Santa’s Hiking Pants, Prada, and Inventory Turnover
I’m a simple man, and I require less stuff with each passing year.
What did I get from Santa (and my family)?
Hiking pants (I rotate pairs of hiking pants and wear them year round)
Quarter-zip pullover (same thing- rotate through them)
2 books- both great
Like I said, I don’t need a great deal of stuff. In fact, we’re making an effort to get rid of stuff.
A few years ago, my wife had the idea to rent a dumpster- they drop it right in your driveway.
“We’ll never fill that up!”, I said.
We filled it.
The Boyd’s also have a storage locker. We’re going through plastic tubs in the basement, throwing out more items, and moving the remainder to our storage locker facility.
Which, by the way, has the feel of a horror film set. Sterile, too quiet, no one around…
Which brings us to luxury brands.
The Devil Is Not Buying Prada
The Wall Street Journal Reports that: “The luxury industry is slowing as shoppers sober up after their pandemic spending spree. This year’s growth rate is expected to be around half what the industry managed in 2022.”
The impact of slowing sales?
Retailers are stuck with unsold inventory.
What To Do
Common sense would say: “Well, just move the inventory off the shelves by offering a deep discount.”
We see that all the time- just witness how many people were shopping for after-Christmas sales.
But there’s a problem.
Maintaining the Customer’s Perception of the Brand
Luxury brands don’t typically offer deep discounts to sell inventory.
“… luxury brands will never pile it high and sell it cheap because they are protective of their reputations for exclusivity. Adding to the challenge, one of their old tricks for making leftover inventory vanish—burning it—has become taboo. Earlier this year, EU countries voted to outlaw the incineration of fashion waste.”
Burn inventory?
I guess it was a thing…
The luxury brand’s goal is to maintain the perception of exclusivity and scarcity.
Say that you see a bag at a Prada store, then see the same bag on the shelf at TJ Maxx for 20% of the original price.
You might conclude that the Prada bag isn’t that unique or special- and you’re not willing to consider paying the full retail price. From the Journal:
“Luxury brands have spent the past few years diligently weeding out discounts.
Prada, for example, has halved its reliance on wholesale accounts since 2018. Now the Milanese brand sells mostly through its own stores, where it has full control over prices. With control has come discipline: Prada has stopped discounting in its own boutiques.”
The message? Our product is a luxury brand, and customers who pay high prices won’t find that same item sharply discounted somewhere else.
But this strategy comes with a cost.
What About Collecting Cash?
If you don’t sell inventory, you don’t collect cash.
And that impacts a business in two ways.
First, you’ve made a cash investment in producing an item that hasn’t sold. Second, you can’t collect cash – ANY cash- on the item that remains on the shelf.
Let’s say that Prada has $20 million in inventory that didn’t sell, and that they’re not willing to unload goods at a deep discount. Assume the retail price for the items is $40 million (50% markup, which is not unusual).
They spent $20 million in cash to produce the item- and they can’t recoup any cash. Sure, not one’s willing to pay $40 million, but maybe they could get $30 or $25 million.
To maintain their brand image, they collect zero.
The impact can be measured in the inventory turnover ratio.
Using the Inventory Turnover Ratio
Managing a business is about collecting cash faster.
Sure: Profit, mission, growth are also important, but the ability to generate cash inflows pays for everything.
Managers use the metrics like the inventory turnover ratio to assess cash collections.
The formula is:
(Cost of sales) divided by (average inventory for the period)
The goal is to sell more (increasing cost of sales) while minimize the inventory you need to keep on hand. Again, the problem with unsold inventory is that inventory requires cash. Less inventory frees up more cash.
Let’s say that a manufacturer generates this inventory turnover ratio for 2023:
($4,000,000 cost of sales) divided by ($600,000 average inventory for the period) = 6.7 times
The company sells all of its average inventory balance 6.7 times per year.
OK, now assume that with better marketing and inventory management, the average inventory declines to $400,000. If 2024 sales are the same, here’s the new formula:
($4,000,000 cost of sales) divided by ($400,000 average inventory for the period) = 10 times
The business is driving more sales (and cash inflows) using less inventory.
The Lesson
Each dollar invested in inventory impacts cash in two ways:
1. You can’t collect the dollar from a sale, and
2. You have a dollar tied up in inventory that can’t be used for some other purpose