The Bottom 20
What does the "Bottom 20" mean, and why should you care?
By Lenny Polivy
Featured in the May 2012 Edition of National Jeweler
What does the "Bottom 20" mean, and why should you care?
The Bottom 20 is the merchandise that occupies the bottom 20 percent of your inventory. You should care because it is costing you money.
In its simplest form, the Bottom 20 usually consists of mistakes in buying, aged or discontinued models, broken collections or just items that no longer fit in the assortment. This merchandise is typically featured in sale events, often multiple times, and as this inventory fails to sell through, it continues to age. The unseen problem runs much deeper. The Bottom 20 costs you in terms of money spent to store and maintain it in addition to lost sales opportunities
When your store is shopped by a prospective customer, the sales staff and visual displays create a lasting impression. If that customer is drawn to a display featuring the latest colors and fashion merchandise, they will be more likely to want to see it, touch it, try it on and make a purchase. However, if that customer first sees merchandise from seasons past, they may simply pass that case by, and the other cases, even those featuring current merchandise. When the Bottom 20 figures into a customer’s first impression of the store, it taints everything. That customer may then question the quality and freshness of your "Top 20," too. In this intangible way, the Bottom 20 costs you sales.
The impact of the Bottom 20 can also be seen in the hard financial implications of carrying aged inventory. Assuming the Bottom 20 is your oldest and slowest moving inventory, what is it really costing you? Let’s assume the cost of this merchandise is $200,000 and the retail is $400,000. If you sell it at a 70 percent discount to move it quickly, you would recover $120,000 gross, for a net loss of $80,000. Most would argue that they would rather hold this inventory than sell it below cost. But consider the fact that it may take years to sell and will require a discount of 50 percent just to recover the cost. This may alleviate the issue of taking a loss but does not address the aging problem. The inventory aging will compound as slow -selling items continue to accumulate in the cases, which also costs you sales.
Alternatively, if you took the net revenue of $120,000 after a 70 percent discount and put that towards your fastest-turning merchandise, assuming you get a modest one time turn at the same margin, you would have generated $120,000 in gross profit, and covered your net loss on the selloff of the aged inventory by $40,000.
Every lender these days examines their clients differently, but the Bottom 20 is always an important consideration. Typically, lenders will look at turnover rates and the best uses of working capital. If they see that you have an inventory segment that is aging or not performing well, they may introduce inventory exclusions or reserves against the eligible inventory. The Bottom 20 will now cost you in lender penalties for allowing your inventory to age and may also affect your advance rates.
The Bottom 20 and the overall inventory composition naturally also affect your sales staff. Retailers typically pay a commission rate to sales staff based on sales volume. Recently, the trend has been to pay full commissions only if the item sold is transacted at the full retail price. However, the presence of aged goods limits the quantity of new merchandise, which then limits sales associates from earning full commission rates. This structure also does not provide incentives to feature aged items, causing them to continue to age. To combat this situation, a retailer must offer incentives for the staff to move through older goods, which may entail paying a spiff or supplementing the regular commission rate. An incentivized structure of this kind is a win-win, for the company and its employees, as it increases earnings opportunities as well as replenishment opportunities for fresh inventory.
Today’s suppliers increasingly have sought long-term, mutually beneficial relationships. When a buyer seeks assistance in trading out or exchanging slow moving inventory, most suppliers now see this as an opportunity rather than a burden.
Previously, suppliers solely focused on near-term sales opportunities without any regard to the maintenance of current styles at the store level. If the account was up to its credit limit or saturated with product, leaving no dollars available to purchase new inventory, suppliers frequently would not or could not continue making sales to these clients. However, vendors have experienced a shift in thinking when it comes to servicing a client of this kind.
Many vendors are now more willing to accept returns and exchanges or to recycle goods as it provides for long-term sales opportunities. The bottom line is that these vendors value continued business opportunities, which also benefits the client by creating space to refresh the inventory mix. An agreement of this kind may cost you in terms of having to meet certain sales thresholds. However, consider this is better than not selling your existing merchandise or discounting aged goods to the point of incurring a loss anyway. Remember, the top of your inventory turns regularly, but the bottom does not.
There will always be a bottom of the inventory. Whether it is ugly, old-but-pretty or just does not sell, it is still the Bottom 20 of your capital, and it is not working for you. You may think that “it will sell someday, and I don’t want to take a loss by selling it below cost.” But keep in mind that as you move aged inventory out of the bottom, the balance of the inventory will begin to slip down to occupy that space. The challenge then becomes to focus on the bestselling goods and continually replenish fast-turning product. Vendors want retailers to carry the whole line. But sometimes that just does not make good business sense for your store. The vendor has the same issues as you do. Not every item turns as quickly as they would like.
The argument you cannot win
Resisting selling or disposing of Bottom 20 inventory below cost will not serve your business in the long run. The bottom line is that keeping inventory that is not selling costs you sales, customers and upset employees. When a new shipment arrives from a vendor, you can see the emotions your staff feels opening, tagging and stocking the case with exciting new goods. The opposite can be said about the old necklace that is never even shown. So at what cost beyond the actual dollars spent on an item is that piece costing you and your business?
Conclusion with positive results
When you first opened your new store and bought the entire inventory, it was an incredible feeling. The high we all get when we touch new goods reminds us why we love this business and got into it in the first place. When you walk by a case of goods that no longer gives you that thrill, it’s time to act. The initial pain felt will quickly resolve itself when the new shipment arrives that just replaced those goods. So why wait until you have the Bottom 40 to deal with when you could be looking at the Top 90!