Why optimising lead times contributes to an increase in retail profitability

Lead times are an inevitable part of any supply chain, so they often go unchallenged and remain unoptimized, despite having a huge impact on profitability. Some companies, however, are now challenging these assumed rules and reaping the rewards of shorter lead times that more accurately meet demand.

Lead times exist because whenever a brand places an order with a manufacturer there is always a delay before the products hit the shelves. In some sectors, such as fashion and sportswear, the lead times can be significant including sometimes many months in between the ordering and placing the product on the shelves.

Because it’s impossible to gauge demand this far in advance; the safest approach is to optimise the cost of the items, as this seems to have the most direct impact on the financial outcome. Suppliers are therefore naturally drawn to those manufacturers that offer the best price. However, they do so without considering the unseen costs. Let’s consider recent events such as the obstruction in the Suez Canal or the mountains of clothes in Chile. What all these events share is their negative impact on the supply chain and a retailers’ profitability consequently. Not to mention the impact on the environment!

Compared to more predictable sectors like Fast-Moving Consumer Goods (FMCG), which produces a consistent flow of ‘always in demand’ items, the fashion industry has little historical data to inform order quantities (apart from standard ‘Never Out Of Stock’ items). These unpredictable items have either a much lower sales rate (as a result of producing too much), or a totally unknown rate of missed sales due to selling-out long before demand diminishes.

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How do lead times influence the profitability of retail operations?

Optimising your lead times consists of more than simply shortening them. Excessively short lead times can be just as hazardous to profitability, as the additional cost of shipping in smaller batches must be added to the overall margin. In theory, one could order an item to be FedExed the same day – directly to the consumer from the factory – but the additional cost would be prohibitive in this extreme scenario.

It is clearly much easier to predict demand for trend-based items on a shorter timescale, however. A longer lead time makes the task of ‘demand forecasting’ impossible in any meaningful sense. The longer the lead time, the more wrong a prediction is likely to be.

Getting the right length of lead time is something that brands can (and should) be more actively involved in, instead of this being dictated to them by the ‘cheapest’ supplier. To find this balance, retailers and brands need to take a long hard look at their assumptions about stock management strategy and consider where there is room for change.

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Here today, gone tomorrow: the challenge of rapid trend cycling

For the fashion and sportwear sector, there are two huge factors that influence sales. The first of these is natural volatility in demand, which can occur due to unpredictable events (like weather, war, or economic situations), as well as entirely predictable events (like Black Friday sales, or seasonal purchases).

The other main area of influence is, of course, trends.

In times gone by the trends were set by the brands themselves, who selected the colours, fabrics, styles, or cuts that would be ‘on-trend’ that season. Today, trends are no longer on the leash of brands and retailers. Instead, brands are being forced to chase the trends being set by external factors.

Today, celebrities and social media influencers will push up demand for certain looks, styles or items over a very short period, and the lifecycle of these trends is equally short. Meeting this strong level of demand with uncontrolled, long lead times is simply not possible.

Getting to grips with the assortment

Thankfully, assortments are not made up of entirely ‘hot today, gone tomorrow’ items. Although hot new trends are a fillip for driving sales (directly and synergistically), a significant chunk of the overall assortment will be made up of items with a more dependable level of demand, and a much lower level of risk.

Never Out Of Stock (NOOS) items are the ‘essential’ items from a brand’s range that the consumer always expects to have in stock. These have a longer shelf-life because they are usually tied to a specific and reliable consumer need or are an iconic design that is always in demand to some degree. As a result, these can be produced in relatively large batches and can be held in central inventory nodes, waiting to be pulled down to retail locations in line with demand and real sales. Over time, these may get small updates and upgrades, but the majority of NOOS items remain unchanged for many years.

In contrast to NOOS, retailers and brands need to adopt a different strategy for ‘Fast Movers’ that are driven by current trends or seasonal demand. While NOOS items can be made to order in large batches, fast-moving items need to be produced and supplied differently – so the product flow more closely matches the real rate of sales.

Ideally, fast-moving items would be made continuously in small batches that trickle down to the next supply node at the same rate of sales that week. In reality, this can be a costly way of producing goods. To find the middle-ground, fast movers can still be made ‘to stock’ in moderate quantities but should be held centrally until they are actually demanded by retail outlets.

To avoid stock-outs the retailers and supply nodes all need to maintain a buffer level of stock that includes enough of a margin to ensure that stockouts do not occur. This prevents retailers being stuck with unnecessary quantities of unsold stock, and ensures that stock is still available centrally, to be delivered to those locations where it is still selling.

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How Zara takes control of its own lead times – and wins

Every assortment is essentially a portfolio that includes a mix of assets with different risk exposures. Finding the right mix of NOOS and fast movers is a huge part of managing this inventory effectively. Another factor in success, however, comes from paying attention to real consumer demands. This has an equally strong effect on NOOS items but occurs at a smaller scale due to diminished volatility.

Fashion retailer Zara is a superb example of a successful retailer that leverages assortment planning and management to shorten lead-times on fast movers. The company utilises agile production methods, postponement, and in-depth customer trend analyses to inform decisions about orders and replenishment. This practice eliminates a lot of the cost, risk and inefficiency from their supply processes.

As a result, the company achieves four times the profitability of its peers by reducing their inventory risk. Zara is able to take control over their lead-times by utilising close relationships with producers, using standardised processes, and the agile production of partially-finished items (with final quantities only being committed to once real demand is gauged). Thanks to these methods, designers at Zara can turn a finished design into a product on display, in-store, in just over two weeks.

Zara is frequently used as an outstanding example of how retailers and brands can stop accepting long lead times as a governing influence in their business-model, and shows the fashion industry how we can all take control over our own destiny and profitability. Likewise, TFG (formerly The Foschini Group), which includes South African fashion brand Foschini, has abandoned long lead times in favour of more local production. Near-shoring now accounts for 72% of their production, while growing sales by 51.8%, since making the switch.  

Lead times are inevitable, but it’s possible to have significant influence over exactly how long they need to be – especially for fast-moving products.

Can a company ever shorten lead times by too much?

The primary objective for a company is always return-on-inventory (ROI). This is the ultimate reason for shortening lead times when it is prudent to do so. Shorter lead times give companies the increased ability to meet demands for trend-driven items without amassing stock risk. It also boosts profitability by decreasing the lost sales that would occur due to stock-outs. However, this has to be held in balance; when the cost of supplying goods at such a short timescale outweighs the increase in revenue (from a higher volume of on-trend goods flowing to the consumer), then it no longer contributes positively to ROI.

Attaining this balance isn’t always easy, but it certainly keeps operations running in a truly efficient way. Paying attention to the real costs of ‘low cost’ also makes it less likely that a company is undermining its own profitability; instead, it keeps the attention on achieving the best return-on investment with fully optimised lead times.

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