Two years ago, several reports emerged that delved into the various pricing models and the need for a more effective and scientific approach to pricing strategies. Since then, the retail industry has continued to shift far faster than many could have predicted a mere 24 months back.
At that time, the success of ‘Price Matching’ and ‘Everyday Low Prices’ (EDLP) was uncertain. Today, we see some retailers strained beyond repair, closing stores while putting even more pressure on suppliers to retain some level of margin and profitability.
The certainty is now clear: pricing and inventory strategies need to go far beyond a roll of the dice, guessing game, or reactive price matching to compete with other retailers. The growth in omnichannel only intensifies the need to continually fine-tune product pricing, which products to carry and at what levels in order to make the necessary adjustments that won’t put your business out of business.
Thankfully, the scientific approach has evolved, and now retailers can quickly determine where they stand in six key areas of their operation.
Keep in mind that it’s one thing to be aware of the six retail Key Performance Indicators (KPIs) below, and it’s another to know the specific data for each one relative to your business at anytime, all the time:
1) Gross Margin
2) Stock Turnover Rate
3) Sell-Thru Rate
4) Average Purchase Value or Average Order Value
5) Units Per Transaction
6) Sales Year-Over-Year to Date
If you’re an omnichannel merchant, having these six foundational retail metrics at your fingertips is essential. If you also sell across multiple countries and currencies, it’s even more imperative that these numbers are checked frequently.
If you wait to really know your full-loaded product costs every quarter or annually, you may be in for a very unpleasant surprise. By then it may be too late to turn the ship in a positive direction. Processes and operational adjustments need to be able to be continually and constantly tweaked, and the information to make those adjustments needs to be accessible.
So let’s dive into each of these key retail areas and the part they play in running a successful omnichannel business.
#1: Gross Margin
The formula = (Total Sales – Total Cost of Goods Sold) / Total Sales) * 100
This comes in at number one for a reason: this metric determines whether your company stays in business…or not. Set it too low, and you’ll fall short in paying your suppliers, employees, taxes, rent, or being able to cover critical operation costs like shipping products to customers.
Remember the ‘everyday low price’ model? That may work for large-scale retailers like Wal-Mart and Costco who operate at margin levels between 10-20 percent. They also have millions of customers.
This won’t fly for small to mid-sized retailers. Gross Margin needs to be set at a level that covers all costs of business while providing room to discount products with low Sell-Thru Rates (metric #3), as a short-term promotion or for flash selling.
For example, clothing and apparel retailers are known to work at 30-50 percent gross margin levels, which include any discounting required. Specialty retailers with lower sales volumes need to operate at even higher gross margin levels in the 100 – 500 percent range given their niche product market fit.
Multi-regional retailers’ gross margin is also impacted by currency exchange rates that can raise or lower supplier and shipping costs, requiring an adjustment in pricing strategy. These have the potential to fluctuate unexpectedly, especially after changes in the political climate and potential shifts in global trade agreements. This makes it necessary to continually monitor currency rates and how changes impact the Gross Margin KPI.
#2: Stock Turnover Rate
The formula = (Average Inventory / Cost of Goods Sold) x 365 OR (Cost of Goods Sold / (Beginning Inventory + Ending Inventory) / 2)
Stock Turnover Rate can have both positive and negative financial implications, so it requires monitoring as frequently as tracking sales.
Since stock is typically purchased via credit with your supplier, if that stock is sold before you’ve had to pay for it, that leaves more working capital for your business.
If the stock sits on the shelf for a long period of time, that money can’t be spent on operating expenses like employee payroll, rent, new products, or taxes, which can put a potential strain on your business. As the clock keeps ticking, the risk of obsolescence increases, forcing you into discount or charge off mode.
The ideal Stock Turnover Ratios will vary by retail sector, by size of retailer, and by geography. A flower shop will have a much higher turnover rate given they sell lower-priced, perishable products in comparison with a jewelry store’s hundred to thousand dollar items. Even the highly-regarded brand, Tiffany & Co., is known to have a very low inventory turnover ratio of 0.7, with their products in the infamous blue boxes taking over 521 days to leave the store on average.
Keep in mind that inventory management and turnover rate can also impact your margins, increasing or decreasing levels depending on your Sell-Thru Rate or your need to discount.
#3: Sell-Thru Rate
The formula = Sales / Stock on Hand (at Beginning of Month) * 100 (Convert to %)
Regularly monitoring your Sell-Thru Rate will let you know if you’re meeting your Stock Turnover KPI.
Sell-Thru Rates can vary by store location, time of year, region, by product and product line. They can be impacted by a variety of factors, including the selling season, pricing, demand, related promotions and marketing, or by the use of flash selling.
A women’s fashion retailer would expect the Sell-Thru Rate for lower-cost, everyday items like stockings and socks to have a higher ratio versus higher ticket items, such as leather jackets. Going back to the florist example, Sell-Thru Rates of particular flowers like roses will be higher during Valentine’s Day and Mother’s Day as compared to other times of the year.
Consistently tracking historical Sell-Thru Rate data over time enables merchants to establish average sell-thru metrics by product and product line, quickly realizing spikes or dips in sales and what may have been the cause. Continually fine-tuning your purchasing and pricing strategies and having the data to determine restocking or discontinuing SKUs will empower your retail business to achieve the optimal Sell-Thru KPI.
#4: Average Purchase Value or Average Order Value
The formula = (Total Sales / Total Transactions)
This KPI, known as either Average Purchase Value (APV) or Average Order Value (AOV), indicates a merchant’s average order total over a specific period of time.
The value of this KPI is it aligns with other KPIs such as Sell-Thru Rate and Stock Turnover Rate by reflecting the impact of marketing campaigns for related product promotions, inventory management, in-store product placement, and even ecommerce product pages.
Say you operate five boutique stores that cater to city dwelling organic gardeners. Spring time is here, so you’ve stocked a new line of pots in a variety of colors and sizes, along with gardening accessories, seeds, and potting soil.
By tracking the AOV and reviewing the particular products within in each order, you can glean consumer buying behaviors and adjust your inventory and pricing strategy if needed. You also launch two ‘get started’ gardening kits, one for vegetables and another for spring flowers. The marketing campaign presents how even newbies on their way to growing a green thumb need only start with this kit to set up their own patio garden. Then you compare those sales with orders where similar products were purchased separately or in combination with another promotion.
This KPI is a close cousin to the Average Customer Order KPI, which reflects how often customers make repeat purchases and additional buying behaviors, such as: Do they only buy items on discount? Are they quick to respond to marketing promotions of new items arriving in the store? Do they participate in Flash Sales or does a sale item spark an upsell opportunity, drawing them into buying additional products at full price? It’s common practice to use the answers to these questions and related data to create customer segments – frequent or high-paying returning customers, those that only buy at a discount, and one-time buyers – to create specific marketing messaging and promotions by segment to increase this metric over time.
Pairing AOV with the next KPI, Units Per Transaction, will contribute to effectively manage your supply chain and inventory management.
#5: Units Per Transaction
The formula = (Total Units Sold / Total Transactions)
Units Per Transaction (UPT) averages the number of SKUs or units that customers are purchasing in any given transaction. In an omnichannel environment, tracking UPT by channel – online, in-store, Amazon, and eBay – is essential to managing inventory, pricing, and promotions by channel to measure sales activity and consumer engagement for each.
If you discover your UPT is flat or decreasing for your website’s ecommerce store, you’ll want to dive deeper into the customer journey and see if there are ways to improve product recommendations or ‘customers also bought’ upselling tactics. Test out the offer of free shipping if the customer buys over a certain amount. These same tactics could apply to your eBay and Amazon stores.
For your in-store operations, having a regular dialogue with your floor sales staff is always a recommended practice. First-hand customer experiences can be shared from staff to management or senior sales personnel where potential pricing, product, or inventory issues are realized and resolved.
Management and senior staff can in turn, mentor staff on upselling techniques that further enhance the customer experience while contributing to the increase of UPT. In-store merchandising is a key component as well, stylizing new product displays to match related online, social media, and print advertising so customers can connect the dots to what they saw in the ad, they could buy and take home today.
#6: Sales Year-Over-Year to Date
The formula = ((Sales for Time Period This Year / Sales for Time Period Last Year)-1) * 100
Sales Year-Over-Year to Date is a most commonly known retail metric. It is often used as the key indicator of a merchant’s overall health. That’s a problem and why this KPI is listed last.
If you’re not meeting your Gross Margin KPI because you’ve had to drop your price points too low, even if your sales to date are higher than the same time as last year, there should be red flags waving.
Let’s say you discovered a niche toy product at last year’s Toy Fair in New York. It was promised to be the next must-have gadget for kids. You agreed to investing in stocking and marketing this product.
Sales went through the roof this time last year, but as the Fall leaves fell, so did children’s passion for this toy, and right before the holiday rush. Calculating your Stock Turnover Rate confirmed that you needed to quickly liquidate this stock since you were now stocking up on products in preparation for the peak holiday season.
You’ll find that once you’ve analyzed the other five KPIs and calculated other factors that provide a clear vision of your operational standing, then your Sales YOY to Date will provide more validity to this metric.
There are numerous KPIs that apply to gauging retail operation standing, and we plan to delve into them in the future. But by beginning with these core commerce KPIs, understanding how they’re all interlinked, and frequently and consistently capturing the data to analyze each, over time you’ll develop a deeper understanding of your business’ operational health. The kind of understanding that will empower your business to grow and thrive.
This article originally appeared in Multichannel Merchant.
