Life in the Fast Lane: Open-to-Buy vs. Balance-to-Buy

The traditional open-to-buy (OTB) process examines each department by projecting sales and cost of goods sold (COGS) and comparing that with on-hand inventory, resulting in an “open-to-buy” amount available for new inventory.

In many cases, however, OTB is actually a negative number, as the on-hand inventory exceeds the available OTB budget. Therefore, the term “open-to-buy” is a misnomer; what we’re ultimately looking for is “balance-to-buy.” OTB deals with buying but not necessarily merchandising, except to report that you have too much inventory and can’t buy any more. At some point, when existing inventory sells down to a certain point, buying may resume.

How then, if we follow the OTB budget, do we deal with an overstocked situation? Also, how do we handle an inventory that is out of balance where our best-selling price points are concerned?

Getting started. A balance-to-buy (BTB) process may begin with the same goals as OTB, which takes into account inventory levels and on-hand inventory. But we can drill down further into the data to develop a more merchandise-centric action plan, rather than simply an accounting tool.

The process of developing a traditional OTB requires that you forecast your anticipated sales. You would start with last year’s sales, add 15% (for argument’s sake) and build your OTB around the aforementioned assumptions—i.e., turnover, margins, COGS, on-hand inventory.

But this is simply a guess: We don’t expect that sales will grow at a predetermined, arbitrary rate and that this rate of increase will apply evenly across all departments. The thinking is that overall sales may average out to 15%. The problem is that we determine inventory levels months or even a year in advance in anticipation of hitting these numbers.

Some departments, when fed properly, will grow much faster than the 15% goal; others will languish behind our arbitrary targets and just sit there, sucking up the inventory dollars that we budgeted. Adjustments will need to be applied to our budgets as often as quarterly, which places an enormous burden on us to refigure our numbers. But the nonproductive inventory is already in the showcases and must be dealt with, while the productive inventory must still be fed.

BTB, however, takes into account not merely sales, but what is selling … and here is where the “balance” in balance-to-buy comes into play.

Our goal should be to look at sales by category and sell-price as it relates to inventory on hand by category and sell-price. For example, if 20 amethyst rings sold in the past 12 months for $300-$400 each, and you have three in stock, you need more amethyst rings. If you sold three but have 20, you have too many.

Throughout your inventory, misalignment exists by category and price. The job, therefore, is to balance what’s needed with what you already own. We’ll discuss the four-step process to accomplish this later in the article, but first, let’s go for a virtual drive.

Life in the fast lane. Imagine your store as a three-lane highway. Each lane represents how fast inventory moves through your store. Merchandise enters the roadway from the right-hand lane and, because of slow traffic there, immediately tries to move one lane to the left. This would be merchandise you just got in, the new 2004 models.

If they’re exciting, they’ll turn some heads. You start to promote them. In fact, billboards and TV ads appear and you start to see more of them on your highway. Sales take off.

As sales take off, you feel more comfortable with your new wheels and step on the accelerator, moving into the left lane—the fast lane. All traffic from the fast lane exits to the left side of your highway, the side where customers shop, so merchandise moves in the same direction—in on the right, out on the left. There is nothing to slow down the fast-moving items.

The challenge is to get your goods from the right lane to the fast lane. If you’ve ever entered a Los Angeles freeway at rush hour, you know this is no easy task. That’s because other cars—or, for our purposes, slow-moving inventory—are in the way.

Cars take up space. Inventory takes up dollars. A well-constructed merchandise highway allows plenty of space (dollars) for new product to enter from the right and move from lane to lane without obstruction. As these products accelerate, other merchandise gets out of the way to allow their passage. They beep and wave as they go by and exit off to the left at often blazing speeds. If they are replaced immediately, the speed at which they travel actually creates a draft for others to follow, further accelerating the action in the fast lane.

As new merchandise blends into the scene, newer, faster models overtake these former best sellers. The old stars decelerate a bit and, being cooperative players, move to the center lane to let the newer models pass. While they can still tool along at a good clip, they’re no longer considered “hot.”

This is not to say that all older models move over. We’re likely to see a 20-year-old version alongside a sleek new Italian number, but the older, classic model can still move like nobody’s business.

It’s what winds up in that far right lane that can mean trouble. Imagine the right-hand lane in our three-lane merchandise highway, with bumper-to-bumper traffic. Even worse, the drivers are bad—they won’t let anyone in! They’re taking up all the space (or in our case, cash), and the whole system is starting to break down. Everything stops.

Yes, they might eventually work their way to the left lane to exit our merchandise highway, but they’re really slowing down. They’re starting to wear out and becoming very expensive to maintain. It costs money to keep these beasts on our highway, and those costs continue to escalate as the inventory ages.

The good news is that there is a market for everything—at a price, of course. Just as the used-car market has customers for every vehicle, there is a market for all of the merchandise on our highway. Sometimes a price reduction will move these beasts off the roadway. Sometimes the manufacturer will send a tow truck in the form of a stock balance. And other times, the scrap yard is the only answer.

But imagine our roadway clear of such debris, where merchandise enters freely, moves over to the middle and then to the fast lane while other product moves from the fast to the middle to the slow and exits under its own steam, before the wrecker has to be called. Imagine the Autobahn, and you’ll get the picture.

The four-step process. Here’s how the Balance-To-Buy system works, in four easy steps:

  1. List all items sold in one category by price. Before we take our next step, we must organize our data into a “decision-relevant” format. We’ll take the information and present it in a visual way that helps us see what’s been going on in the past, forecast the future, and start making intelligent choices based on what we see.
    Exhibits A through D on the previous pages give us an example of information that was generated by one company’s point-of-sale system, exported into a series of Excel spreadsheets. (If you’re an Excel whiz, you can create your own. If not, you can visit our Web site at www.brs-seattle.com and download the B.I.G. spreadsheet called Balance-to-Buy.) What we see here are spreadsheets that visually organize one department, in this case diamond stud earrings.

  2. List all on-hand inventory by sell price and number of days in stock by department.
    Exhibit A, Diamond Studs –Sales vs. Inventory, is a report that shows all diamond studs sold ranked by retail selling price from lowest ($89) to highest ($14,835). The second column of this report lists all on-hand inventory, again ranked from lowest retail selling price to highest, along with the numbers of days on hand.
    Exhibit B, Diamond Studs –Adding Aged Inventory, shows us all on-hand inventory ranked by price (lowest to highest) in the left-hand column. The right-hand column shows us inventory on-hand by days in stock, ranked from oldest (more than 1,400 days in stock—that’s four years!) to newest (14 days in stock).

  3. Reprice nonperforming inventory to fit into price-points that are selling well.
    Remember, BTB takes into account not merely sales, but what is selling. To determine what price points will sell, we must determine what price points have sold. That’s where the information from Exhibit C, Diamond Studs –Sales by Price Points, comes into play.
    This table shows us all items sold, ranked by retail price—but note that we’ve added a visual cue to indicate how many diamond studs sold in each of our price-point groupings. For example, take a look at the $300-to-$499 group. While we’ve sold 11 sets in this price point, when we look at what we’ve got on hand (right-hand column in Exhibit A), we see that we have only three pairs left. Clearly, we need more diamond studs in this hot price point.
    This is where the balancing part of Balance-to-Buy comes in. By organizing our data in a decision-relevant format, we’ve discovered some important issues:
    •We have old inventory (more than 365 days in stock) that we need to deal with.
    •We have to beef up the in-hand stock in our more popular price points.
    •We have some inventory that’s not only old but also in the wrong price-point group.
    In order of choice, here’s what we can do about the old inventory:
    •Stock balance—talk to vendors about taking back old inventory.
    •Reprice the oldest stuff to better fit it into the “holes” in our price points.
    •Reprice the old stuff to get it out the door.
    But haven’t we just spent the last couple of months talking about the need to protect our margins? What about the hit to gross margin caused by heavy discounting?
    There are two points to keep in mind: One is the high hidden costs (shrinkage, insurance, obsolescence, etc.) related to having old inventory around. Industry experts peg it at 20%-25% per year. Whether you realize it or not, you’ve already taken the hit both profit-wise and cash-wise with the old inventory. The other problem is the cost of not having the cash on hand to buy inventory that moves.
    So bite the bullet now, move on, and sell it so you can generate cash to buy the stuff that does sell. Which lets us proceed to the fourth step:

  4. Replace fast sellers when they do sell. Exhibit D gives us a summary of Final Inventory Needs, with inventory on hand compared with inventory needs. It includes notes on suggested pricing changes and a “shopping list” for new items needed to plug those price-point holes. For example, we’ve taken our oldest diamond stud earrings (SKU#200-10385), languishing at $849, and repriced them into our “hot price point” of $499. The “Inventory Needs” column gives a handy summary of what we’ve got on hand, the pricing adjustments we’ve made, and our new shopping list in the “Open-to-Buy” column.

Repeat steps one through four for all your categories. It’s a lot of work, but it’s well worth the effort. Remember, it will get easier as you deal with your past mistakes and use your departmental action plans to better align your new purchases to your price points as you move forward.

See you on the Autobahn!

Exhibit A
Diamond Studs – Sales vs. Inventory
Sales – Items Sold by Retail

Sku Retail #of days o/h
200-10593 $89 84
200-10593 $89 89
200-10632 $99 88
200-10645 $99 103
200-10654 $99 21
200-10596 $111 103
200-10596 $119 114
200-10633 $129 11
200-10685 $139 7
200-10655 $149 76
200-00001 $169 3721
200-10564 $169 407
200-10577 $188 226
200-10599 $189 91
200-10656 $199 79
200-10683 $215 11
200-10572 $235 233
200-10637 $249 90
200-10647 $249 105
200-10662 $249 5
200-10636 $299 189
200-10657 $299 73
200-10659 $299 84
200-10566 $310 334
200-10644 $369 139
200-10644 $369 139
200-10566 $399 464
200-10607 $449 109
200-10569 $466 260
200-10649 $469 100
200-10650 $469 100
200-10312 $499 1409
200-10486 $499 734
200-10651 $499 90
200-10591 $516 204
200-10686 $521 7
200-10624 $555 94
200-10646 $562 111
200-10642 $595 20
200-10635 $599 252
200-10545 $647 520
200-10602 $659 256
200-10658 $659 76
200-10660 $659 16
200-10588 $849 116
200-10684 $925 4
200-10629 $985 249
200-10600 $1,149 403
200-10592 $1,395 431
200-10597 $1,408 354
200-10589 $1,495 429
200-10640 $1,495 121
200-10551 $2,018 635
200-10594 $2,342 90
200-10610 $2,422 178
200-10639 $2,875 195
200-10673 $3,400 35
200-10631 $3,474 2
200-10671 $4,413 2
200-10641 $4,500 4
200-10672 $4,695 28
200-10638 $4,811 9
200-10634 $5,000 133
200-10626 $6,700 17
200-00001 $7,195 3943
200-10678 $8,400 20
200-10670 $14,835 9
Total $101,403  
Inventory – On Hand by Retail
Sku Retail #of days o/h
200-10697 $80 69
200-10697 $80 69
200-10698 $80 69
200-10603 $99 528
200-10688 $169 91
200-10557 $239 771
200-10712 $249 14
200-10604 $289 528
200-10713 $299 14
200-10704 $329 43
200-10703 $349 44
200-10705 $429 43
200-10696 $695 69
200-10385 $849 1491
200-10693 $999 91
200-10675 $1,299 140
200-10552 $1,395 777
200-10708 $1,495 21
200-10630 $1,595 360
200-10699 $1,795 59
200-10707 $1,795 21
200-10463 $2,495 1157
200-10643 $2,895 251
200-10672 $4,695 164
200-10709 $5,795 21
200-10710 $8,900 21
Total $39,148  

Exhibit B
Diamond Studs – Adding Aged Inventory Sales – Items Sold by Retail

Sku Retail #of days o/h
200-10593 $89 84
200-10593 $89 89
200-10632 $99 88
200-10645 $99 103
200-10654 $99 21
200-10596 $111 103
200-10596 $119 114
200-10633 $129 11
200-10685 $139 7
200-10655 $149 76
200-00001 $169 3721
200-10564 $169 407
200-10577 $188 226
200-10599 $189 91
200-10656 $199 79
200-10683 $215 11
200-10572 $235 233
200-10637 $249 90
200-10647 $249 105
200-10662 $249 5
200-10636 $299 189
200-10657 $299 73
200-10659 $299 84
200-10566 $310 334
200-10644 $369 139
200-10644 $369 139
200-10566 $399 464
200-10607 $449 109
200-10569 $466 260
200-10649 $469 100
200-10650 $469 100
200-10312 $499 1409
200-10486 $499 734
200-10651 $499 90
200-10591 $516 204
200-10686 $521 7
200-10624 $555 94
200-10646 $562 111
200-10642 $595 20
200-10635 $599 252
200-10545 $647 520
200-10602 $659 256
200-10658 $659 76
200-10660 $659 16
200-10588 $849 116
200-10684 $925 4
200-10629 $985 249
200-10600 $1,149 403
200-10592 $1,395 431
200-10597 $1,408 354
200-10589 $1,495 429
200-10640 $1,495 121
200-10551 $2,018 635
200-10594 $2,342 90
200-10610 $2,422 178
200-10639 $2,875 195
200-10673 $3,400 35
200-10631 $3,474 2
200-10671 $4,413 2
200-10641 $4,500 4
200-10672 $4,695 28
200-10638 $4,811 9
200-10634 $5,000 133
200-10626 $6,700 17
200-00001 $7,195 3943
200-10678 $8,400 20
200-10670 $14,835 9
Total $101,403  
Inventory – On Hand by Retail
Sku Retail #of days o/h
200-10697 $80 69
200-10697 $80 69
200-10698 $80 69
200-10603 $99 528
200-10688 $169 91
200-10557 $239 771
200-10712 $249 14
200-10604 $289 528
200-10713 $299 14
200-10704 $329 43
200-10703 $349 44
200-10705 $429 43
200-10696 $695 69
200-10385 $849 1491
200-10693 $999 91
200-10675 $1,299 140
200-10552 $1,395 777
200-10708 $1,495 21
200-10630 $1,595