Retail Metrics: Key Performance Indicators (KPI’s) – Gross Margin Return on Investment
By Scott Kreisberg
CEO, One Step Retail Solutions
This is the 5th article in what turned out to be a series of articles on KPI’s – Key Performance Indicators. There’s quite a bit to cover on each one of these and I’ve only just scratched the surface on each one, but I think there’s enough here to help you improve your inventory management.
Gross Margin Return on Investment
The last KPI to cover is everyone’s favorite, Gross Margin Return on Investment, (GMROI). For every dollar invested, how many dollars did I get back? A business is measured on cost and price. All success is built around these two things. How much did I pay for the merchandise (cost)? How much did I sell the merchandise for (price)?
When you look at the items for sale in your store, ask yourself: how much did I invest in this inventory and what profit am I going to get out of it? If you’re going to spend money on inventory, mark it up and sell it, you do have to consider these factors in order to be profitable. If you invest a lot in merchandise that doesn’t sell very well then you have to mark it down to move it out of the store in order to get your money out of it. That investment didn’t return as much, so in that case, you need to evaluate why that was, using other KPI’s to balance out the information that indicates why an investment was good or bad. By determining this sooner rather than later, you can free up the investment you made in the poor selling merchandise and reinvest it in a better choice.
GMROI calculates the return based on the gross margin from sales. For example, if you purchase $2,000 of inventory and sold it all in the same year for $6,000, your profit would be $4,000. The return on your investment of $2,000 was $4,000. The GMROI in this example is $4,000/$2,000 = 2.
GMROI is closely related to Turn as mentioned in the previous article (read article). If your Turn increases, your average inventory cost will be lower (relative to your profit), and thus the greater the return on your investment and that’s what everyone likes best: low investment with a high return. Your merchandising goal is to increase the GMROI, by keeping your inventory turning, at high margins.
Here’s the mathematical way to figure out GMROI:
(Sales Margin Dollars ÷ Months Passed) x 12
Averaged Inventory Cost
As an additional note, always remember to set objectives for the merchandise you are buying. When you purchase merchandise, you usually have an idea of how much you want to sell over a certain amount of time. For example, when buying a new style of jeans, set a target for how many pairs should be sold in some reasonable time frame like, sell 12 pairs in the first week. Have this amount in mind when you run your KPI reports. This way you will know if the item is performing according to your expectations. If you only sold 6 pairs the first week and were expecting 12 pairs to be sold, you know you need to change something in order to meet your expectation of 12 pairs being sold. Then you can take quick decisive actions to sell off that item before you get stuck with it and have to mark it down thus lowering your profit.
There is so much that can be covered about GMROI, I could go on and on about it. The main focus of GMROI really just comes down to two basic things – cost and price. How much did it cost you to make a profit on a particular item? And gauging how much your profit margin is on that particular item to make it worth the investment you made to make that profit. It requires a constant tweaking of the gauges (KPI’s), as in the pilot example, to adjust the plane for an optimum flight experience. As a retailer, you’re not flying a plane and looking for an optimum flight, but you do have tools that can help you navigate in order to obtain the optimum profit on the merchandise you invested in.
All of this information comes down to one simple question: do I have the right inventory in the right place at the right time? If you don’t know, the KPI’s will tell you just that.
Using these KPI’s and reporting tools, which should all be available to you from a good POS system, you will better manage your inventory, gross profitability and have less mark downs in your store. Your point of sale, properly set up and used, will help give you all of this information so that you can optimally manage your store(s). So, here’s to higher profits and better store management!