March 16, 2010

The New Scarcity of Retail Space: How “Smart Allocation” Is Changing the Landscape

With the average household annually purchasing less than 0.1% of all SKUs available, players in the retail chain face major challenges to maximize profits.

As consumers seek a simplified and customized shopping experience, retailers and manufacturers will have to curate an ideal product mix. Moreover, retailers that cut non-useful stock-keeping units (SKUs) will appeal to shoppers and improve profitability. To become practitioners of smart allocation, leading players in the industry will simplify the mix, leverage local insights, and build a responsive supply chain, according to a new study by Booz & Company.


The New Economics of Retail

Some smart retailers are starting to move away from big-box multi-storey stores and create smaller box-sized versions. Retailers however still need to address what to do with their existing footprints, and how to best allocate space. Many are fundamentally rethinking the economics of retail, and are doing so for two critical reasons. The first is a change in consumer shopping habits, namely consumers’ desire for a simpler shopping experience. “This came through clearly in Booz & Company’s 2007 Shopper Insights Consumer Category Survey. Consumers are looking to reduce the number of stores they visit and expect all stores to do a better job of curating their merchandise,” stated Gabriel Chahine, a partner at Booz & Company.

The current economic environment is making this need a greater priority, as consumers want to drive less and visit even fewer stores. Increasingly, if consumers can’t easily find the items they want in particular stores; those retailers are likely to suffer in terms of customer satisfaction.

“The second reason that retailers are rethinking their use of space is the challenge they are facing to increase, or even sustain their profitability,” explained Karl Nader, a senior associate at Booz & Company. In a study published in October 2008, Booz & Company found that 32 percent of U.S. households had become more frugal about their shopping habits in the previous six months. Today, there is more emphasis on retail metrics such as gross margin return on investment and profitability per square foot. This kind of pressure forces retailers to focus on what’s working. “There’s also data to support the idea that smaller, more focused stores do better when judged by the critical measure of same-store sales,” continued Nader. Moving to smaller stores, or fine tuning the assortment of products in-store, imposes a big burden on retailers to get the allocation right.

What will separate the retail winners from the losers in the future will be the extent to which they master the art of smart allocation; this also has important implications for manufacturers. Three rules will help retailers and their suppliers get smart allocation right:

Rule 1: Simplify the Mix
A recent survey by Information Resources Inc. looked at 280 product categories and found that 40 percent of the items retailers shoehorned into those categories left shoppers cold. Many retailers have seen boosts in category performance of between 25 percent and 50 percent after eliminating SKUs.

“Thoughtful editing within categories can lead to better in-stock performance for key items and the successful addition of new items,” Chahine stated. Smart allocation requires that retailers find category combinations that improve both the overall turn and the quality of the shopping experience. As consumers demand more simplicity of choice, manufacturers may face a very different sort of decision—to help retailers decide which products to discontinue.

Rule 2: Leverage Local Insights
The rationalization of space within categories makes it imperative that retailers adjust their offerings to the needs of local shoppers. The essential thing for retailers is to recognize that it no longer makes sense for them to, say, stock 100 brands of shampoo. “Once they’ve recognized that, the challenge becomes figuring out which 25 items to keep on the shelves,” said Nader. With smaller categories, customized local assortments are a must, with stock decisions dependent on everything from demographics to climate.

Recently, retailers have improved their ability to leverage point-of-sale data, shopper card information, store demographics, and psychographic information. Other research indicated that stocking some hard-to-find brands could drive customer loyalty. It is essential to understand the role each item plays in driving overall shopper behavior.

Rule 3: Build a Responsive Supply Chain
With limited shelf space and in many cases localized assortment, the ability to restock in hours has become critical. “A fast and responsive supply chain keeps items fresh and limits the incidence of markdowns, improves in-stock performance, and reduces the amount of working capital tied up in inventory,” Chahine explained.

The need to be part of a more agile supply chain is also starting to drive the strategy of some manufacturers. While a reduction in SKUs would partly be an answer to consumers’ less-is-more mind-set, it would also help the manufacturer focus its supply chain efforts, enabling it to keep key products in stock and minimizing the need for working capital in the form of inventory.


The Pressing Questions for Executives

The average household buys about 650 unique SKUs in the course of a year—a tiny fraction of the 1 million consumer products available worldwide. This statistic highlights the challenges that every player in the retail chain faces in trying to maximize profit: Which products should we stop offering? Which products should we focus on? Which new product groupings will profitably lift our sales? Companies that accurately answer these questions, and put them into effect, will be the ones that thrive.