Thursday, September 6, 2018

Rising Cost of Goods (Tradecraft)

I've been tracking my cost of goods every day since I opened my store in 2004. I wasn't really sure what I would do with these numbers on day one, but I thought they were important. I can't stress how ignorant I was about retail back then, but I knew from working in IT you couldn't over measure.

The numbers I tracked were the COGS I actually got on the sale of merchandise each day rather than what I bought the product for. It doesn't include some tiny categories like used products and card sales, so it might actually be a point or two higher. This was all tracked on my Open to Buy spreadsheet, which today is on line 5,053.

I might have bought a $50 board game for $25, but if I had to clearance it for $30, that's reflected in my numbers as higher COGS. As margins shrink, especially with the recent announcement Wizards of the Coast is reducing margins on Magic the Gathering for a second time, rather than raise prices, I've decided to attack low margins head on.

Usually low margins have historically meant inefficiency. When I'm growing quickly and taking a lot of chances, I make more inventory mistakes, which is reflected in a higher cost of goods. It's like how geologists can look at a cross layer of rock to discover historical events, like volcanic eruptions. Yep, that rise is when we moved and guessed wrong on product. That low point was when we were saving for construction and not taking any chances. For the last three years, cost of goods have risen steadily and margins have shrunk, and with Magic about a quarter of our sales, I can't imagine it not moving a point or two higher next year.

There are a few tools you can consider for addressing low margins. In the past, turn rates have been all I've cared about. If a product moved fast enough, the margin was far less important. I don't think speed is making up for low margins, as the industry margins seem to be shrinking overall. Turn rates are about opportunity cost, and we have limited money, limited opportunity, to pay our bills and be successful. For the first time, I'm running margin reports.

Most point of sales systems can't run a margin report, much like most can't do turn rate analysis. To make your own, run a report with prices and costs, dump it to a spreadsheet and create a new column with a percentage comparing those numbers. Now sort. The first think you'll probably notice is errors, which should be fixed. For me, there are items with no COGS noted. Then look at your lowest margin items. Like working with turn rates, perhaps address your lowest 20% performers.

I've delegated entering data into our POS, so sometimes low margin items get past me. Some companies, like Ultra Pro has laughably low margins, if you use their MSRP, for example, as do some direct accounts where we pay shipping. These are easy to fix.

When I looked at Magic a year ago, I saw how it had shifted from pack sales to box sales and singles over the years. In 2004, it was inconceivable I could sell a box, which I sold at full MSRP ($133). It's 2018 and we're selling them hand over fist at $120 (like $92 in 2004 money). These are inherently lower margin sales, and combined with low margin draft events, Magic doesn't look so hot. Our solution in the case of Magic is to increase our discount prices to less of a discount for these things. Event fees will go up a dollar, box sales by five. If the market won't bear it (customers have shown tremendous understanding), we'll shift.

So now is the time to raise prices, set items not to re-order, or maybe even clearance entire low margin product lines to free up cash for other areas. You might combine this with a turn rate threshold: 50% margin needs to turn at four times a year, 45% turn at five times a year, 40% six times, and anything lower perhaps ten times a year. We're using multiple tools here to get results. There is no impossibly low margin, if performance is good enough. I'll take a 10% margin, if I'm buying a product on Tuesday with a guaranteed buyer on Wednesday. New car dealerships make their living on low margin, near guaranteed sales of 10-15%.

Like turn rates, blowing out low margin items is about opportunity cost. You need to have a better place to put your money when you do this. If you don't have a better place, you're better off leaving well enough alone. In a small market, low performance may just be your lot, and a Subway franchise may be in your future.

Another option is to use GMROI, which I talked about in this blog post. Gross Margin Return on Investment is the perfect tool for calculating inventory performance when margins are all over the board. You'll definitely see under performers using this tool. In my example from that post, I beat up on toys for not performing. After I wrote that post, I ditched toys. Classic games also underperformed, and we streamlined that department, treating it as a seasonal department.

Here in California, inflation is a staggering 3.6% and wages are rising around 10% a year. We're being eaten alive by expenses while cost of goods is going up, and we're seeing a re-alignment in our product mix, resulting in lower board game and CCG sales. It only makes sense we look deeper at exactly what we're doing and make some hard choices.

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