First Measure, Then Manage

Problems with operational execution plague even the largest, most successful retailers, resulting in inaccurate inventory records and misplaced products. A new study examines the causes of poor execution and suggests plans for improvement.

As retail organizations have expanded, retailers have come to rely more on information technology (IT) to manage inventory and operations. In recent years, retailers have invested nearly $30 billion a year on IT. Using bar codes, point of sale scanners, and automatic replenishment systems, retailers track merchandise, automate transactions, keep inventory at optimum levels, and collect data to make important supply chain decisions.

The key to taking advantage of such IT investments is operational execution. Execution in retail operations can be thought of as the many activities necessary to get the right product in the right amount to the right place at the right time for the right price.

A new study, "Execution: The Missing Link in Retail Operations," by Nicole DeHoratius, an assistant professor at the University of Chicago Graduate School of Business, Ananth Raman, a professor at Harvard Business School, and Zeynep Ton, a doctoral student at Harvard Business School, indicates that operational execution is surprisingly inadequate even at leading retailers.

The study draws on information provided by leading retailers in the food, apparel, book, music, and office product industries, and extensive data from audits at two major retailers, referred to as Beta Corporation and Gamma Corporation to preserve their anonymity. Beta and Gamma are both leading publicly traded retailers with hundreds of stores and billions of dollars in annual sales. Both are also well regarded in the industry for their excellent operations. However, DeHoratius, Raman, and Ton found two widespread execution problems: inaccurate inventory records and misplaced items.

Two Common Problems

Problems with inaccurate inventory records and misplaced items have significant and expensive consequences. Contrary to popular belief, most retailers cannot precisely identify the number of units of a given item available at a store. At Gamma, more than 65 percent of the inventory records were inaccurate, indicating that the recorded quantity of an item failed to match the quantity found at the store for nearly 240,000 items across 37 stores. Inaccurate inventory records can mean carrying too much inventory without realizing it, or carrying too little inventory and not reordering it - a problem that reduced profits at Gamma by more than 10 percent.

Even when inventory records are accurate, misplaced items mean that customers can have difficulty finding sought-after products. At Beta, 16 percent of items in a store could not be found by consumers who approached a sales associate for help. The items were not out of stock, but rather misplaced in storage areas or in the wrong aisle or location within the store. Misplaced items reduced profits by more than 25 percent at Beta.

Inventory record inaccuracy and misplaced items can lead to a substantial decrease in profits due to lost sales, additional labor costs, and higher inventory carrying costs. These problems may also have a long-term negative impact on a firm's brand image. For retailers like Beta and Gamma that rely on computerized replenishment systems for managing store inventory, these execution problems may result in inaccurate demand forecasts. Demand forecasting systems rely on historical sales data to estimate future demand for each item in the store. If an item is out of stock at the store and no sales transactions occur, but the item is not recorded as out of stock in the system, the new forecast may be inaccurately low, causing the retailer to drop what may actually be a popular item.

"The question is: Can retailers make better use of the technology they have spent substantial amounts of money and time implementing?" says DeHoratius. "Because automation is only effective if the data it utilizes accurately reflects what is happening with the organization's operations."

What Causes Poor Execution in Retail Operations?

The study identifies three main causes of poor execution. First, replenishment and sales processes at stores and distribution centers (DCs) affect the quality of execution. Errors often occur during the simple process of scanning items at the checkout counter. For example, when a grocery store checkout clerk rings up a lemon yogurt and a plain yogurt, the clerk may erroneously scan the lemon yogurt twice instead of scanning each item separately, inadvertently creating errors in the system. Ineffective use of scanners may also occur when salespeople process exchanges, such as sizes of clothing, by handing over the new item to the customer and taking the item to be returned, instead of scanning both barcodes into the system to reflect the exchange.

Other related problems include the many potential errors at the distribution center. For example, DCs may send the wrong items to stores, and these shipments may not be diligently inspected upon arrival. The authors find that merchandise shipped directly to stores from vendors tends to have more accurate records than that shipped from a retailer's own DC. Vendors are more careful since store managers check vendor shipments closely to ensure proper invoices.

A second cause of poor execution is inadequate merchandising and inventory management. The study shows that a greater variety of products creates more confusion for employees at both the DC and the store, and therefore increases the likelihood of inventory record inaccuracy and misplaced items. Additional inventory also leads to more crowded stores, making it harder to keep track of items.

"Increasing variety increases complexity, and it's difficult for many stores to manage that complexity appropriately," says DeHoratius. "It is critical to recognize that some stores manage this complexity better than others and to understand why."

Third, employee turnover can result in more misplaced items. Stores with a higher turnover of floor employees, who are responsible for reshelving merchandise, had more misplaced items. These stores rely on employees to know if an item is in the storage area, and new employees get confused more easily. Store manager turnover also disrupts operations.

Improving Retail Execution

The quality of execution at stores in the Beta and Gamma retail chains varied considerably. The authors suggest that operational execution can be improved quickly and dramatically if retail managers make the severity and impact of execution problems in the supply chain known at all levels of their organization and learn from those stores that are executing well.

In response to the three major causes of poor execution, the authors recommend three strategies for improvement. First, retailers should create awareness of the problem and its impact on the firm's performance.

Stores tend to train checkout clerks to scan quickly rather than accurately, so they may not realize the impact of their actions on the accuracy of inventory records. Employees must be made aware of how data is collected via the point of sale scanners, and how inaccuracies have repercussions down the line.

At Gamma, calculating lost profits due to inventory record inaccuracy was a vital step in gaining the commitment of senior management to address the problem. At Beta, efforts to create awareness of execution problems and store training initiatives reduced misplaced items by 22 percent.

Second, retailers should count and inspect store inventory more frequently. At Gamma, stores that were audited twice a year had substantially lower errors than stores audited annually. The study also recommends spot checking items and inspecting the location of items in stores.

Third, retailers should take note of the stores within the chain that are executing well. These benchmarks can offer useful pointers to the other stores and provide motivation to managers that operational execution can be managed and improved.

Recommendations for Immediate Improvement

To see immediate results, the study suggests the following:

1. Retailers should measure performance along the dimensions of operational execution that are important to their business. Depending on a store's particular problems, a retailer should measure inventory record inaccuracy or the fraction of misplaced items using physical audits or other sampling methods.
2. The measurements should be used to create awareness of the problem.
3. The measurements should also be used to set up a plan for continuous process improvement.
4. Large retailers can benefit from the fact that they typically control hundreds or even thousands of stores. They can use the differences in processes and performance at these stores to understand how execution can be improved.
5. Retailers can improve performance by using operational data for decision making.

Focus On the Process

In order to identify why employees are not executing according to plan, retailers need to have an in-depth understanding of their store and DC processes. Once retailers begin measuring execution problems, it is important to share that information throughout the organization. By measuring the problem, retailers can then begin to manage the problem and track improvements over time.

Getting the broad buy-in necessary to focus attention on these problems is sometimes the toughest part. Only when retailers realize the extent of their problems with inventory record inaccuracy and misplaced items-and the subsequent impact on profits through unnecessary inventory carrying costs and lost sales from out of stock items-will they be able to initiate changes in their policies and practices that result in improved supply chain performance.