An Oracle White Paper

January, 2009

Profitable Customer Centric Retailing:

Having Your Cake and Eating It
 Profitable Customer Centric Retailing

Introduction
A retailer lives and dies by the quality of its customer offer and by efficiently maintaining
its availability. The old standard of “Right Product, Right Place, Right Time, Right Price
and Right Amount” remains valid, but identifying the most profitable balance of these
factors that satisfies both the retailer’s goals and the consumers’ needs has never been
more difficult to achieve.

Today‘s environment involves changing macroeconomic patterns, rapidly shifting

demographics, strong competition and saturated markets. In addition, operational costs
are rising, and consumers are choice-conscious and marketing-savvy.

As a result, the cost of error in retail has been steadily rising. Just one wrong pricing
decision, or the incorrect allocation of stock across a large network of stores, or a poorly
chosen mix of promotional goods, can result in significant loss of margin coupled with
loss of availability, overstocks and misalignment of supply to demand.

Within this environment, retailers are increasingly seeking to introduce more rigorous and
reliable methods of making key trading decisions that affect performance and minimise
the chance of negative impact. The goal is to reduce uncertainty while boosting results
and attaining a competitive edge. The challenge is how to reliably ensure improved
decision-making.

Before we consider the answer, let’s review the problem in more detail.

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Challenges and Barriers

There are a number of challenges and barriers that must be understood and overcome if you are
to be confident of creating the best customer offer possible, and making it available at the lowest
cost to your business.
Some are functions of differing merchandise types and sales channels. For example, highly
seasonal apparel represents a very different challenge than perishable fresh food. Regular basics
like socks and undershirts differ from very expensive, slow-selling consumer electronics such as
LCD and Plasma Televisions. There are also the available channels you can choose to support -
traditional bricks and mortar, catalogues, Internet, mobile or TV or a multi-channel combination
of these.
Before you can consider how to improve your performance in inventory management and
customer offer creation, it is important to be clear about the characteristics of your business.

Seasonal Challenges
Seasonal merchandise, particularly apparel, is based upon a repeating cycle of pre-season and in-
season activity typically based upon the process shown in Figure 1.

Figure 1: Simplified Seasonal Process

Within this process there are clearly a number of key decisions that must be made at critical
stages, such as:
• What is the correct assortment in terms of number of options, price points, etc?
• What are the right size profiles per store?
• What are the right pre-packs to order?

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• What is the right quantity to order?

• What is the right allocation strategy?
• What is the right inventory flow to support demand?
• What is the optimal clearance strategy?
To understand the potential impact of these decisions, let’s consider size profiles as an example.
With many stores, many styles and a number of standard sizes, most retailers adopt a strategy of
defining one or more size profiles, then using these for all or large groups of stores. The
problem is that if actual per store sales are reviewed, in almost all cases it becomes apparent that
the true demand per size at the store level differs from the standard profile, as shown in Figure 2,
which is an example of data from a typical retailer.

Figure 2: Example of Real Size Profile for 30 Stores and 4 Sizes

As can be seen within this sample of thirty stores, while a common shape is clear, each store’s
exact mix of demand across four sizes is slightly different. When you have fifty or hundreds of
stores, and more than four sizes, the problem simply becomes exacerbated.
What happens if a standard profile is used to allocate to stores? Unsurprisingly, each store has
essentially allocated sizes slightly out of alignment to the probable percentage demand for that
size at that store.
As Figure 3 shows, if the actual demand per store differs sufficiently from the standard size
profile, the likely result is excess stock of some sizes that will probably result in markdowns at
the end of the season, and insufficient stock of other sizes that will result in lost sales.

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Figure 3: Result of Incorrect Alignment of Inventory to Size

This can also lead to some stores suffering from fragmented size availability early in the life of
the product in the store, harming the overall attractiveness of the assortment. Another potential
consequence is that rather than suffer markdowns and out-of-stocks, some retailers will re-
allocate inventory and transfer it across the store network to try and solve the problem mid-
season. While this may reduce markdowns and lost sales, it will increase cost of goods sold,
impact supply chain capacity and therefore reduce margins.
Defining size profiles is just one of many decisions that must be made for each assortment.
Every decision is vital to avoid a loss of margin, with a potentially significant cumulative effect
for the assortment by the end of the season, as shown in Figure 4.

Figure 4: View of Cumulative Impact of Poor Decision Making

Figure 4: View of Cumulative Impact of Poor Decision Making

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For many types of merchandise, the continued collapsing of cycle times and the growing trend to
support multiple assortments with much shorter lifecycles aimed at keeping the in-store
experience fresh for the consumer is exacerbating the scale of the problem.
Of course, overall assortments may be profitable but increasingly it is vital to ensure that each
assortment is a profitable as possible, and that margin leak per item is minimised and life-for-like
performance maximised.

Continuity Challenges
Continuity merchandise is based upon the on-going management of a range, typically of different
categories, and ensuring its availability is maintained at the store. Figure 5 illustrates a simplified
view of the key elements of this process.

Figure 5: Simplified Category Management Process for Continuity Merchandise

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Within this there are clearly a number of key decisions that must be made, such as:
• What is the right mix of items to satisfy consumer demand?
• How much space should each category and item be allocated within the store?
• What are the most effective promotions to run?
• What is the optimal price strategy for each item?
• What is the demand for each item?
• What is the optimal inventory position for each item at each store?
• What is the optimal inventory position to maintain at the warehouse?
• What is the optimal order to place for each supplier?
To understand the impact of these decisions, consider space allocation as an example. Space is a
premium resource and return on space per category is a key element of maximising profitability.
However, with many stores, often of different sizes or layout configurations, the standard
approach is to balance the better results of allocating space per store with the more manageable
overhead of simply planning a number of space allocation options (or variants) and then
assigning these to groups of stores.
In many cases the tradeoff often errs towards reducing operational complexity, with the result
being that a great deal of potential business value is effectively ignored. As Figure 6 shows, if
space allocation is based on either a series of consumer based store clusters or per store, then
greater benefits can be realised.

Figure 6: The Ability to Manage Operational Complexity Unlocks Value

While it is tempting to take fifty stores, define them as small, out-of-town stores, allocating them
a category space assignment that is essentially identical, this delivers a greater capacity for certain

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categories to result in a sub-optimal use of space and reduced profitability by space for certain
stores.
Figure 7 shows the common impact of sub-optimal space allocation.

Figure 7: Results of Incorrect Alignment of Space with Demand

Again, the key challenge is to understand the effects of differing space allocations, and the real
relationships between stores and categories of merchandise from a consumer purchasing
perspective.
Of course, the amount of space to allocate a category is just one of many key decisions to be
made to maintain your customer offer. Taken together, each has the potential to contribute to a
cumulative positive or negative effect on category performance as shown in Figure 8.

Figure 8: View of the Impact of Cumulative Poor Decisions

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Overall the majority of categories may be profitable, but increasingly it is vital to ensure that each
category is as profitable as possible, that each store’s performance and use of space is maximised.

Challenges in Summary
As we can see differing merchandise types typically require different decisions to be made well.
Consider the impact of differing channels as summarised in Figure 9.

Figure 9: High Level Characteristics of Differing Sales Channels for Customer Offer

If you wish to support different channels this will impact the key decisions made regarding the
customer offer. For example, it is easy to make the entire range available via the Internet,
whereas a store is constrained by available space to hold and display physical stock. However,
stores can more readily have differential pricing vs. an Internet store where a single price is the
more expected option.
Whatever channels are used, and whichever merchandise is sold, in each case there are
unarguably critical decisions to be made, and how well each is made will directly influence the
profitability of the assortment and the business as a whole.
Let us explore why planning and optimization techniques can be so powerful in solving these
challenges.

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Trends and Techniques

While there is no substitute for skilled staff who intimately understand the business, even the
best staff are unlikely to have the time and means available to understand every possible choice
they could make, and identify the optimal decision every time.
It’s nearly impossible even for fairly small retailers: just 80 stores with an assortment of 10,000
SKUs would potentially mean 800,000 decision points to manage on an ongoing basis.
This is why the use of planning and optimization approaches is becoming increasingly vital as a
true decision support mechanism.

Planning and Optimization Summary

Before proceeding let’s consider why planning and optimization is so suitable for solving complex
decisions in retail, particularly those pertaining to your customer offer and your supply chain.
At the highest level, every retailer is trying to understand the likely result of making certain
decisions, as illustrated in Figure 10.

Figure 10: The Challenge of Understanding Business Results from Key Merchandising Decisions

As shown, there is a cloud of uncertainty overlaying every choice, and to ‘pierce’ it requires
identifying and understanding the underlying relationship between the decisions and the result
they will likely produce.
Mere reports and raw data are not enough, and without specific tools for the job most retailers
rely on human instinct and ‘gut feel’ to make the intuitive leaps needed.
Yet optimization techniques are perfect for the job of ‘piercing’ the cloud and laying bare the real
relationships between choices and results. Why? Optimization techniques coupled with
forecasting models, as shown in Figure 11, can determine the underlying relationship between,
for example, price and demand, or space and demand. It can also help more complex

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relationships such as product relationships when promoted, and the demand promotions will
generate.

Figure 11: Low Level Data Contains Relationships to Drive High Level Questions

For example, the relationship between a markdown and the sales uplift it will likely generate can
be extracted from historic performance data as shown in Figure 12.

Figure 12: Markdown Price Elasticity Curve

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Another challenge in retail is the sheer number of possible options to evaluate. As previously
discussed, with so many potential SKU/store combinations sheer volume of data is also a major
contributor to avoiding dealing with low level decisions and trying to simplify the process by
making ‘average’ decisions at an aggregate level and applying these to multiple SKUs.
So for example it is often tempting with seasonal merchandise to handle markdowns using
simple schedules applied at an aggregate level, as shown in Figure 13.

Figure 13: Standard Class Level Markdown Schedule

Even assuming that the techniques to optimize the markdown decision were understood, the
sheer volume of data to review each potential markdown at a lower level can be daunting, as this
would require staff to find the time to perform far more analysis and calculate unique markdown
strategy at a much lower level, for example at Style level as shown in Figure 14.

Figure 14: Low Level Style Specific Markdown Recomendations

This challenge is perfect for a software solution, which can provide the computational ‘might’ to
perform the large number of calculations involved, removing that overhead from staff and
allowing them to focus on evaluating the results.
The situation is essentially the same for continuity merchandise if, for example, the goal was to
optimise the allocation of space, or determine the optimal promotional strategy for a category, or
optimize regular price.

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As a result, optimization and forecasting science, coupled with planning solutions to provide a
complete modelling framework enable retailers to adopt a far more rigorous, fact-led approach to
decision-making within a solution environment that remains easy to use and nullifies the impact
of high data volumes.

Adopting Advanced Planning and Optimization Solutions

Adopting planning and optimization solutions can seem daunting, particularly with regards to
business acceptance. Buyers and Traders may be concerned with the idea they are handing over
control to a system they don’t understand, while for others the notion of retail science and
optimization can seem like ‘science fiction’.
While planning solutions have traditionally seen success for Merchandise Planning with seasonal
retailers, they remain under-utilised at the assortment level and for continuity merchandise.
Ironically, from a technical perspective planning and optimization solutions are relatively easy to
deploy, provided they have proven scalability, which unfortunately not all such solutions available
can boast. They are typically non-intrusive and can be deployed with whatever current
operational and execution systems are already in place. They are self-contained and focused on
supporting very specific retail processes and decisions.
What it is important to understand prior to evaluation of a combined planning and optimization
solution is that they require a different approach from the usual ‘tick box’ checklist of
requirements, system demonstrations and technical review of operational systems, such as a
merchandising system or a warehouse management system.
For a start, it is important to consider that the science behind such solutions is key and that
optimization solutions may need ‘tuning’ of their parameters to fit a specific business. Therefore,
the following key points should be taken into account:
1. Buying more than software – users will also be entering into a consultative engagement
that will involve science consultants who will need to work closely with retailers to
ensure any solution is properly aligned to that specific business. It is important that
retailers are prepared to share data and knowledge about their business
2. It is vital to trust the science behind the solution – this doesn’t mean users need an
advanced mathematics PhD, but it does mean require users to ensure that suitable
references and proof are provided to convince the business to trust the solution and the
science upon which it is built.
3. With regard to planning processes, such as Assortment Planning for seasonal
merchandise or Assortment Rationalization for continuity merchandise, it is important
to understand that planning processes are flexible and easily modified. When reviewing a
solution’s pre-defined processes vs. the user’s needs, it is important to focus on how

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well these match needs and how easily they can be adjusted if required. Don’t assume a
perceived gap in the planning process means the solution can’t support the business.
The underlying planning engine may well be capable but the supplied process doesn’t
quite match requirements.
4. Understand that planning and optimization solutions are designed to assist key decision-
makers, not remove them from the decision-making loop. Optimization provides
understanding and recommendations: the final choice remains with the decision-makers.
Planning processes help decision-makers efficiently plan goals, model assortments and
review the results of potential decisions before committing to what they believe is the
correct course of action.
In summary, effective planning and optimization deployments require trust, collaboration and
skilled staff together with senior management backing to ensure success. They also require users
to ‘put aside’ the more traditional methods of evaluating software and embrace an approach
based on understanding potential value vs. cost.

Summary
As we’ve seen, while operational efficiency remains important with most retailers having modern
transactional and operational systems in place, the new focus, particularly in today’s challenging
market, is making the most of current operations by optimizing every decision that will directly
affect customer offer and how to maintain its availability.
Today, by embracing the possibilities offered by planning and optimization solutions and aligning
these with strategic goals, retailers can empower their most key assets - staff - to confidently
make the optimal decisions that will drive the most profitable performance for their business.
Coupled with operational systems, planning and optimization solutions can truly enable you to
“Have your cake and eat it”, to coin a familiar phrase. Real business benefits and competitive
advantages await those ready and willing to adopt new approaches to retailing in the 21st
Century. The cake is waiting, would you like a slice?

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Profitable Customer Centric Retailing:
Having Your Cake and Eating It
January 2009
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