Session 2

Some Elements of Operational Excellence

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 Inventory and a firm’s valuation

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 Inventory and a firm’s valuation

• Investors, especially in the Wall Street keep a close watch on Retail firms’ inventory
levels from public data
• Some important metrics like inventory turns, accounts payable to inventory, growth
rate in inventory
• Inventory in excess can cause severe issues in valuation of a company

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 Inventory and a firm’s valuation
Scenario 1

Sales (Stable) 1000

Gross Margin Percentage 30%
Gross Margin 300
SGA Expenses (Stable) 270
Net Margin 30
Cash Flow 30
Discounting Rate 10%
Inventory (kya) NA

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 Inventory and a firm’s valuation
Scenario 1

Year -> 1 2 3 4 5 6 7 8 9 10
Sales 1000 1000 1000 1000 1000 1000 1000 1000 1000 1000
Gross Margin
Percentage 30% 30% 30% 30% 30% 30% 30% 30% 30% 30%
Gross Margin 300 300 300 300 300 300 300 300 300 300
SGA Expenses 270 270 270 270 270 270 270 270 270 270
Net Margin 30 30 30 30 30 30 30 30 30 30
Cash Flow 30 30 30 30 30 30 30 30 30 30
Discounted Cash Flow 30.00 27.27 24.79 22.54 20.49 18.63 16.93 15.39 14.00 12.72

Total DCF 203

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 Inventory and a firm’s valuation
Scenario 2

Sales (3% growth y-o-y) 1000

Gross Margin Percentage 30%
Gross Margin 300
SGA Expenses (Stable) 270
Net Margin 30
Cash Flow 30
Discounting Rate 10%
Inventory (kya) NA

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 Inventory and a firm’s valuation
Scenario 2

Year -> 1 2 3 4 5 6 7 8 9 10
Sales 1000 1030 1061 1093 1126 1159 1194 1230 1267 1305
Gross Margin
Percentage 30% 30% 30% 30% 30% 30% 30% 30% 30% 30%
Gross Margin 300 309 318 328 338 348 358 369 380 391
SGA Expenses 270 270 270 270 270 270 270 270 270 270
Net Margin 30 39 48 58 68 78 88 99 110 121
Cash Flow 30 39 48 58 68 78 88 99 110 121
Discounted Cash Flow 30.00 35.45 39.89 43.44 46.21 48.30 49.80 50.78 51.33 51.50

Total DCF 447

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 Inventory and a firm’s valuation
Scenario 3

Sales (3% growth y-o-y) 1000

Gross Margin Percentage 30%
Gross Margin 300
SGA Expenses (Stable) 270
Net Margin 30
Cash Flow 30
Discounting Rate 10%
Inventory 183 days

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 Inventory and a firm’s valuation
Scenario 3

Year -> 1 2 3 4 5 6 7 8 9 10
Sales 1000 1030 1061 1093 1126 1159 1194 1230 1267 1305
Gross Margin
Percentage 30% 30% 30% 30% 30% 30% 30% 30% 30% 30%
Gross Margin 300 309 318 328 338 348 358 369 380 391
SGA Expenses 270 270 270 270 270 270 270 270 270 270
Net Margin 30 39 48 58 68 78 88 99 110 121
Inventory 350 361 371 382 394 406 418 430 443 457
Net Inventory 0 11 11 11 11 12 12 13 13 13
Cash Flow 30 39 48 58 68 78 88 99 110 121
Adjusted Cash Flow 30 29 37 47 56 66 76 86 97 108
Discounted Cash Flow 30.00 25.91 30.95 35.07 38.37 40.96 42.92 44.35 45.31 45.86

Total DCF 380

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 Inventory and a firm’s valuation
Scenario 4

Sales (3% growth y-o-y) 1000

Gross Margin Percentage 30%
Gross Margin 300
SGA Expenses (Stable) 270
Net Margin 30
Cash Flow 30
Discounting Rate 10%
Inventory 365 days

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 Inventory and a firm’s valuation
Scenario 4

Year -> 1 2 3 4 5 6 7 8 9 10
Sales 1000 1030 1061 1093 1126 1159 1194 1230 1267 1305
Gross Margin
Percentage 30% 30% 30% 30% 30% 30% 30% 30% 30% 30%
Gross Margin 300 309 318 328 338 348 358 369 380 391
SGA Expenses 270 270 270 270 270 270 270 270 270 270
Net Margin 30 39 48 58 68 78 88 99 110 121
Inventory 700 721 743 765 788 811 836 861 887 913
Net Inventory 0 21 22 22 23 24 24 25 26 27
Cash Flow 30 39 48 58 68 78 88 99 110 121
Adjusted Cash Flow 30 18 27 36 45 54 64 74 84 95
Discounted Cash Flow 30.00 16.36 22.02 26.70 30.53 33.62 36.05 37.92 39.28 40.22

Total DCF 313

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 Inventory and a firm’s valuation
Scenario 4

Sales (3% growth y-o-y) 1000

Gross Margin Percentage 30%
Gross Margin 300
SGA Expenses (Stable) 270
Net Margin 30
Cash Flow 30
Discounting Rate 10%
Inventory (6% growth y-o-y) 365 days

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 Inventory and a firm’s valuation
Scenario 4

Year -> 1 2 3 4 5 6 7 8 9 10
Sales 1000 1030 1061 1093 1126 1159 1194 1230 1267 1305
Gross Margin
Percentage 30% 30% 30% 30% 30% 30% 30% 30% 30% 30%
Gross Margin 300 309 318 328 338 348 358 369 380 391
SGA Expenses 270 270 270 270 270 270 270 270 270 270
Net Margin 30 39 48 58 68 78 88 99 110 121
Inventory 700 742 787 834 884 937 993 1053 1116 1183
Net Inventory 0 42 45 47 50 53 56 60 63 67
Cash Flow 30 39 48 58 68 78 88 99 110 121
Adjusted Cash Flow 30 -3 4 11 18 25 32 39 47 54
Discounted Cash Flow 30.00 -2.73 3.10 7.98 12.04 15.37 18.07 20.21 21.87 23.11

Total DCF 149

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 Inventory and a firm’s valuation
Scenario 4

Sales (3% growth y-o-y) 1000

Gross Margin Percentage 30%
Gross Margin 300
SGA Expenses (Stable) 270
Net Margin 30
Cash Flow 30
Discounting Rate 10%
Inventory (6% growth y-o-y) 365 days
Inventory Write-Off annually 10

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 Inventory and a firm’s valuation
Scenario 4

Year -> 1 2 3 4 5 6 7 8 9 10
Sales 1000 1030 1061 1093 1126 1159 1194 1230 1267 1305
Gross Margin
Percentage 30% 30% 30% 30% 30% 30% 30% 30% 30% 30%
Gross Margin 300 309 318 328 338 348 358 369 380 391
SGA Expenses 270 270 270 270 270 270 270 270 270 270
Net Margin 30 39 48 58 68 78 88 99 110 121
Inventory 700 742 787 834 884 937 993 1053 1116 1183
Net Inventory 0 42 45 47 50 53 56 60 63 67
Cash Flow 30 39 48 58 68 78 88 99 110 121
Adjusted Cash Flow 20 -13 -6 1 8 15 22 29 37 44
Discounted Cash Flow 20.00 -11.82 -5.17 0.47 5.21 9.16 12.42 15.08 17.20 18.87

Total DCF 81

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 Inventory and a firm’s valuation

• Can inventory drive sales growth? For how long?

• Can inventory turns be used to compare firm performances?
• More inventory means more markdowns, sometimes earnings shock, firing of CEO
• Less inventory means sales loss, customer complaints, stagnation, decline, firing of CEO

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 Inventory and a firm’s valuation

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 How (in)flexible is my company’s supply chain?

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 Flexible supply chains are extremely important in Retail

• Product sales are really hard to predict with large forecast errors
• Investing in supply chain flexibility is one way to fight margin killing markdowns
• Several factors contribute to inflexibility
• Long chains with multiple stakeholders
• High set up times
• Lack of trust in collaborative forecasting
• Inappropriate placement of supply chain decoupling point

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 Flexible supply chains are extremely important in Retail

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 Flexible supply chains are extremely important in Retail

Key elements of supply chain flexibility

• Efficient production of small quantities
• Decoupling point placed at the point where maximum variety resolution happens
• Accommodation of variation in demand
• Short lead time – a good process analysis can give surprising results.
• Cross-functional, collaborative, rapid-turnaround teams
• Partnering with suppliers

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 How does my company configure the last mile delivery?

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 Last Mile Delivery Challenges

• Pure-play online retailers had been struggling till around nineties. Matching the
operational capability of brick-n-mortar was impossible
• To compound that further, brick n mortar stores developed hybrid channels
• In the last decade, again pure-play online retailers are getting increased dominance
• This has created an increasing mix of Last Mile Supply Networks (LMSN)
• For example, DC-to-store is fundamentally different from DC- to-customer
• Small quantities, erratic frequencies, delivery windows, non acceptance, moving customers
• Designing a LMSN can be an extremely challenging task
• Read: ‘Configuring the last mile in business to consumer E-Retailing’ procured and distributed
in the hard-bound poly-copy.

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 Classification

• One way to classify is on the

basis on product variety and delivery
responsiveness

• A company can have more than

one LMSN structure

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 Classification

Simple LMSN
• Slow responsiveness, low variety
• Aim is to build efficiency, low cost
• High levels of aggregation of
inventory
• Centralization
• Eg: Ocado, UK

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 Classification

One-Stop LMSN
• Slow responsiveness, high variety
• Inventory pooling
• Reliability and Flexibility are key
• Hub and spoke, 3PL, Modularized
• Multiplicity in product sourcing
• Eg: Amazon

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 Classification

Protean LMSN
• Fast responsiveness, low variety
• Small, frequent orders
• Mostly hybrid mode
• Low inventory aggregation,
decentralized

• Eg: Argos

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 Classification

Hyperlocal LMSN
• Fast responsiveness, high variety
• Partnerships are absolutely
important- platform based.
• Mostly hybrid mode
• Low inventory aggregation,
decentralized

• Eg: Prime Now

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