The Art of Fine Tuning

One of the great truisms of business is the 80/20 rule. This is a universal law which states that roughly 80% of the output is generated by 20% of the input.

At the heart of most retail businesses is merchandise or product and here, in majority of cases, the 80/20 rule equally applies. In generalised terms it breaks down to:

• - the top 20% of the range produces 80% of the profit
• - the next 40% of the range produces 40% of the profit
• - the next 20% of the range breaks even, and
• - the bottom 20% of the range loses 20% of the profit

Increasingly retail businesses are focussed on returns and productivity from a given set of inputs and any variance to those inputs is based on justification through a minimum set of returns.

Gone are the days of naively focussing on top line sales to the detriment of everything else. Return on space, return on assets, return on capital and return per customer are increasingly forcing retail businesses to be far more disciplined in regard to the way they construct their merchandise ranges and how they fine tune them on an ongoing basis.

As retail is a game of incremental growth, increasing profit relies on adding to rather than substituting. In a world where the middle market is under threat from a polarisation between value and relative luxury, this is not always as simple as it once was.

Understanding customer purchase behaviour in relation to your range is critical to driving increasing amounts of profit. The first step is analysing historical data - as it applies to the 80/20 rule - and balancing range decisions against future trends. Fine tuning range is not an exact science though. It is an art that balances science (transaction history) with trend (opportunity). No range is ever 100% productive and the aim is just to be better than last year – not to search for a mythical perfection that doesn't exist.

The key objective in range tuning is about your ongoing relevance to your customer – relevance that increases both the frequency with which they shop you and the size of the basket (sales & profit) when they do. Your customers will always seek "newness" for stimulation, while relying on you for key items. But even key items have a decay cycle or shelf life that you must factor in to your range selection process.

Retailers as diverse as Target and Louis Vuitton use the same basic approach.

They use a continual review of transaction data to cull non-performing lines in order to free up space, capital, energy, time and noise to be invested in new lines or new categories or new revenue generating initiatives. Newness that can be seen, noted and valued by the customer. Newness that increases the retailer's perceived value to the customer. Newness that adds incremental revenue from the customer.

Newness that also carries risk.

But retail is a business built on the back of trial and learning. None of us would survive in this game with weak hearts or a lack of nerve.

By culling under-performing merchandise – just as you would prune a rose bush – the stem of the business is healthier and far more capable of coping with an acceptable level of calculated risk in the search for new growth. Wild experimentation and inconsistency may be the enemy, but standing still is equally as deadly.

So how do you go about the range tuning process just as Woolworths or David Jones would?

The start (and end) point is the customer. Putting together a simple segmentation of their purchase behaviour, their needs and wants and their connection to you (what makes you most relevant to them) is the start point. This can be a simple as high, medium and low purchase value and the needs and wants you serve for them. That produces a framework.

The next is to overlay your range in rank of importance to each of the customer segments.

By season or turn cycle (or however you manage your inventory cycles), you then review your transaction data against this simple segmentation. This gives you an understanding of where you win or lose. The difference here with the more sophisticated retailers is that they have systems which can track real time transactions to individual customer numbers or segments. But observing the behaviour of your customers first hand can be equally – some would say more – valuable and insightful.

Once you understand where your range is winning or losing with your customers, you need to do some simple detective work on who you are losing to and why. Ask your customers where they are buying those items from and why. Think through whether lines can be rescued or should be culled or indeed whether they will ever be capable of producing the returns you seek.

But make sure you cull. You cannot continually bring newness to market unless you actively make room for it every season.

Stay abreast of trends and new innovation. Make sure you see where your competitors and selected best practice benchmarks are winning and/or finding new growth.

This is where you will find the opportunity for newness, innovation and growth. Exploring where your customer's behaviour may evolve next by testing newness in a calculated, low risk way, you are creating a future for your retail business while at the same time offering your customer the stimulation of finding something new from someone they already trust. Something that may also attract one of their friends or family.

Fine tuning of range and offer should be a part of a continual improvement cycle for all healthy retail businesses. Far from being something which is onerous or risky, when kept simple and in line with retail fundamentals, range tuning is the most rewarding and truly creative part of the business. It is the art that fuels growth.