Head & Tail Categories – Selection, Turnover (GMS), Margin and Rotations

Retail management is all about the rotation of capital. To emphasize the importance of rotations, let us take an example: Let’s say I have Rs.10,000 to invest in my business and I am reasonably good at making sofas. So, I invest my Rs.10,000 in raw-material and labor and make a sofa costing me Rs.10,000 (exhausted my initial money but I have a sofa on hand now). Let’s say I sell this sofa on 1 Jan at Rs. 10,500 (markup of 5%, not margin – margin is 4.7%) with a credit period of 30 days. With the Rs.10,500 I receive, I put Rs.500 in another bank account and I make another sofa with the remaining Rs.10,000 and sell again on 30 days credit period. At the end of the year, I will be left out with Rs.10,000 in my main account and I would be having Rs.6000 in my second account (60% return on an investment of Rs.10000). If you observe, the margin is only 5%, but the capital is rotated 12 times giving Rs.6000 in profits. However, in this example we didn’t take the time taken to manufacture the sofa – that is how long the capital is not making any money for me. Most of the money that retailers make actually come from rotations and not from margins. Typically head selection is high in rotations and low in margins and tail selection is low in rotations and high in margins.

Head & Tail Categories

Head selection in a category or head categories among all categories typically contribute about 60-70% of business value and are typically about 30% as a percentage of the overall selection. So it is like a 70-30 Pareto.

Brandalyzer-Category-3070Pareto

Most head selection in retail is usually very price competitive with thin margins, but the retailers rely on fast rotations and high volume sales in this selection to earn their return on capital. On the other hand, the tail selection is usually higher on margin but low in turnover and low in rotations. The best retailers know how to achieve a balance between them to get the best of both the worlds across all crests and troughs in the year.

One might question the need to even operate in tail selection or tail categories in retail. Like, why should a retailer even operate in a tail category? Some of the reasons are:

  1. A tail assortment today is your pipeline for the future head categories. Retailers want to carry the tail selection in order to keep a check on how the selection will grow and to get an idea about the customers’ preferences (for other than head selection).
  2. To drive more traffic or footfalls to the store. A long tail is more a phenomenon of the e-commerce strategy. When you carry head selection such as Apple or Samsung, you know that every other retailer is also carrying the same. Usually, the head brands or head selection is very strong in distribution and every retailer wants to carry them and, therefore, carrying the same head selection as every other retailer doesn’t give any unique advantage and that is where tail selection can drive more traffic and a unique advantage to the store.
  3. 30% sales is not a small number. Most retailers would give their arm for that especially in a cut-throat low margin environment.
  4. 30% sales from 70% selection or assortment doesn’t mean 30% sales from 70% inventory. A retailer always carries inventory in proportion to the sales and therefore 70% long tail selection should only have 30% inventory of the company. However, this is easier said than done.
  5. If the head selection is rotated 20 times in a year and is achieving a return of 40%, then the retailer should aim for the same 40% even from the tail with higher margin and fewer rotations, say 8 rotations in a year.

How do you achieve 70% long tail selection from 30% or less inventory?

  1. One best way to achieve long tail selection is to only list the selection/assortment and not carry the inventory. This allows testing if enough traffic is coming to check this tail selection and basis that data the retailer can decide to carry inventory on high traffic SKUs.
  2. However, it is not always possible in business to do step 1. In case, if one is forced to carry inventory then it is very important to look at conditions. Retailers would want to buy a tail selection on sell or return (SoR) clauses applicable or with extremely thick margins protecting them from losses in potential liquidation situations.
  3. Partner with potential liquidators before you decide the carry the selection so that in case if it doesn’t sell one has the protection of liquidating on at least a decent margin to cover all op-ex and gain minimum margins.
  4. Position the vendors near to the retailer’s warehouse and avoid carrying the inventory. List the selection and ask the vendor to deliver in short time in case of an order. This can be done for generic selection and for products which don’t have a long lead time for manufacturing. In any case, the brand or supplier does hold some inventory for other channels and other customers.
  5. The other strategy which can be used is to take a special warehouse in remote cheap areas only to carry the tail selection. This reduces the op-ex significantly. Use aggregated transporters to be able to ship-in and ship-out at cheap rates. Promise a longer lead time to delivery for the customers so that when an order comes you will be able to do all this in the background and deliver in say about 10-12 days.
  6. As you would’ve guessed, if you are a reasonably big player then carrying long tail selection won’t be a very hard thing to do. Because you can bully the supplier in the negotiations to provide thicker margins, sell or return clauses, buy back at cost or a certain percentage, price reduction or liquidation support to protect margins, etc. However, if you are unable to bully the supplier for whatever reasons and still you want to have the tail selection in inventory, then one has to be very cautious about the inventory positions.
  7. Enroll a small seller such as a mom&pop store near to the supplier as a supplier to you (retailer) for a fixed fee per month. The inventory will be on the mom&pop store’s books and the retailer is guaranteed stock for the customer’s order.
  8. Enroll the largest customer of your main supplier as the supplier to you. Typically, large customers will have strong terms of trade with the supplier. If the primary customer has a SoR or liquidation support, then you can enroll as the (secondary) customer to that primary customer and take advantage of the same terms at a fixed fee.

If the retailer is unable to bully the supplier into clauses like SoR, buy-back or liquidation support at protected margins, then how should the retailer approach its tail selection strategy? How should the retailer decide to carry a tail selection or not if the retailer has to carry the danger of unsold inventory, after-all there is only so much working capital?

In such a case where all of the above is not possible and still the retailer, for strategic reasons, need to operate in tail selection or category, then the retailer should be reasonably sure of success in the tail selection. This can only happen if:

  • there is a lot of customer data (search queries, forms, customer purchase data on other channels) showing that customers are genuinely interested in that tail selection.
  • similar value-to-price or benefits-to-price ratio products are selling well in the market and with the same retailer. In different categories, the value is measured very differently. In electronics, it could be spec-to-price ratio and in home-decor it could be the features-to-price ratio.
  • conduct conjoint analysis for the category with various consumer groups and identify the value that the customers attribute to a particular benefit or spec of the product. This provides a list of attributes and the value and importance assigned by the customer to that attribute. Basis this, one can come up with the gaps tail selection in a Features or benefits X price matrix.
  • long tail categories such as home decor, luggage and kitchen are very difficult for customers to understand the value of a product and are typically not driven by a few large brands like that in electronics. Customers don’t understand the difference between two bedsheets, two sofas or two kitchen utensils unless the descriptions provide the difference in an understandable language and also with specs about the quality of steel or iron or the fabric. So, for these categories and selection, the product description has to be really in detail and strong. However, the downside is that the customer may not be so involved in these kinds of purchases. But, it is the responsibility of the category manager to drive such high intent communication to the customer to build awareness among the customers.

Having the right tail selection and deciding whether to carry a particular selection or not is not an easy question to answer and there is no clear science to it. If it was so, the science would’ve been algorithmized and there would have been a clear ERP solution for finding out which selection to carry. Selection is both an art and science and will always remain so.

Thank You.

 

 

 

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