Product segmentation

We’ve seen this so many times. Business owners in retail and wholesale just ‘guesstimate’ what items in their inventory make the most profit. This actually happened, just the other day. A client, represented by its two owners, was having this conversation.

demand planners

The company sells about 12,000 SKUs, among them shorts. One of the owners kept saying, “I think we should try to sell more of the expensive shorts, in low volume”. The other one countered, “No, I think we should try to sell more cheap shorts in higher volumes”. So what did they end up doing? Nothing. They continued down the not so golden middle way, because they had no other way to find out which guess was more accurate. That is, until they started to use Inventoro.

At Inventoro, we like to start our sentences not with the words “I think” but rather with “the data show that… .” Because numbers don’t lie. It does, however, sometimes takes super powered software to get to these numbers. That’s why we created the “Winners and Losers” section of our software.

Winners and Losers is a simple screen which divides your portfolio into three categories. Winners are the cash cows of your business, Chasers the strongholds of your inventory. And Losers, the underdogs of your business, are those products which bring nothing but heartache and tears, even financial ruin if not discovered in a timely manner.

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Winners and Losers as an ABC analysis

On the code level of our software, ‘Winners and Losers’ is nothing more (but nothing less!) than an ABC analysis (ABCD analysis to be exact).This calculation, which is essential for any retail and wholesale business, is done the same way whether you are a local shop or a global conglomerate.

To do the analysis we look at the retail price of a product, its purchase price, and the sales volume of each item. With these numbers we can divide the entire sales portfolio from most profitable to least. It is important to emphasize that the sales volume parameter plays a big role in this sorting process. You can have an extremely profitable product which only sells at a rate of once every three months. On the other hand, a smaller margin product that sells in the thousands of sold units can eventually make more in profit.

When the analysis is complete (and we recalculate it every single day), you get something like this:

Take a closer look at the graph, and you see that Category A includes only about a fifth of all products but about 80% of the revenue. If you’re keeping score at home, you have probably already guessed that Category A is ‘Winners’ in the Inventoro app.
Category B contains a majority of the products, but only about a fifth of your total revenue.
Category C represents no or almost no revenue.

Making sense of product segmentation

What’s so beneficial about this basic yet important analysis is the ability to see the portfolio as a whole. Analyzing each item in Excel with the total number of SKUs reaching tens of thousands would take days. By the time you finished, the results would no longer be valid.
The Winners and Losers categories help our customers see the results of this analysis on one screen. Like one-stop shopping, understanding the dynamics of your portfolio becomes a fast daily check, saving hours of unnecessary manual data work.

So to be clear, Winners in our app are represented by Category A, Chasers are in Category B, and Losers are in C and D. Identifying the products in these categories is the first step. Then, it’s up to savvy business owners as to how to work with these categories and take the actions needed based on the data.

Know your cash cows

Let’s start with the winners. These are your pure gold. They have high margins, and although they make up a relatively small share of your products (typically under 20%), they represent the majority of your profits.

It is advisable to keep these products in stock at all times. Stockouts on these items significantly damage your business results. You want to make sure that these goods are available at all times.

Your first reaction might be, “Why not sell only these products?” Well, you could, but your customers wouldn’t appreciate such a small product offer. Customers like convenience. They like to shop in one place, so they like e-shops and stores which offer a large variety of goods. That makes Chasers so important. Without Chasers, you can’t sell Winners.

Offer a wide variety of goods to keep customers satisfied

Chasers are your biggest category in number of goods. This category represents a majority of your products, although if analyzed item by item, they don’t sell so well. As a whole, however, they attract customers to your store or e-shop.

In the typical customer journey, a customer googles a product online, often a niche product, something unusual like a manual tire pump (something you buy once or twice in your life).
The pump attracts the customer to your e-shop, and he makes a purchase, but he also starts to scroll around your shop to see what else is available. This is the typical moment when they end up adding an “A” product, a Winner, to their basket.

Chasers are incredibly important to your business, because they attract customers to your shop or site, hopefully eventually leading to bigger sales (of Winners). Think of Chasers as marketing teasers for your business. You want to keep these available, but nothing serious happens if you face a stockout for a day or two on these items.

Underdogs of your inventory

Losers are aptly named, because they are truly the garbage of your inventory. There simply isn’t much positive to say about this category, and you should try to get rid of them as fast as possible. Losers sit in your warehouse taking up space and waiting until you finally get rid of them, often expiring in the meantime.

But getting rid of these products is easier said than done. Of course you can choose to stop ordering them completely, but that’s not going to sell the ones you already have in stock. So you need to find active ways to speed things up.

Generally our customers choose two scenarios. First, they put these goods on sale at a massive discount. Even zero margin sales are cheaper than keeping the goods in your warehouse for long periods of time. If nothing else, you free your cash up and use it for better things. Or, you can negotiate with your suppliers for a buyback. This requires making some telephone calls, but some wholesale suppliers do it. You can always try.

How we use product segmentation for order
optimization

Inventoro is software for demand planning and replenishment optimization. So, you might ask, why do we do ABCD analyses for our customers? Well, as it turns out, these two fields are closely related. We use the results of this analysis to set an important parameter in replenishment called service level. This number (measured in percent) determines the availability of goods at all times. 100% service level means that of 100 customers who wish to buy a product, 100 will have their demand satisfied. 50% means that every second customer goes home without the goods. You can change the setting of your service level in the Strategy section of our app. By design, the service level for Winners is set to 99.5%, with Chasers set at 95.0%. And Losers? They’re just junk, so they don’t need any service level at all, because nobody buys them in the first place.

There is a reason why we keep Winners close to 100% but not 100% exactly. The last 0.5 percentage points are the most expensive and most complicated to maintain. Let us explain.

Let’s say you sell chocolate bars. You have 100 in stock, and your forecast shows you will sell 300 by the next delivery. For a 99% service level, our system recommends that you order around 240 more, so you have 340 chocolate bars in stock to satisfy a forecasted demand of 300. Actual sales could be slightly above the forecasted 300 chocolate bars, but with 340 in stock, you will still be safe to meet that potential extra demand.
If we set the service level to 100%, our system will recommend that you order an additional 336 chocolate bars, not 240. That’s an extra 96 chocolate bars just to go from 99.5% service level to 100%, of course with little hope that you’ll actually sell all of them.
No one in the industry keeps 100% service levels, unless they are vital for human life, such as medical supplies in hospitals, for example. But that’s not your case, clearly. Take a look at the graph to see how fast costs rise in the last 0.5% of service level, just to make sure that you satisfy ALL possible demand:

Warehouse location is a factor for product segmentation

When you connect your data to Inventoro and run your first Winners and Losers analysis, you might find that certain items appear in the Winners and Chasers categories, for example, at the same time. This is not a mistake, as certain products sell differently in various locations.
When you think about it, this is not surprising at all. Let’s say you have an e-shop and three retail branches. You sell sporting equipment of all kinds. One of your shops is just next to a beach. It seems logical that snorkels in your beach shop will sell like crazy. But snorkel sales in your e-shop are low, even insignificant.

So if you look at the company as a whole, snorkels are categorized as Chasers, but in your beach shop they usually do much better, well enough to reach the Winners category.

Filter product segmentation

For this reason we have added the filtering option to the Winners and Losers section. You can analyze your portfolio by category, warehouse, and supplier. You should click through these and see how the items vary to familiarize yourself with what’s really happening in your business.

If your company has several warehouses, you may find that your employees only find it useful to focus on the data that is relevant to them. In this case, all you have to do is select the relevant data and give your people the specific information that they need.
Filtering products by supplier is useful especially for the Losers section. If you find out that one or two suppliers have a lot of products in the Losers section, you can use this information to initiate a buyback, as discussed earlier.

Filtering products by category is beneficial, because it helps you understand what category of products is important for your business. That applies to both Winners and Losers. Understanding the structure of your product portfolio enables business owners to make data driven top level decisions, and not just ‘guesstimate’.

Manage inventory like the retail giants

From a mathematical point of view, Winners and Losers is probably the least complicated part of our system. It doesn’t require any next level calculations. But it turns out that it is the first eye-opening feature of our app.

Inventory management is the number one opportunity for automation in the retail industry. It is also the area where retail owners, e-shops, and even warehouse owners have the ability to save the most money and therefore make a significantly higher profit.
And yet our data show that inventory management is one of the least well thought through parts of business among small and medium-sized enterprises. In reality, this is what truly disqualifies them from being competitive with global retail conglomerates.

But not you. You know you can be better. If you’ve read this far, chances are you are ready to automate your inventory management. We are here to help.

Stay in touch with Inventoro

Supply chain management software can be complicated. We have spent thousands of hours to make it as simple for you as possible. Still, we believe that we can still improve and your feedback on our software is always appreciated. Please contact us in our chatbot or by email. You may also find it useful to read through our knowledge base where we go deeper in the subjects mentioned here.