Automatic Store Replenishment

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Author: Joost van der Laan, Retail Economics, June 2006.

Benefits of Automatic Store Replenishment and cycle-counting are:

• Lower out-of-stocks and higher sales
• Lower inventory costs and higher margins
• Lower labor costs by cycle-counting
• Shrinkage reduction
• Store Order Leveling™ and truck-load optimization
• Reduction of price mark-downs
• Reduction impulse-buying of loss-leaders

Definition: Automatic Store Replenishment is: the preparation of orders by a computer that integrates information about product movement (as recorded by point of sale equipment), outside factors that affect demand (such as seasonal changes), actual inventory levels, product receipts, and acceptable safety stock levels. Inventory data integrity is maintained by cycle-counting.   (Source : ECR US - Automatic Store Replenishment, Computer Assisted Ordering, Sales Based Ordering, Automatic Ordering)

How to Realize Maximum Profits from Automatic Store Replenishment

This article shows what you can do to benefit from every aspect of Automatic Store Replenishment. How to build high data integrity. What are pitfalls to avoid. How to manipulate ordering parameters. What choices to make: do you prefer minimum inventories or full shelves. And what are benefits of warehouse production leveling and truck-load optimization.

Lower Out-of-Stocks and Higher Sales

A rule-of-thumb is that 1 % out-of-stock results in 0.5 % lower turnover. Retailers suffer from customers buying elsewhere or buying not at all. Manufacturers suffer from brand substitution and also from non-sales. Strong brands show stronger store-substitution and weak brands show stronger brand substitution. The effects are different for stores with large assortments than for stores with small assortments. And sales effects of out-of-stocks are limited for both retailers and manufacturers by package-size substitution and delay of purchase.

Ordering mistakes by store employees are a main cause of out-of-stocks. Other main causes are delivery delays of manufacturers, out-of-stocks and order-picking mistakes of the central warehouse and quality of product introduction and deletion. But in-store manual ordering mistakes amount to at least 50 % of out-of-stocks. This is one of many potential benefits of Automatic Store Replenishment.

Why do store-orders improve by Automatic Store Replenishment? Inventory levels at time of delivery are estimated by a forecasting system. The system takes into account any shipments underway and turnover during lead-time from order to delivery. This forecasting is almost impossible by classical manual ordering. But there are some conditions for Automatic Store Replenishment to work right.

Conditions for improved store-orders are:

• Low non-scanning rates to generate correct sales data
• Discrete (separate) scanning of varieties of products (colors, flavors)
• Regular match of physical and database inventory levels through cycle-counting
• Correct input of minimum and maximum shelf-stock levels

If these conditions are met, lower out-of-stocks will have a positive impact on net profitability. See the next calculation.

In my practice some retailers already have low out-of-stocks by solving every order-picking / ordering mistake by extra deliveries, shipments and returns. This solution proves extremely expensive. In these cases net profits from Automatic Store Replenishment are up to 350.000 for every 500 million of sales.

Lower Inventory Costs and Higher Margins

Automatic Store Replenishment makes it possible to choose between many different ordering techniques. Most important are "fill-to-minimum" and "fill-to-maximum". Fill-to-minimum is ordering just enough to stay above minimum stock levels. Fill-to-maximum is ordering for full shelves. Advantage of fill-to-minimum is low average stocks, but disadvantage is a good chance of unattractive looking shelves. Advantage of fill-to-maximum is attractive full shelves, but disadvantages are higher average stocks and increased possibilities of product shrinkage.

Highest profit from Automatic Store Replenishment - and every solution to any problem! - is obtained by maximizing advantages and minimizing disadvantages. For store ordering this means: choosing a middle road between fill-to-minimum" and "fill-to-maximum". You can work with a percentage of each ordering technique, or you can define so-called "nice stocks".

"Nice Shelf Stocks" are minimum shelf stocks to give shelves an attractive look. "Nice Shelf Stock"-levels are often larger than safety-stock levels, which are maintained to avoid out-of-stocks when turnover is extra high. A simple way to define "nice stocks" is: one or two items per facing.

Other inventory benefits of Automatic Store Replenishment are "sales anticipation" and "on-order information".

"Sales anticipation" means that the ordering system makes a forecast of turnover during lead-time between order and delivery. This forecasted turnover is added to the order, so shelf-stock is just right when delivery is put on the shelf.

"On-order information" takes into account that during ordering a former delivery has not arrived yet. In classical manual ordering this problem is often tackled by lowering order frequencies. Automatic Store Replenishment has no problem with deliveries on route. These are just added to in-store stocks when calculating an order.

Space for new assortment is created by Automatic Store Replenishment, because fast-moving items often need less facings when stock levels go down. New assortment creates more choice for customers and higher sales. Facings of slow-moving items are not effected by lower stock levels, because facings of slow-movers totally depend on case-size. See article on optimal case-size.

Automatic Store Replenishment makes it possible to substitute low-margin sales by high-margin sales. Fast-moving items - especially A-brands - often have very low gross-margins and negative net product profitability. Lower stock levels reduce impulse buying of these loss-leaders. New assortment can be chosen from high margin niche groups. Or you give high margin private brands extra facings to induce impulse-buying. Resulting average gross-margins will rise. If free space is used optimally, resulting net profitability will be higher than net profit from stock reduction.

Lower Labor Costs by Cycle-Counting

Automatic Store Replenishment reduces labor costs, because manual ordering is substituted by automatic ordering. It is true that new tasks are introduced to maintain correct stock data, but these tasks require fewer and cheaper labor.

Cycle-counting is the technique of choice to maintain correct stock data. Instead of checking shelf stocks at each order cycle, stock levels are counted every 4 to 8 weeks and compared to database information. Labor cost savings are substantial:

• Cycle-counting frequencies for ASR are much lower than manual ordering frequencies
• Cycle-counting is a simpler task than manual ordering and therefore cheaper
• Timing of cycle-counting is not time-critical and can be done at quiet moments
• ASR techniques as "Counting by Exception" improve efficiency and data-integrity

Counting by Exception is an important feature of Automatic Store Replenishment, which makes cycle-counting even more efficient. Exceptional stock levels trigger counting: zero physical stocks, zero database stocks, zero turnover and vulnerable products. Effect: obvious problems are tackled with a minimum of work.

Zero physical stocks are checked to detect order picking mistakes and theft. In takes a few minutes to walk the isles after every shelf filling cycle, and to check empty - or almost empty - shelf spaces and corresponding database stock-levels. Zero physical checks are important: if database stocks are above minimum stock levels and physical stock levels are zero or very low, the ordering system will not generate necessary replenishment orders. Sales will drop to zero.

Checking zero (or negative) database stocks is method of choice to manage shelf space for unexpectedly successful products, deleted products, new product introductions and products temporarily out-of-stock. A list of zero stocks is compared with physical stocks every day. This also takes little time. Deviations require some analysis and adjusting of shelf space.

Zero turnover checks make it possible to detect problems with product availability and visibility of fast-moving products. If a product is normally purchased 20 times a day, it only takes a few hours to produce an automatic trigger for store management to check if anything is wrong with products on shelf. Zero turnover detection requires sophisticated statistical software, but is a powerful tool to improve attractiveness of the store.

Vulnerable products are articles which have a high probability of shrinkage and other causes of stock level deviations. Examples are perishable goods, or small expensive items like cosmetics, cigarettes, batteries and razor blades. These products (or product groups) are pre-defined or are detected by frequent stock level mutations. They are cycle-counted more frequently than normal. The effect is that counting frequencies for "normal" products are limited to a minimum level, and average counting frequency remains low.

Shrinkage Reduction

High frequency cycle-counting of vulnerable products will detect shrinkage problems in an early stage. When store management addresses these problems, cycle-counting makes it possible to measure effects and evaluate solutions.

Shrinkage of vulnerable products can be resolved in many ways, for example:

• Increasing visibility of small and expensive items by placing them next to point-of-sale, but maintaining self-service presentation
• Reducing shelf stock to a minimum of a few hours of sales
• Reducing "sweeping" of multiple products by placing high priced items in racks
• RFID tagging
• Placing products behind a service counter to reduce theft by customers and employees.

Each solution has advantages and disadvantages. For example: placing products behind a service counter will result in lower sales and higher costs. This is a high price to pay for shrinkage reduction. It is better to develop solutions that increase sales, at the cost of some closely monitored shrinkage.

Placing small expensive items next to point-of-sale has two distinctive advantages. We measured the effects in two interesting shrinkage studies. First benefit: increased visibility for POS workers and lower shrinkage. Second benefit: increased visibility for customers and higher sales. Increased visibility is very interesting for high margin batteries and razor blades. These products generate high gross margins (up to 60 % of an average price of € 4,50), and they have a high visibility elasticity or high impulse factor. Customers buy these products when they see them. Batteries and razor blades are the best products to place on a counter or next to point-of-sale. Shelf profitability of this high-opportunity store real estate is much higher then for the usual low-price/ low-margin candy bars.

We were able to obtain these results only through the availability of item-level inventory and cycle-counting.

Store Order Leveling™ and Truck-Load Optimization

Turnover is not equally distributed over days of the week. More customers shop on Fridays and Saturdays than on other days of the week. These two days together may even constitute half of total weekly sales, as in the next diagram.

When stores order every day, they will generate large orders around the weekend and small orders in the middle of the week. This disrupts the entire supply chain:

• Unbalanced workload at distribution centers and suppliers
• Unbalanced truckloads and average lower utilization of trucks and truck space
• Unbalanced workload at store

This problem is not new and retail organizations have developed different solutions:

• Ordering and distributing slow-moving products only on quite days
• Pre-producing fast-moving items on quite days
• Maximizing daily orders

But every solution creates a new problem. Ordering slow-movers on quite days makes the ordering and distribution system more complex. Pre-producing fast-movers on quite days creates extra inventories in the pipe-line. Maximizing daily orders makes ordering more complex and is cause for increasing out-of-stocks on busy days.

The best solution is Store Order Leveling™ by simply manipulating input parameters of the automatic replenishment system. The system uses free shelf space of set-to-minimum order algorithms, or redundant stock levels of set-to-maximum algorithms. Orders can be leveled to an ideal distribution over days of the week. The next diagram shows flat orders fro Monday to Friday and reduced orders on Saturday.

We have made many simulations for set-to-minimum and set-to-maximum order algorithms, and these simulations are tested in real-life situations. It is now possible to generate almost any order leveling distribution for any actual turnover distribution. It is also possible to shift automatic orders further to compensate for manual - non-leveled - orders.

Estimated financial results of Store Order Leveling™ are very interesting:

Reduction of Price Mark-Downs

Fashion retailers plan their budgets every season for item procurement and distribution to the stores. Logistics is mainly push oriented. Traditionally the leftovers are discounted at the end of the season with high mark-downs. These mark-downs are high because the season is over and leftovers are the least desirable items for regular customers.

A system with item-level turnover planning and inventory control makes it possible to monitor sales development from day one. After a few weeks it is clear which items are slower then expected and will not entirely be sold during the season. If price mark-down is started during the season, overall mark-downs will be lower. This is called "quick response". The earlier a store starts its mark-down program, the lower the overall price reduction will be. See the next table.

Profit effects depend on seasonality and fashion characteristics of the assortment. If 20 % of items is normally marked-down on average by 50% at the end of the season, and "quick response" makes it possible to lower average mark-down to 40%, the net profit effect is a staggering 10 million on every 500 million of turnover. There will be some substitution effects in the season, but early mark-down will also improve the price image and customer attractiveness of the store.

One additional aspect of "quick response" is the reverse of early mark-downs: additional production and distribution of fast-moving items. If sales of certain items are higher than expected, producers should be flexible and quick enough to produce and distribute these items to the stores in a very short time.

Reduction Impulse-Buying of Loss-Leaders

Often logistics requirements and commercial requirements do not match. For example: logistics managers prefer low distribution costs and low delivery frequencies, but commercial managers prefer low store inventories, low out-of-stocks and high delivery frequencies. An easy solution is a compromise with a heavy weight on store requirements.

A better solution is to choose for high delivery frequencies to the stores, in combination with concentrated deliveries by one channel. In other words: minimal "direct store deliveries" and maximum deliveries via the central warehouse. This creates a win-win situation for the stores and for logistics.

But high delivery frequencies are not sufficient to prevent a costly problem in the stores. There are always 100 - 150 super fast moving items - with low gross-margins - that still require much shelf space in order to meet customer demand. Large shelf space means high visibility, and high visibility means high impulse sales. And here is the problem: super fast moving items are often loss-leaders: net product profitability is below zero. You do not want to sell these products, but you have to. Extra impulse buying works very negative on the stores profitability and must be avoided. But these items are traffic builders and they must never be out-of-stock, otherwise the store will lose customers to the competition.

Item-level inventory control - as part of Automatic Store Replenishment" - makes it possible to maintain low inventory levels and low visibility on the shelf, in combination with an extra backroom stock. The computer will take the two stock locations per item into account, for cycle-counting and ordering purposes. Unwanted impulse buying of loss-leaders is prevented and there is even shelf space available for additional high-margin assortment.

Net profitability effects are not easy to calculate, because ''space-elasticity" is different for every item. We also have to make estimates about substitution from low margin to high margin products. But this improvement concept is intuitively promising and can be tested in practice.

Conclusions and Recommendations

Potential results of Automatic Store Replenishment are high: 1.5 million hard benefits and another 1 million soft benefits for every 500.000 million of turnover. For fashion retailers potential benefits are much higher, because these retailers have the potential to cut back in expensive price mark-downs.

These benefits have a long life span. If you are making an investment decision for SCM software licenses and implementation, use at least a 5 years time span. At 10% DCF, the NPV of hard benefits is 5.5 million. This is about 10 times the cost of a SCM software licence and these benefits may cover the investment of an entire ERP system.

There are three important critical success factors for Automatic Store Replenishment:

• At start: data integrity
• During project: develop correct forecasting and order algorithms and avoid manual order corrections
• After project: use Automatic Store Replenishment information for maximum benefits

These critical success factors must be managed to realize their specified results. This requires assistance from experienced implementers and users of Automatic Store Replenishment.