Organize Vertically Manage Horizontally

The business model of retail is fairly simple; buy, hold, and sell. What needs to be done
to succeed in retail is also visible to all; track consumer trends, identify target consumers
and develop a distinctive positioning, get good locations, use the power of IT to make
organization processes efficient, manage stocks in the supply chain, increase buying
power based upon scale, and motivate staff to increase productivity and deliver customer
service, and so on. Starting a retail business is also relatively easy since retail industry,
compared to other industries, has low barriers to entry. If every retailer knows what is
required to succeed then why the performance different retailers differ? And why do even
retail giants sometimes stumble? In 2006 Wal-Mart exited Germany and S. Korea. Does
the apparent simplicity of the retail industry hide some complexity? Probably yes. I am a
strong believer that the ‘quality’ of retail strategy lies in the details of the execution, and
different retail organization’s do differ in the details. On a trip to visit Wal-Mart logistics
and distribution centers in UK, where Wal-Mart managed its own distribution center, and
Germany, where the logistics and distribution center operations was outsourced, I noticed
differences in the measures being used for managing operational performance.

The challenge of retail (and I think every business) lies in successfully ‘linking’ strategy
to operations (and operational results), ‘identifying’ people who will be responsible and
accountable for achieving results by implementing (strategy) through time-bound
initiatives, ‘synchronizing’ different people, their functional skill sets and
‘interdependencies,’ ‘linking rewards’ to results, and ensuring that the retail organization
remains ‘flexible’ enough to monitor and manage the dynamic consumer environment. In
this article I focus upon what I consider very important in retail - ‘synchronizing’
different people, their functional skill sets and ‘interdependencies.’ This is important
because traditionally retail organizations are organized vertically into different functional
specializations (e.g. buying, logistics, and operations) whereas efficiency requires them to
be managed as horizontally (Figure 1). Most retailers know that merchandising is the core
of retail business and it needs to be the basis of managing the business. But retailers are
often less sensitive to the need of managing merchandising process as a series of
‘integrated and interdependent processes or activities’ (Figure 1). Merchandising is an
end-to-end business process that runs from merchandise assortment to sourcing, to
distribution, to allocation of goods to stores, to selling the assortment to customers, and
finally to replenishing inventory. It is a cross-functional ‘horizontal’ process and not
broken into vertical functional buckets of buying, logistics, and store operations, and
needs to be managed as such with emphasis upon simplifying the processes focused upon
assortment performance. Not that simple as it reads. Decisions taken by different
individual decision-makers (verticals in figure 1) like buyers, store personnel, logistics
operators, etc. have an impact upon overall strategy and execution (horizontal costs in
figure 1). Take an example of a decision by a buyer. Under pressure to increase sales the
buyer takes a decision to increase the range of products. This has both direct and indirect
costs, and the latter are often not factored in decision-making. The direct impact is the
increased costs of selecting, buying, storage, and delivering. The indirect costs are
associated with time spent in managing the additional merchandise – costs associated
with planning space for the merchandise, assessing the performance of the additional
merchandise, reduced inventory turns, potential reduced staff productivity, and other
store level processes.

Figure 1

Retail organization

Buying Logistics Store

operations

Vertical decisions Vertical decisions

impact material flow impact material flow

Material flow from vendor to shelf

Increase in cost of products as they flow from left to right

Decisions at every stage of the material flow directly and indirectly

impact costs at subsequent or previous stages

The often contradictory influence of costs (e.g. incremental sales and margins associated
with increased width or depth of merchandise may not off-set the incremental costs or
even though private label looks great on paper but need for overseas inspection, increased
volume purchase, storage, and markdown risks need to be factored in the gross margin)
associated with various decisions in retail requires managing assortments using indicators
that factor the different influences. As merchandise flows through the system it
accumulates costs (Figure 1), and assortment performance that balances the three effects
of inventory efficiency, space efficiency, and labor productivity (Figure 2). It is for this
reason it is necessary to manage retail businesses using a profit and loss account structure
based upon identifying the costs of different retail operations, which is different from a
traditional profit and loss account (Figure 3). This methodology requires identifying costs
of each of the activities associated with the retail business and managing the activities
based upon contribution of each of the activities to the overall business.

Conclusion

Retail is both a simple and a complex business; simple at the conceptual level, and
complex at a management level. Complexity of retail multiplies since decisions of the
different functions like buying, logistics and operations are highly interdependent;
ostensibly increased sales may often be accompanied by increased costs at other locations
of the business. It is for this reason that retail is difficult to manage as vertical silos
organized functionally. It is for this reason that effective management of retail requires an
innovative organization design based upon simplifying and visualizing the business
process as material flow focusing upon merchandising, assortment management, and cost
analysis as the basis.

Figure 2 – Retail Efficiency is made up of stock turns, space productivity, and staff efficiency

Figure 3 – Profit and loss account based upon activity-based costing

Traditional P & L account Retail P & L account

Sales Revenue Sales Revenue

Less cost of goods sold Less cost of goods sold

Gross margin Gross margin

Less Less

Salaries and wages Freight inward

Rent Storage costs
Warehousing Logistics cost
Transportation Cost of Store Operations – merchandising
Utilities Inventory carrying cost
Marketing Costs associated with stock-outs
Depreciation Ordering costs
Supplier management costs
Net Profit Marketing costs based upon efficacy of promotions
Etc.

Net Profit

© Manoj Nakra Jan 2007