Definition and calculation of the ROI metric How to use

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Merchant Prophet
News for the Independent Retailer July 2009, Volume 4
Getting the most Bang for Your Buck - Merchandising to the ROI Marketing Tip
What is the ROI of your advertising
Guest Writer - Drew White, Senior Merchandise Analyst dollar? We all know that it is far less
expensive to get an existing customer
We thank Drew for sharing with us his insight on perhaps the most
important factor in profitable merchandising. Drew has helped retailers
back into the store than to attract a new
improve their profitability for over 22 years as a Senior Merchandise customer. It is not uncommon for our
Analyst for RMSA and can be contacted at msaguy@fuse.net or clients to get a 20% or better response to
513-470-9550. birthday promotions to existing customers
- what a great way to thank a loyal
Return on investment - ROI - perhaps more accurately ROII, customer and drive additional revenues for
return on inventory investment. If I were to ask 20 a very small investment.
merchants to define or calculate it, I would likely get 20
different responses, so this is my attempt to explain it without too much complexity. In When investing in advertising to draw new
fact, the ROI computation is a simple fraction: a ratio; a numerator divided by a customers, a response rate of 2% is
denominator. It's "are you smarter than a fifth grader" math. considered successful.. Achieving a 2%
response rate may not seem worth doing,
What makes ROI valuable as a benchmark calculation is that it's a distilled or pure but in really understanding the Return on
representation of "bang for your buck." It defines how many gross margin dollars you Investment (ROI) of advertising, it is
receive in return for every cost dollar you, the merchant, have invested in inventory. important to consider the lifetime value of
a new customer.
Any merchant knows if they can improve their ROI, they'll have a more efficient and
profitable business. So let's define it exactly and then see how it can become one of the For example, if you spend even $2,000 to
most important merchandising tools in your tool box. market to 1,000 new prospects and get
only a 1/2% response, you might think that
As stated previously, ROI is a simple fraction. The numerator is gross margin dollars an expensive investment if only 5
generated. The denominator is average cost inventory dollars owned. So, simply customers responded. Let's say your
said, dollars divided by dollars over a period of time - the time frame is usually a rolling average sale is $100, meaning you spent
12 months. $2,000 to generate $500 in sales (maybe
$250 in margin). But if the lifetime value of
If the numerator can grow while keeping the denominator constant, the ROI calculation an average customer is five, ten, fifty
will go up. If the numerator remains constant and the denominator decreases, the ROI thousand or even more, the true ROI is
calculation will go up. If the numerator increases and at the same time the denominator more attractive.
decreases the ROI calculation really explodes - up!
If ever there was a time to attract new
Let's talk about the numerator: gross margin dollars. All effective retail inventory customers it is now. Be smart about your
management software calculates $$GM. In order to improve gross margin, a merchant advertising dollars to attract new
needs to understand the relationship between two things - the initial mark up (IMU%) as customers and be even smarter about
new goods come into inventory and markdowns (MD%) associated with the generation continuing to invest in one-to-one
of sales. marketing to retain your loyal customer
base.
Now the denominator: average cost inventory. All effective retail inventory
management software calculates turnover. We understand if turnover rates can be Quote of the Month
improved it's healthier for the business. If we can own less over time and generate the "An investment in knowledge pays the
same sales result, our business is more cash flow efficient. best interest."
- Benjamin Franklin
All effective retail inventory management software calculates ROI in some fashion.
Where exactly? At the style level, at the vendor level, at the class level, and at the Related Issues
store/company level. For the sake of brevity, where the calculation is best suited for
merchandise decisions is at the class level. Effective Inventory Management - The
Importance of Planning
Here's why.
Norton Ditto: A Case Study
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When the merchant sees immediately across all classes to what degree they are
contributing, then a course of action can be rendered and a strategy can be employed. Join us on Facebook!
Weaker classes can be targeted - but is it the numerator or the denominator that has
the most potential for improvement? Remember in the ROI fraction if the numerator With the exploding membership in
can't be readily increased due to, let's say, competitive pressure on initial markup, then Facebook we thought it might make a
emphasis shifts to reducing the denominator. great venue for a User Forum. It's a great
way to get to know other users of
There are pressures against increasing initial markup in many cases; for example, Merchant Plus and pose to the community
athletic footwear as an industry enjoys a lower IMU% than other classes. That questions on how others handle different
suggests that turnover is the critical element to ROI improvement. situations - from software specific
questions to general retail issues. Please
As the merchant reviews the ROI contributions, one may see that a lower IMU class join us!
with a fast turnover can contribute as much ROI as a class with much higher IMU but a
slower turnover.
So what comes to the surface is a solid strategy of what to target and how to execute.
A store may have a broad range of initial markup across its classes, which means
every numerator will have a different result. That's okay. As long as the merchant
understands how to improve the denominator, ROI improvement can occur across all
classes.
A well-constructed OTB plan will allow the flow of new goods to meet the demands of
the selling season, will promote turnover and reduce the impact of markdowns against
your gross margin. A well constructed OTB plan impacts the numerator and the
denominator.
What should your ROI be? What's acceptable? What's the minimum? Let's talk about
the minimum. ROI has to be greater than 1.00 - remember the fraction, dollars divided
by dollars. A dollar back for every dollar invested isn't good enough! What about
expenses? It costs about 40 cents of every sales dollar to cover overhead, so lets add
the 0.40 as well. Therefore a good rule of thumb is ROI greater than 1/40 is a healthy
contributor to the business.
Here's your challenge: Find the ROI reports in your report menu. Sort it by
department/class. You'll see where the "bang for your buck" is the loudest. Then do
something!
MERCHANT PLUS! SOFTWARE THAT THINKS LIKE A MERCHANT!
© 2009 Smyth Retail Systems
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