is some supreme controller steering them. But every bird is alone interacting only with its neighbours – each bird cannot possibly see all the rest nor react to all the rest. A local movement spreads almost instantly throughout the flock – not dissimilar to the way an avalanche of demand spreads in our markets}.

We are often ‘surprised’ when a new acquaintance knows someone from our network … ‘it’s a small World’ etc. In fact we are all closely connected – there is a claim that it takes a maximum of 6 links between you and every other person on the planet! So, even if it takes seven links we are close. Interactions between parts of the network will, somehow, influence the rest! When an avalanche starts – it moves quickly.

The ‘Tipping Point***’ describes the phenomena of how an avalanche of demand can occur – but cannot tell us how to predict them in advance. It does tell us how or who might be the triggers for a really big avalanche of demand.

** Critical Mass – how one thing leads to another, by Philip Ball; ISBN 0-09-945786-5

In a sense the whole book is an elaboration of the argument summarised on page 568:  "Society is complex but that does not place it beyond our ken. As we have seen complexity of form and organisation can arise from simple underlying principles if they are followed simultaneously by a great number of individuals." Complex behaviour can result from the interaction of lots of simple parts. This is now well established, but the implied corollary that the complexity we observe is a result of lots of simple interactions (or that it is useful to model this in this way) does not, of course, follow. Grounds for hope does not make it a reality.

*** Tipping Point, by Malcolm Gladwell;

1. The Tipping Point is that magic moment when an idea, trend or social behavior crosses a threshold, tips, and spreads like wildfire. At what point does it become obvious that something has reached a boiling point and is about to tip?
   
2. The possibility of sudden change is at the center of the idea of the Tipping Point -- big changes occurring as a result of small events. If we agree that we are all, at heart, gradualists, our expectations set by the steady passage of time, is it reassuring to think that we can predict radical change by pinning their tipping points? Can we really ensure that the unexpected becomes the expected?

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Shortages & Surpluses - Consumer Products - II

 

Retailers

Retailers appear to accept shortages and surpluses in consumer products as a fact of life. Every season shops run out of the really popular items and at the same time shops must discount large quantities of slow movers that did not sell so well – either during end of season clearances or in so-called outlet stores. These phenomena are well known, but do retailers and their suppliers have to accept them as a fact of life? Can’t a supply chain find a way to dramatically reduce the problem and create for itself a decisive competitive advantage? What happens to the first to be able to do so?

 

Forecasting and Actual Consumer Behaviour:

• Forecasting:

How much retailers expect to sell of any article, group of articles and in each store is usually decided well before a season has even started. To allow time for production and distribution to the stores (often from Asia) the decision on what article and how much to make is made well before the start of a season sometimes a year before consumers see the article in shops. The die is cast well before consumers have seen the article and even longer before the consumer has expressed an opinion about his or her preferences. What will be popular this season becomes clear only after inventory is produced and displayed in stores.

The forecaster has nothing to go on about the future – he can only use history as a guide – plus what ‘experts’ tell him will be the fashion (colours, style etc.) for that type of product in the coming season. He will also know what the fashion experts are saying in the various publications – publications that (try) to guide consumers to the ‘right’ article for them to buy. If a forecaster has the time available he can study all the various opinions and decide for himself how the consumer will react – but will he be right?

The forecaster and buyer are therefore in a terrible dilemma – buy a lot of those articles they believe will sell well and risk being terribly wrong; or buy more or less the same quantity of all articles (in the ratios of sales of similar products last year) to hedge their bets and minimize their risk of standing out – as a failure (or a huge success). How many forecasters and buyers are likely to choose the risky option? They might buy a little more of those items they think will be more successful. Whatever they do it will be a compromise, probably biased towards lower risk!

If this is the case, what is the unavoidable outcome? Clearly every consumer product supply chain will suffer from surpluses of those items that turn out to be less popular and shortages of the popular items. Would the result be much different if everyone took the risky route – to bet all of their purchases on what they believe should be the popular items? Averaging over all buyers the result will be more or less the same since nobody knows what the consumer will actually do – nobody knows what causes consumers to flock to whatever become the popular items next season. Even over time forecasters and buyers that take the risky route would end up near the average – if they were allowed to keep their jobs after a disastrous season*!

So, the need to be safe guarantees forecasters and buyers will take the minimal amount of risk and surpluses and shortages will be perpetuated. This is not news, but maybe it should be recognized and reflected upon by consumer goods companies when they make their strategic and tactical production and distribution plans.

*If forecasting were an accurate science, sales and outlet stores would be a much smaller factor in a retailer’s sales.

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Shortages & Surpluses - Consumer Products - I

 

Executive Summary:

Consumers (people) behave in a fashion that cannot be anticipated with forecasting (especially not with forecasts done many months before a selling season starts). Retailers do know that there will be ‘avalanches of demand’ for specific products and that most avalanches will be small while really big ones are more rare. The retailer knows this, but will never know in advance, which products will experience an avalanche of demand? Three possible strategic responses to shortages and surpluses in a retail supply chain are to respond by a) using the immediate past to decide what shops should hold ‘tomorrow’; b) holding the maximum possible centrally for immediate distribution to locations where demand for the product exists now; and c) producing as little as possible before the season and as much as possible during it – when we have fresh, much more accurate knowledge of these avalanches of demand.

Being able to respond quickly and reliably seems to be the best direction retailers have to significantly reduce both surpluses and shortages and significantly boost their bottom line. {If a retailers purchase costs are 45% of the expected full price sales, then halving surpluses and adding 10% to sales due to less shortages should result return on sales increases from currently 5% to over 15%. If transportation expense were to remain constant return on sales would increase to over 20%.}

We probably will never be able to forecast what will be the hot item(s) next season; but we can build a highly reactive supply chain that can respond very quickly as actual demand becomes clear – even given long lead-times from Asian suppliers. We can build this highly reactive supply chain without ‘breaking the bank’.

Would such a supply chain result in a decisive competitive edge in the market?

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I wish I could still ski like this!!