> >

Beyond Revenue and Margin: Understanding GMROI and Productive Inventory

We partnered with Todd McCormick, Owner of Keystone Climbing Consultants to bring you a series of gym-focused retail optimization articles.

Beyond Revenue and Margin: Understanding GMROI and Productive Inventory

By: Todd A. McCormick, Owner of Keystone Climbing Consultants

Have you ever run a marathon? If so, was your goal to run the whole time without stopping to walk? Or did you just want to cross the finish line? Or run under a certain time? What success looks like to one person could be different from another person. And the success of a retail shop is the same, success of a retail shop depends on the purpose of your retail shop.

Many gyms view a retail shop as a way to add service to their customer experience, giving customers a one-stop place to shop for the items they’ll need to have a fun time while they are in your gym. But of course, the bottom line, making money, is probably also a part of the reason for having a retail shop. Making money and being profitable gives you a broad sense of how your retail shop is doing. Sure, your shop needs to generate revenue, and hopefully you’re selling products at a price so that you are profiting from those sales too. But those two metrics only tell part of the story. Is your inventory actually being productive for you?

Most businesspeople are familiar with at least the basic metrics used to define a successful retail shop:

  • Revenue = gross sales - returns - discounts
    and
  • Margin = revenue - cost of goods sold

But it’s important to look at a few other metrics and dig a little deeper into the data to really be able to understand the aspects of your shop that are doing well versus those that aren’t doing so well. Figuring out if you have productive inventory is an important part of the picture, and in turn this will help you develop a plan so you can work towards that ultimate and ongoing goal of increasing profits.

Let's look at a simple example to illustrate how you could have nonproductive inventory: Let’s say your business is buying and reselling pens.

  • You buy pens for $1 each and sell them for $2 each (50% margin). 
  • You plan to sell 25 pens a month and you want to keep 12 weeks of stock on hand (planning to turn your inventory every quarter).
  • You start with $100 in the bank.

How many pens should you buy to be stocked up for the quarter? If you want a few extra pens as a small buffer in case you sell more than expected, then starting with 80 pens is reasonable if your sales projection is accurate. So, you invest $80 into inventory. But what if you only sell 45 pens in the quarter instead of the projected 75? You generated $90 in revenue, but that leaves you with $35 still tied up in inventory at the end of the quarter.

FEATURED PRODUCT
FEATURED PRODUCT

With buying Plan A you ended up being overstocked for the quarter, so a better sales forecast (and subsequent buying plan) would have been something like buying 50 pens instead of 80. This would still give you the same $90 in revenue and $45 in profit but would leave you with only $5 tied up in inventory at the end of the quarter. Which buying plan would yield more productive inventory? Simply put, if investing $80 returns $45 in profit, but investing $50 gives you the same return, then the latter is a more productive use of your starting inventory dollars. Buying plan B (buying 50 pens) is a better buying plan, it yields more productive inventory, and possibly most important is that at the end of the quarter it leaves you with more money in your bank!!

So what other metrics are important to track to understand inventory productivity? Inventory turnover and gross margin return on investment (GMROI) are the two most basic metrics, but in order to calculate them you’ll also need to track average inventory.  

  1. Turns are also called stock turns or inventory turnover. This refers to how many times you replace your inventory in a specified time frame, typically a year. For example, if you buy 100 bags of Friction Labs chalk and sell 100 bags of chalk in a year, then you’ve turned your inventory once. It’s generally better to turn your inventory more often than this—more frequent turns make it so that you have less inventory on hand at any given time, which allows you to keep more money in your bank. Turns can vary between industries, but most retailers aim for 3 to 5 turns per year. 

Turns = Cost of Goods Sold (for a given period) ÷ Average Inventory on Hand (for the same period)

  1. Average inventory on hand is what you pay for the products you are selling (subtract out discounts you might get from your vendors and add in shipping and handling charges) averaged over a certain period (like a month or a year). For a month you take inventory held at the beginning of the month plus inventory held at the end of the month and divide by two. For a year, you sum the inventory held at the beginning of every month plus inventory held at the end of the last month and divide by 13. Aside from knowing how much inventory you’re holding for a month or over the course of the year, which is helpful in itself, you’ll also need this number for calculating GMROI.

Average Inventory on Hand (for a year) = (Inv. beginning of month 1 + Inv. beginning of month 2 + … + Inv. end of month 12) ÷ 13

  1. Gross Margin Return on Investment (GMROI) is the glue that brings Average Inventory and Margin together. Knowing those things alone are helpful, but GMROI gives you a fair way to compare apples to apples between products with different margins or different amounts of inventory on hand. Just because one product has more or less margin than another or more or less average inventory than another doesn’t exactly tell you how these products compare to each other, and GMROI is the piece of the puzzle that tells you that. 

GMROI = Margin ÷ Average Inventory on Hand

Let’s apply this to the pen example. You are trying to compare Buying Plan A with Buying Plan B to make decisions about upcoming purchases:

FEATURED PRODUCT
Get It
FEATURED PRODUCT
Get It

Which buying plan is best? What purchasing decisions should we make? What products should we discount? Should we shift inventory dollars from one product to another? These are some of the questions we can answer by using GMROI to analyze productive inventory. In this example the only difference is whether we bought 50 pens or 80 pens at the beginning of the period. Since we sold 45 pens, Plan A has a higher average inventory on hand for the quarter. If you only look at revenue and margin, then you can’t tell which buying plan is better because you are ignoring how much inventory you’re holding and how much money you’re putting back into your bank! 

So, let’s look again using GMROI as well.

GMROI adds to the story, and if it’s above 1 then you are at least profiting from your inventory of that product. If GMROI is equal to 1, then your profit is equal to your average inventory, so all of your profit is being used to hold the same level of inventory. Buying Plan A has a GMROI of 0.78, which means if we continue holding $57.50 in inventory on average but only profiting $45, then our average investment in inventory is only returning a 78% profit. This is not good. Buying Plan B has a GMROI of 1.64, and above 1 is what we’re looking for, so this is telling us that our return is greater than our investment (our average inventory investment is returning 164% profit). Returns greater than 100% are what we need to be successful.

You can improve GMROI a few ways: increasing your turnover (this will be dependent on demand and marketing), increasing your margin (this could slow your turnover), or decreasing your average inventory on hand. Since you can directly control your inventory levels, this is likely the easiest way to improve your GMROI. Just like one person’s goal in a race is to cross the finish line and another person’s goal could be to run the whole time without walking, what metrics you use to determine success of your retail shop is up to you and your goals for the shop. Holding more inventory can give better customer service, but takes more space and therefore costs more money to hold (and decreases GMROI). Offering a member discount is a great perk for members, but then we need to be ok with lower margins (and again, a lower GMROI).

Regardless of what you decide, these tools will help you determine how productive your inventory is, and in turn give you more guidance to make better purchasing decisions as you work to grow your shop.

Related Posts

Pick Up Your Gear

No items found.
Subscribe
We only send emails we'd be psyched to receive ourselves.

Got it! Thanks for the support!

Oops! Something went wrong while submitting the form

© 2020 Friction Labs, LLC All Rights Reserved.