In the previous post, we looked at two bookstores run by Phil and Turner. These characters were running their stores based on two different purchasing philosophies. At the end of the year, they both ended with the same gross profit.
- He had more titles (breadth of selection)
- He ordered more often, and could meet changes in demand more quickly
- More selection led to higher dollars per sale at the register
- Fewer units per title meant less overstock and fewer returns
- Faster turns meant faster cash flow, and cash is king
But wait a minute, what happened to the old adage, ‘stack-em-high and watch-em-fly?’ Certainly discount is more important on hot best selling items…right?
Let’s look at a hypothetical best-seller called Laugh Out Loud (LOL). The retail price is $20.00. The publisher is promoting the book heavily, and is offering the bookstore 52% for an advance order of 150 units. The book is successful, just like the sales rep said, and the inventory sells out in six months.
Phil loves discount and he jumps at the deal.
His sales are $3,000 (150*$20)
His cost of sales is $1,440 ($20*.48*150)
His gross profit is $1,560 ($3,000-$1,440)
Phil’s average inventory investment is 75 books for six months (150/2) at a cost of $720 ($20*.48*75). Average inventory investment means the cash is gone. It can’t be used for anything else.
Phil’s inventory turn is four times/year (150 book sold in half a year).
Phil’s ROI is $1.08 for every dollar invested in inventory on the best-seller. (gross profit/cost of sales) or ($1,560/$1,440)
Phil’s annualized return is four times the ROI (4 turns/year) or $4.32 for every $1.00. Phil earned $4.32 for each dollar he invested in the LOL promotion
Turner, being a different sort, says no to the discount and buys 25 units from his wholesaler at 40% discount. He continues to order 15 units every time the inventory falls to 10 units on the shelf.
His sales are $3,000 (150*$20)
His cost of sales is $1,800 ($20*.6*150)
His gross profit is $1,200 ($3,000-$1,800)
Turner’s average inventory investment is 18 books ((25+10)/2) or $216 (18 units*($20*.6)
Phil’s ROI is $.67 for every dollar invested in inventory on the best-seller. (gross profit/cost of sales) or ($1,200/$1,800). This is considerably less than Phil’s ROI! Not only is the ROI less, but the gross profit is $240 less too!
Now the rest of the story.
Because Turner operated on a Just-in-Time (JIT) inventory philosophy, his inventory turn is 16.68 times/year (150 book sold in half a year divided by average inventory of 18*2 to annualize). Because of these turns, Turner’s annualized jumps to an astounding $11.34 for every $1.00. Turner earned $11.34 for each dollar he invested in the LOL promotion!
Turner was also able to use the available cash on hand due to less inventory investment ($216 vs. $720), which was more than $500 more than Phil had to work with, to buy other titles. If Turner invests this $504 at the same rate of return, he will generate nearly $3,000 MORE in gross profit during the same six month period than Phil will earn, from the same inventory investment.
Even if Turner’s additional titles only turn twice on each dollar invested, instead of the eleven turns he sees with LOL, he will generate another $334 of gross profit during the six month period, easily wiping out the perceived discount advantage that Phil thought he had
As with retail, the publisher has to consider this same math when deciding on a print model. The old ways of ‘stack-em-high and watch-em-fly’ don’t work for the publisher either. The new model utilizes short run printing and true print-on-demand options. Retailers are maybe less important for some publishers, but engaging sales through direct-to-consumer tools are becoming more important. How does this sort of math help a publisher be more nimble? Profitable?
Something to consider.