Inventory Management and Safety Stock (Tradecraft)

With my inventory management presentation at ACD Games Day in May, I've started deeper research into the topic. If you do something for a number of years, you might be pretty good at it, but you don't necessarily have the context to go beyond, and it certainly doesn't mean you can teach it.

I'm reading the informative and thankfully somewhat fun book, Inventory Management Explained, by David Piasecki. Honestly, the bulk of what there is to know about inventory management doesn't apply to every business. About 20-30% seems to apply to any given situation, since inventory management also covers manufacturing, but can include a lot of practices we don't see in the game trade. On the plus side, as game store owners, we have it really good, with things like "lot sizes" (how much you have to buy of one product at once, or buying for a volume discount) and lead times being as ideal as they could be. The distributors get to deal with that stuff.

According to Piasecki, there are seven categories of inventory, with the important ones for game stores being your current demand inventory, safety stock, anticipation inventory, and hedge inventory. "Your stock,"is current demand inventory, stuff you buy for right now. Safety stock, is the most interesting category and the one you probably spend time on the most, after general stocking of your "current demand" items. Anticipation inventory is stuff you buy in anticipation of a season or event, like stocking up on Magic or buying in for the holidays. Hedge inventory refers to taking advantage of price fluctuations, such as distributor sales or perhaps stocking up  before a known price increase, like the annual Games Workshop increase.

Why does this matter? Because ordering is where you make your money, and if you're not making money, you can often trace it back to bad ordering. If you trace it back, you'll need some tools to categorize and figure out where your problem lies.

Out of money in November? Check your anticipatory inventory, as you may have ordered holiday stock too early. My current anticipatory inventory problem relates to CCGs, as in ordering too much Born of the Gods that exceeded my 30 day terms window. The bills are due, and finances are tight because I've got too much inventory. These problems work themselves out eventually, we tell ourselves, but in the mean time, your business is suffering and profitability is effected. You can go for years, decades, like this, selling like a sales god, but wondering why you never make a dime.

You could see where hedge inventory could get you into trouble, and in a trade that doesn't offer a lot of deals, getting stuff at a discount sounds even more appealing. I have one vendor I avoid on the phone because of a combination of high pressure sales tactics and volume discounts. I've got cases of unsold product, hedge inventory, that tells me this is one of my trouble points.

Safety stock is a buffer against variations in demand, but also variations in supply. I've got four deep of Settlers of Catan because of variations in demand and four deep of Arkham Horror because of variation in supply. Safety stock is stuff I never want to be out of, rather than forecasted current demand inventory. Even the newest store has some safety stock, as the saying, "an inch deep and a mile wide" has some exceptions. If you play it safe, current demand inventory and safety stock compromise the bulk of your decision making.

Here's an example of analyzing our two types of safety stock.  You have four Arkham Horrors on the shelf year round as hedging Safety Stock, due to stock outages. You also have four Settlers of Catan as Safety Stock, but primarily because of demand variation. Those four Settlers get a free pass, because you can't account for demand variation, but those four Arkham Horror are costing you money, because you're hedging against supply difficulties.

Identifying Arkham Horror this way allows you to make some calculations and decisions. First, assuming Arkham is a Safety item, we would normally want to stock two copies. Since I'm forced to stock four, due to outages, that's two copies too many. Having to stock them year round due to supply chain problems has an opportunity cost, that of 3 turns a year of other games I can't carry (my board game average, as AH turns more like 8). In gross sales, I lose $360 a year because FFG can't guarantee supply. We'll ignore the lower Fantasy Flight Games margins and look just at retail prices. That 8 turn board game really only performs like a 2 turn board game because of the lost opportunity costs. It goes from a top game to a below average game because it exists at the expense of other inventory.

Breaking inventory down into its constituent categories allows us to analyze in more detail, focus on behavioral changes, and find solutions to our stocking problems. Problems with current demand inventory might be related to not properly tracking with an "open to buy" worksheet, or it might be poor forecasting, since tracking is only half the battle. You might have the wrong safety stock, or you might be putting too much ego into what you've decided you can't ever live without. Our new POS system will track how much of an item we had in stock historically, so you know you were overstocked at a particular time.

Looking at the graphic for Settlers of Catan, our lowest point shown was on February 13th, when we went down to two copies. If we could show our lowest point ever was two copies, we could reduce quantities from four to three. Big deal? Well, that one copy, like the Arkham Horror example, can be multiplied by our turn rate, which is three for board games. So that's $126 in lost sales a year because we have four instead of three selected. That's just one game. One of the challenges in the book, one I haven't taken on yet, is identifying exactly what stock is safety stock to come up with some more strategies.

Discounting (Tradecraft)

If you listen to the game trade experts, you will know that discounting is a bad thing. It dooms you to your parent's basement and a life of ramen noodles. But what do they mean? I've talked to people that have taken this mantra so much to heart that they're afraid to discount anything. "But Dave said no!"

What the game store gurus are referring to is running a discount store, where everything is discounted across the board. That's a recipe for ramen, er, I mean failure. You can absolutely do it. If you want to be a game store monastic and take one for the team, by all means, it's possible. Your store won't have nice things. You certainly won't have nice things, or a future, but you can. I've got a competitor right now that does that and I'm basically waiting for them (or their mom) to lose interest.

What you should do, what you absolutely must do, is discount things to get rid of them. This assumes you run a profitable business with inventory management, payroll, and profit. Dead inventory ties up your cash flow and impedes you from paying your bills and getting all the new things, which is your recipe for success. Inventory is your economic engine and when it's full of sludge, the performance of your store will absolutely suffer. You owe nothing to anyone in this regard. Your job is to tune for high performance.

Sure, you can run a "shock and awe" store, and many do successfully. They never get rid of anything. They've got gems from a decade ago. But could a single one of them tell you how to run a shock and awe store? Could they put down on paper exactly what's required to run a one turn a year inventory hoarding business? Can they tell you why their retirement funds are tied up in sludge inventory?

The best I've gotten is "This is what we do, it works for us somehow, but I don't recommend it." There's probably a way to slog through the first decade of a shock and awe store, without making a dime, and coming out strong and safe on the other end, but why would you do that on purpose? Shock and awe is usually something that happens to you, rather than a business plan.

How you discount, where you sell your goods, and how soon is up to you. Generally, I do it like ripping off a band aid. If I get in a product I accidentally ordered and I know it has no hope of selling at full price, I discount it out of the box, and I discount it 40% to quickly get that money back (gross margins are around 45%). I don't wait because I know. That's true of anything I dump. I want it gone. I'm not going to be clever with a graduated sale, with 20% today, 30% tomorrow and 40% on Saturday. I want the money back ASAP because I don't have time with something that already has the stink of death surrounding it and I'm not putting it on sale because I want to entice customers (also dumb).

If I were concerned about image, I might put all my dead stock on Ebay or Amazon and sell it slowly. In a perfect world, I would have an upmarket store and a down market store and I would ship all my junk to the down market location (that's just fantasy though). Generally though, I have a subset of customers, my vultures, that come and pick the bones clean. They shop the clearance bin, and that's ok. Dead inventory is a thing that happens. Vultures are necessary for the ecosystem. Everything will be dead one day, it's just a question of whether the last one goes home at full price or a discount.

The game trade is front list driven. As the last two fairly crappy months of releases have shown, if you don't have the new things in the game trade, your business will suffer. Recovering inventory dollars is how you maintain that cash flow and inventory clearance is how you do it. It's just a tool in the tool box.

Changes in Advertising (Tradecraft)

I was looking at my profit and loss statement for last year and noticed my advertising expenses had dropped 25%. Advertising for small business has changed dramatically over the last 10 years. In my first month in business, we filmed a TV commercial. It ran for several years until we updated it, and then it ran another three years or so. I was paying about $300-500 a month, and usually $1000-1500 during the holidays. The Yellow Pages ran $200 a month. Our direct mail campaign to our customer list was $150 a month. We spent money on many advertising mediums in hopes of finding a magic formula. The ones that didn't work included ValPak, movie theater slide ads, radio ads, magazine ads, and direct email marketing (which we still do for some reason).

Now we don't touch traditional advertising mediums. Our advertising is digital, with the bulk going to Facebook, a nice slice to Google and various independent online advertising targeted by zip code to the gaming community. These new mediums are incredibly effective, to the point we can't possibly justify the old mediums. Even stranger, with a recommended budget in the 2-3% of gross sales range for small business advertising, there is more money in the budget than effective advertising to buy. There's probably another $1,000 a month I could spend, if someone could show me the effectiveness of a new medium (many have tried).

What's really surprising is we've maintained a steady stream of growth, tripling sales from back in the day, while our advertising expense has grown only 50% (whereas it might have grown 300% before digital took over). In other words, we went from advertising comprising 3% of our expense to 1.3% of our expenses, without losing effectiveness. So when we talk about a business revolution in social media, a small business like mine, with say, an 8% net profit margin, just increased their margin to around 10%, or a 20% profit increase. That's pretty revolutionary. The next time that's likely to happen will be credit card processing fees.

I have no doubt there are areas where I could stretch, where I could experiment and try a new medium. Feel free to suggest some. But while sales growth continues to rise, there's not a lot of reason to stretch ... and that makes me nervous. How many other areas can I say that about? Thinking about my upcoming ACD Games Day presentation on inventory management (shameless plug), the need to carefully manage inventory isn't really there when you're in a growth phase.

Do game store owners have the skills to manage their inventory? If you've only been in business for a few years, during the boom, you probably haven't had to tighten your belt and work through tough times. We might have more to learn from struggling, leaner small businesses that aren't game stores than each other in this case.

ACD Games Day (Tradecraft)

I've agreed to do a presentation at ACD Games Day in May. It's in Madison, Wisconsin, one of my favorite cities. My initial plan was to move to Madison and start a store, so strangely, I spent more time in Madison in my research than I did in California. When I started a new job, they even sent me to Madison for training. That's where (and when) I wrote my business plan.

I highly recommend you go to this show, especially if you've got a new store and you're local, like within a half day's drive. It's a mini Gama Trade Show, with presentations and vendors. I haven't entirely nailed down the topic, but I'll most likely talk about inventory management and open to buy.  I did a presentation at ACD Games Day in 2008 where half of it, the half people found most useful (the dozen people who came), was on this topic.  So why inventory management? It's where the money is.

I've discovered something interesting by going to trade shows and talking to other store owners. Those of us who made the decision (sometimes referred to as a mistake) to not have game space in our stores early on have a firmer understanding of inventory management. What else were we going to do? Your store is a traditional retail store with eight hour days, without the circus that's organized play. Without OP, we had far flatter sales patterns, so when everything is selling about equal, you're constantly tweaking and adjusting your mix, as opposed to a modern store, where a lot of effort goes into promotion (events). It's far more product focused. Heck, it's exclusively product focused.

Don't get me wrong, OP is amazing for a store, boosting our sales by 60% when we added it overnight. At the same time it supports and builds the community, allowing for far more rapid growth than a product only store (which is a completely viable, if less compelling business model). But OP is a messy, hard to quantify, often volunteer driven, subjective morass. I wouldn't give it up, but life was far simpler without it. The thought of it, and nothing else, keeps me from wanting a second store. I'll just grow the one I have. So those of us who didn't have to be the circus master seem to have a better grasp of many business fundamentals. That's my little narrative on why.

My understanding of the fundamentals has changed over the years. It's more nuanced, and many of the tools I intend to talk about aren't used as much as they used to be. I used to use the tools all the time, because my business wasn't working properly. If you saw me back then, you saw me with a tool in my hand and you may have winced, because all I ever talked about were tools. Tools kept my business alive. We spent the first five or six years in rapid growth mode, and growth can be painful. We were swinging for the fences. Every time we reinvested, it took a couple years to stabilize. We're about to do it again.

So I have the tools in my toolbox and they're not always in my hand now. I'm talking about sales per square foot analysis, turn rate analysis, and maximizing sales through various inventory means. These are all ways to take what little money you have in inventory and grow your business far more than should be expected. That's the thing. Efficient inventory is a miracle worker, creating wealth far beyond your peers and competitors. It requires you regulate the inflow of goods, measure the outflow of goods, and tweak, tweak, tweak. Or not.

A nuanced approach accepts that you grow your sales not just by numbers, but by psychology. You may focus on a best of breed in each department, completely carrying the full line, despite the metrics. This can also be termed a "top of mind" strategy, where the customer thinks of you first when they think of a product line. We do this with Pathfinder, carrying every single thing available. You have to consider a minimum quantity of items to maintain cohesion. You have to consider collections, accepting that a small subset may have tremendous sales, bolstered by slow sellers, because of the illusion of choice. Things I no longer believe include the "merchandising expense" of slow selling categories, designed to signal you're legitimate. If chess sets don't sell, and you haven't violated the other principles, dump chess sets.

If you've got questions about the topic that you want me to address, I"m happy to consider inclusion in the presentation. If you're there, I'm happy to talk to you about your problems with inventory management. Remember I'm just a guy who does a thing his way, so there are many ways to do inventory management. I happen to think there's only one reasonable way, but that's because nobody has shown me a rational system.

Miniature SKU Creep (Tradecraft)

 Game stores want to support the games they carry as much as possible. The biggest limitation of that support is inventory, a zero sum game, where to carry one game, a piece of the pie must be taken from another. I only have so much money to spend and that number doesn't change. There is only so much pie, and everybody wants some. So how do you determine who gets pie? Performance of inventory can be done a number of ways, but the most common, for those who measure who gets pie, is turn rates.

A solid store will do an overall average of 3-4 turns a year, meaning their inventory will sell, on average, that number of times. If you have $100,000 in inventory, $300,000-400,000 in gross sales is good. Don't get all excited, with a 7% net margin (a bistro math average), that's only $28,000 in profit. That overall turn number can be broken down further, and certain game categories have higher or lower turns.

For example, CCGs have really high turns, probably in the 8-16 range, which is why they're so popular and why so many small stores can survive with them. One box of CCGs sells four times better than the average game trade product. More board games or more CCGs? That's a dumb question if you need more CCGs. A bad Magic product just about outperforms everything else.

When it comes to miniature games, we run into a problem. You can still get your 3-4 turns on a really strong, well supported miniature game, but there comes a point where the system breaks down. That happens with SKU creep. The manufacturer continues to add more and more models without discontinuing old ones. If the store continues to carry all those models, there is no amount of sales that will support that inventory number.

For example, I count 362 Warmachine items available from my distributor, averaging $29 each. Carrying all of them is around $10,500 at retail. Privateer Press puts out models nearly every month for almost a decade while discontinuing very, very few models. To get four turns a year, I need to sell $42,000 in Warmachine. Alas, I get about half that number, so I either flounder along at 2 turns a year on my very popular, absolutely superb, nothing wrong with it Warmachine (close to what I do), or, as a business person, I carry half the Warmachine catalog. Or I get nervous and sell off half my lowest selling inventory to my confused customers who think their game is doing well at the store (it is).

I want to carry it all, but using inventory metrics, it would lead me to the conclusion that Warmachine is broken, and perhaps not viable for my store, for any store maybe. But I know I'm doing well with it, so I pick and choose, but I'm really only offering my customers a paltry 50% of what's available. That makes my store less than great. 50% is a failing grade. It makes my customers shop online or with my competitors; usually both. So great game. I theoretically do well with it, but SKU creep has crippled my ability to serve my customers while maintaining a viable business model.

So what to do? Speaking to manufacturers, cut back your catalog. Let things go out of production permanently, or brought back for special releases. You know who does this really well? Man, I hate to even say it, but Games Workshop. Games Workshop manages their inventory like gods. The beings at Games Workshop are Gods of Inventory. They're rarely out of things they intend to have. They carry what works and they stop selling what doesn't. Things on their core list are meant to sell well and usually aren't there because they add character. Plus they revise their core list regularly to maximize sales. At least that's what GW did in the past, before their core motivation became direct sales.

The down side is customers hate this. Whenever we're talking GW, this is the one place where I go, "Au contraire (because I took French in high school), this is where Games Workshop has it right." But it's true, customers want their models to live on in the rules and on the shelves forever. But you know what? We're running a business here. GW can't produce those models reliably forever, just as Privateer Press can't supply the demand through distribution now. You should hear the frustration on that end.  It's just not happening and hasn't happened for years. Fixing this means obsoleting SKUs before they overwhelm the retailer, while maintaining a happy customer base. How you walk this fine line is your problem, manufacturer. But if you ask me, cut your dead wood, your long tails, and just let that stuff go. Don't write it out of the universe, just stop making it. Oh, and make more combo boxes so I can build twelve different models from a box of plastic bits with one torso.

And this is why game stores would rather focus on CCGs and board games.