Introduction to Retail

Retailers sell goods to the people who use them. A retailer buys in bulk, moves goods close to customers, sells them in small quantities and keeps a small margin on each sale.

What is the purpose of retail?

Retail puts food, medicines, building materials and household goods within reach of almost everyone, through stores and websites. Australian retail turnover is more than $400 billion a year, and household spending makes up around half of the national economy. Retail is also one of Australia's largest employers, with more than a million workers, and a common first job for young people.

Governments, the Reserve Bank and investors follow retail and household spending figures from the Australian Bureau of Statistics as a guide to consumer confidence. Retailers also coordinate thousands of suppliers, transport companies and importers in Australia and overseas, and stores are local employers and supporters of community groups, schools and charities.

Retail also operates on thin margins at very large volumes. Small improvements in availability, pricing accuracy, stock accuracy or labour efficiency are worth large sums, so retailers spend heavily on process and technology.

Story boxes in this course follow four products from factory to customer through Australian retail formats:

• a cordless drill (sold in home improvement stores),
• a 2-litre bottle of milk (sold in supermarkets),
• a children's bicycle bought for Christmas (sold in discount variety stores), and
• a prescription medicine and a bottle of sunscreen (sold in pharmacies).

Definition of retail

Retail is the sale of goods (and some services) to the end consumer (the person who uses the product), usually in small quantities. The word comes from an old French word meaning "to cut off a piece": a retailer takes a large quantity and sells it in small pieces.

Retail sits at the end of a longer chain of businesses.

Common terms:

• Supplier (also called a vendor): any business that sells products to the retailer. It might be the manufacturer itself, an importer, or a wholesaler. In retail, "supplier" and "vendor" are used interchangeably.
• Wholesaler: a business that buys in very large quantities from manufacturers and sells in smaller (but still bulk) quantities to retailers, trades businesses or other organisations. Wholesalers rarely sell to the public. In pharmacy, wholesalers supply most prescription medicines (Chapter 16).
• Consumer vs customer: the customer is whoever pays; the consumer is whoever uses the product. A parent (customer) buys a bike for a child (consumer). Marketing teams treat the two separately.
• B2C (Business-to-Consumer): selling to members of the public. B2B (Business-to-Business): selling to other businesses. Big-box home improvement retailers do a lot of both: DIY households (B2C) and builders/tradespeople (B2B).

Role of the retailer

A dairy farmer rarely sells milk directly to households, because a retailer provides five services that would be costly for a farmer to provide:

1. Assortment: a shopper wants milk, bread, dishwashing liquid and a birthday card in one trip. No single manufacturer makes all of them. A retailer gathers thousands of products from hundreds of suppliers into one place. The set of products a retailer chooses to sell is called its range (or assortment).
2. Breaking bulk: the manufacturer ships pallets of 600 bottles; the shopper wants one. The retailer absorbs the cost of storing, splitting and displaying.
3. Location and time: the product is available nearby, when needed, including at 9pm on a Sunday.
4. Information and trust: the retailer chooses which products are worth stocking, displays prices, handles refunds, and is legally responsible to the customer under consumer law (Australian Consumer Law in Australia; the Consumer Guarantees Act in New Zealand).
5. Credit and payment: the retailer accepts cards, offers lay-by, gift cards or trade credit, and absorbs payment fees.

Retail economics: one dollar of sales

Retail earns small percentages on very large volumes. The example below follows one dollar of sales through a large Australian warehouse home improvement retailer, using proportions in line with the sector. The structure is the same in every format; only the proportions change.

Step 1: sales (revenue)

The customer pays $1.10 at the checkout. In Australia, $0.10 of that is GST (Goods and Services Tax): a 10% tax the retailer collects on behalf of the government and passes on. In New Zealand GST is 15%. Because GST is not the retailer's money, retailers report sales excluding GST. (Some items, such as most basic fresh food in Australia, are GST-free. Most prescription-only medicines are also GST-free in Australia. New Zealand GST applies much more broadly, including to food.)

Step 2: cost of goods sold

COGS (Cost of Goods Sold) is what the retailer paid to acquire the products it sold: the supplier's invoice price, minus any discounts and rebates, plus freight and import costs needed to get the product to the retailer. In this example, $0.66.

Step 3: gross profit and gross margin

Gross profit (GP) = Sales − COGS = $0.34. Expressed as a percentage of sales, this is the gross margin (GM%) = 34%. Gross margin is the main measure used by buying teams. When a buyer negotiates a better cost price with a supplier, gross margin goes up; when the retailer runs a discount promotion, gross margin per unit goes down (the aim is for extra volume to more than compensate).

Step 4: operating costs (CODB)

From the $0.34 gross profit the retailer pays to run the business. Retailers call this the CODB (Cost Of Doing Business) or operating expenses (opex). The main cost groups are:

• Wages: store team members, DC workers, head office. Usually the largest single cost.
• Occupancy: rent on stores and warehouses, outgoings, utilities.
• Supply chain: running distribution centres and trucks (some retailers include part of this in COGS; accounting policies differ, so margins of two retailers are not always directly comparable).
• Other costs: marketing, technology, payment fees, depreciation and general overheads.

Step 5: operating profit

What's left (here $0.12) is the operating profit, reported as EBIT (Earnings Before Interest and Tax). Margins differ widely by format. Approximate EBIT margins reported by major Australian retailers in recent years:

On $19 billion of sales, a 0.5 percentage point reduction in stock loss is worth around $95 million of profit a year. Stock accuracy, pricing accuracy and labour efficiency are major investment areas for this reason.

Inventory and inventory risk

Inventory (also "stock") is the products a retailer owns but has not yet sold. In most retail it is the largest asset on the balance sheet after property. Inventory carries risk. The retailer pays for stock (often within 30 to 60 days) and needs to sell it before the invoice is due, before it goes out of fashion, before it expires, and before it is stolen or damaged.

Inventory creates two opposite risks, and many retail processes balance the two:

SOH (Stock On Hand) is one of the most frequently used terms in retail. It is the quantity of a product the system believes is physically present at a location (a store or a DC) right now. "The SOH is wrong" means the system's number does not match the stock on the shelf. This is a common and costly problem (Chapter 10).

The SKU

Retail systems are built around the SKU (Stock Keeping Unit). A SKU is a unique code a retailer assigns to each distinct product it sells, so that it can be ordered, stored, priced, sold and counted. If two products differ in any way a customer notices (size, colour, flavour or voltage), they are different SKUs.

• A cordless drill with a battery and charger and the same drill "skin only" (tool without battery) are two SKUs.
• 2 L full-cream milk and 2 L light milk are two SKUs. 2 L and 3 L full-cream are two SKUs.
• A t-shirt in five sizes and four colours is 20 SKUs (5 x 4). Apparel retailers call the parent "style" and the children "variants" or "style-colour-size".

Retailers often call their internal SKU number the item number, article number (common in some ERP systems), or product code. Separately, almost every product also has a global barcode number called a GTIN (Global Trade Item Number), which the manufacturer obtains from the standards body GS1. One SKU can have several GTINs (for example, an old and a new barcode during a packaging change). Chapter 4 covers barcodes and GTINs in detail.

A big-box home improvement store may carry tens of thousands of SKUs; a large supermarket typically carries tens of thousands as well; a membership warehouse club carries a few thousand. A retailer's total list of SKUs is its item master (or product master): one of the most important datasets in the business.

Formats and channels

A format is a type of store, defined by its size, range, price position and shopping experience. A channel is a route by which a customer buys: physical store, website, app, phone or marketplace. A banner is a retail brand name on the shopfront; one company may operate several banners.

When customers can move between channels without friction (browse online, buy in store, return by post), it is called omnichannel (Chapter 11). "Multichannel" is an older word that means "has more than one channel", without implying they are joined up.

Main retail processes

Each of the following chapters covers one or more of these steps.

1. Strategy and range: decide who the target customer is and which products to sell.
2. Price and promote: set prices, plan promotions, run loyalty programs and marketing.
3. Plan and forecast: predict how much of each SKU will sell, in each store, each week.
4. Buy: raise purchase orders to suppliers, locally or from overseas.
5. Distribute: receive goods into distribution centres, store them, pick and ship them to stores or customers.
6. Sell: put products on shelves, serve customers, process payments in store and online.
7. Serve and return: handle refunds, warranty claims, product recalls and customer service.
8. Measure and learn: analyse sales, margins and stock to improve every other step.

Four products and their supply routes

Size, shelf life, regulation and seasonality determine the route for each.

Summary

• Retail involves buying in bulk, moving goods close to customers and selling in small quantities at a margin.
• Gross margin (% of sell price) is not markup (% of cost price). Retailers quote margin.
• Operating margins are thin, so small gains in efficiency and accuracy have a large effect on profit.
• Inventory carries risk; most retail processes balance out-of-stocks against overstocks.
• The SKU is the basic unit of retail data, and the item master is the main reference dataset.