DEEP DIVE: The Changing Retail Landscape & The Evolving Opportunity For Better Demand Planning

EXECUTIVE SUMMARY

Retailers are faced with an increasingly complex retail environment, driven by strong demand for e-commerce, more sophisticated consumer preferences, increasing channel complexity and intensifying competition. We see an increasing disconnect between the new norms of consumer retail and some of the supply-chain and demand-planning models that were built around supplying goods to brick-and-mortar stores. The challenge is exacerbated for retailers that have to match demand and supply across multiple channels (owned stores, wholesale, online and franchised stores) and fashion retailers, which typically have shorter product lifecycles.

Externalities are the primary reason why retailers that have to match demand and supply across different channels are more exposed and in need of better demand-planning processes. In addition to the direct-to-customer business, these retailers typically depend on their wholesale and franchisee customers for consistent and trustworthy demand plans.

We recommend that retailers adopt sophisticated demand-planning solutions to better align their supply-chains operations and their customers’ needs. Sophisticated demand-planning solutions help integrate inventory plans, demand forecasts and purchasing decisions to meet customers’ demands. As demand-planning decisions need to be anchored on more scientific approaches, applications that integrate planning, buying, allocation and predictive analytics in real-time are seen as powerful alternatives to spreadsheets.

The transition to better demand-planning solutions will enable retailers to create a single, firm-wide view of demand by consolidating demand plans across their owned-store, wholesale and e-commerce channels. Moreover, better demand planning will lead to an improvement in forecast accuracy that is more responsive to demand signals in real-time. This is consistent with a notable shift of retailers’ supply chains to demand-driven supply chains (DDSC), rather than merely reactive systems.

Better demand planning enables retailers to provide wider product availability and be responsive to customer needs in a cost-effective way. Studies indicate that retailers with higher demand-planning maturity have demonstrated better operating and financial results, including higher sales, lower operating expenses, lower inventory holdings and faster inventory turnover.

Demand planning affects inventory planning, which feeds into a retailer’s the return on capital. We examine the financial data of publicly traded retailers across different product verticals and distribution models. We conclude that efficient demand planning is particularly important for the apparel and footwear (AFA) industry.

In the final section of the report, we introduce the most prominent demand-planning solutions vendors. We also highlight successful case studies in the apparel industry that have leveraged the technologies of 7thonline – a provider of cross-channel merchandise management solutions to the AFA industry – which helped these retailers fulfil their demand-planning strategies.

INTRODUCING DEMAND PLANNING

Demand planning refers to the business process of predicting future demand for products, and then aligning production and distribution capabilities accordingly. The end result is to create a demand plan aligned with financial goals and inventory plans. The process involves the sharing of timely data, accurate processing of this data and agreement from various business functions on joint business plans along the supply chain.

Sophisticated demand planning would help a supply chain achieve its goal of delivering the right product, at the right time, at the right place and at the right price. A customer-oriented demand-planning process will allow for ample inventory levels to meet immediate demand, and future demand projections driven off predictive analytics.

OUR EXPECTATIONS FOR THE EXTERNAL CONSUMER RETAIL ENVIRONMENT

We expect the evolving norms of the consumer retail environment to drive an increased urgency for better demand-planning solutions for retailers. Today’s retail landscape engenders greater complexities which the conventional demand-planning models can no longer adequately cope with. Digital disruption (particularly on the demand side) has given rise to changes in the retail landscape, such as new competitors, more sophisticated consumers and new distribution channels which retailers are pitted against. Themes we explored include: 1) the need for retailers to constantly evolve;
2) growing alternatives for consumers from the emergence of online retailers; 3) how distribution is impacted from “on-shelf availability” to “on demand availability”; and 4) how the added complexity of sourcing from and selling to emerging markets increases globalization.

1. Retailers – the Need to Constantly Evolve

With the emergence of multi-channel retailers, incumbent physical retailers need to constantly adapt to stay relevant. The new breed of retailers they are pitted against is nimble across multiple channels, is introducing a larger variety of merchandise and turning over inventory at a faster pace and with more sophisticated fulfilment.

Moreover, the broader retail landscape has become more complex – retailers are operating in an increasing number of locations, with more business units, more manufacturing sources and shorter product life cycles, and are selling to more markets in which consumers have diverse tastes.

2. Consumers – Growing Alternatives with the Emergence of Online Retailers

Changes in consumer demand are driving the need for better demand planning. Consumers now expect greater convenience, faster speed, more customized orders and more frequent order changes. Retailers are obliged to offer more flexible return policies and more product choices to fast-changing consumer tastes, yet at the same time, maintain aggressive pricing in order to stay relevant with the consumers they sell to. This all necessitates better demand planning.

In addition, retailers need to adapt to more volatile and uncertain global consumer demand, which has become more pronounced following the global financial crisis, and resulted in reduced demand visibility for retailers. Global uncertainties (sharp currency fluctuations, financial and commodity market volatility, divergent monetary policies across leading economies) have hindered a recovery in consumer confidence and are beyond the control of retailers.

3. Distribution – from “On-Shelf Availability” to “On Demand Availability”

Constantly under pressure to deliver merchandise according to their customers’ choice of place and time, has led retailers to rethink demand planning. Omni-channel and e-commerce have increased channel complexity and challenged existing fulfilment models.

The blurring of channel boundaries has led to an increasing number of permutations of fulfilment options expected by consumers, which changes order patterns and necessitates demand planning. Examples include:

• Multi-channel/omni-channel retail changes consumer order patterns. An example would be buying in-store and expecting home delivery or alternative site collection, then requesting free returns across all channels.
• Immediate fulfilment, such as same- or next-day delivery, is becoming the standard.
• Mobile shopping is increasingly bridging the gap between online and offline commerce.
• Returns policy/reverse logistics: Retailers need to plan for returns and exchanges, which account for 30% of e-commerce purchases, compared to just 8% for physical stores, according to CBRE. Data from MIT Sloan Management Review indicated that retailers spend $100 billion (3.8% of their profits) per year restocking and repackaging returns.

4. Increased Globalization – the Added Complexity of Sourcing from and Selling to Emerging Markets

On the supply side, retailers are increasingly sourcing from a wider range of partners in developing countries, in order to take advantage of the cost differentials in terms of labor and the raw materials of the various countries. For example, as costs in China have increased, there has been a shift in retailers’ sourcing needs – instead of solely relying on China, they now rely on a range of lower-cost countries. This increases the complexity of demand planning, as the other countries’ infrastructure may be less mature and more prone to negative externalities.

On the demand side, changes in global economics developments and demographics have given rise to the emergence of new consumer markets. Retailers with better retail-planning capabilities are best positioned to customize their offering to satisfy local consumer demands and seize the opportunity.

Existing Demand-Planning Processes are Inadequate

Many demand-planning processes and supply chains were built for supplying goods to physical stores, i.e. brick-and-mortar stores, and are now outdated and no longer able to meet the new norms of e-commerce and multi-channel retail. Hence, it is critical for retailers to improve their demand-planning capabilities in order to cope with the increasing demands from consumers.

A study on demand planning based on retailers’ self-assessment data found that some retailers’ demand planning lacks maturity and can be overwhelmed by unforeseen demand fluctuations. Some retailers are relatively new to establishing mature demand-planning processes.

THE CHALLENGES OF NEW CONSUMER NORMS TO DEMAND PLANNING

Retailers often find it challenging to match supply and demand across multiple customers and channels.

Challenges Amplified for Retailers that Sell Across Different Channels

The challenge for demand planning is exacerbated for retailers that have to match supply and demand across multiple channels (owned stores, wholesale, online and franchised stores). In addition to their direct-to-customer business, these retailers are exposed to the externalities of demand planning, as they typically depend on their wholesale and franchisee customers for consistent and trustworthy demand plans.

The bullwhip effect refers to increasing swings in demand order variability in the supply chain, which are amplified as one moves up the supply chain. An example would be due to the variability in wholesale orders: a distributor likely relies on external resellers’ demand forecasts to make their inventory forecasts. However, this exposes a distributor to order swings when resellers supply inferior order forecasts. Over time, some distributors have responded by paring down on their proportion of revenue from wholesale channels.

Nike: Nike launched its direct-to-customer (DTC) initiative, which focuses on direct selling to customers. The decline in wholesale channel sales is a general trend among apparel companies that are increasing their focus on the higher-margin retail channel where they have an opportunity to build their brand relationship with customers and collect customer data.

Under Armour: The revenue share of Under Armour’s wholesale segment has declined from 73% of total sales in FY2010 to 66% in the last fiscal year.

VF Corp: VF Corp.’s wholesale revenue as a percentage of total revenue has declined from 81% in FY2010 to 72% in the last fiscal year.

Other retailers have increased the amount of excessive inventory as a buffer against sharp fluctuations in demand.

It would benefit retailers to control the bullwhip effect and improve their supply-chain performance by coordinating information and demand planning.

OTHER KEY CHALLENGES IN THE AREA OF DEMAND PLANNING

We have identified other major challenges that retailers face in demand planning, which include:

• Insufficient internal collaboration leading to disaggregated demand forecast outputs: There may be a lack of communication and coordination among departments. This results in siloed demand planning across owned-stores, wholesale and e-commerce channels rather than a firm-wide forecast for demand.
• Poor data integrity: The lack of an integrated demand-planning tool or process will lead to inconsistent demand forecasts. For example, some retailers may still be relying on spreadsheets for forecasting.
• Lack of robust forecast assumptions and methodology: Irregular sales promotions and marketing activities that impact sales, but do not have historical patterns, may be left out of a demand-planning model that relies on historical patterns.
• Lack of standardization with resellers: The resellers and franchisees that retailers sell to may lack the technology standardization and formal sales and operations planning (S&OP) processes.
• Difficulty in getting timely customer demand data.

WHAT THE CHANGES MEAN FOR DEMAND PLANNING

The emerging norms of consumer demand will increasingly challenge companies’ demand-planning processes across multiple dimensions, such as merchandise planning, responsiveness to consumer demand and forecasting ability.

Introducing “Total Demand Forecasting”

Total demand forecasting refers to establishing a forecast for total global demand across multiple sales channels – owned-store, wholesale and e-commerce. A retailer will need to be able to plan, track and forecast total consumer demand in today’s world of chanel proliferation (stores, e-commerce, wholesale, international). Forecasts should be on an aggregate level, not the level of the individual item, to enable the retailer to plan for capacity and factor in events that might impact demand, such as new product launches, sales promotions and advertising campaigns.

Introducing Demand Planning to the Demand-Driven Supply Chain (DDSC)

The focus has been for retailers to move from a forecast-driven mentality to a demand-driven one, as a more proactive stance to the demand-planning process. A demand-driven mentality is embodied in the concept of a demand-driven supply chain (DDSC) as opposed to the traditional forecast-led supply chains.

The Key Benefits of Demand Planning

The aim of demand planning is to ensure that a retailer can achieve the highest level of customer satisfaction through on-time deliveries with minimum inventory and costs.

The key business benefits that can be derived from demand planning solutions are:

• Accurate inventory levels forecasts across all channels and regions.
• Increased efficiencies and streamline processes.
• Improved customer satisfaction.
• Ability to respond to extreme seasonality and volumes, optimized inventory positions.
• Seamless integration across multiple channels.

1. Improved Financial Performance

Retailers with best-in-class demand-planning processes are better positioned to outperform their peer group on most operating and financial metrics. In general, companies with more sophisticated demand-planning processes have less inventory, higher asset utilization and shorter cash collection cycles than their peers, leading to major cost savings.

Surveys have also shown that demand-forecast accuracy leads directly to a higher return on assets and improved profit margins. Further benchmarking reports show that for every 1% improvement in forecast accuracy, companies report a 1-2% drop in inventory levels.

Introducing Inventory Turnover and Why It Matters for Retailers

The inventory turnover ratio measures how efficiently a company manages inventory, and the rate at which inventory is sold over a specific period. The inventory turnover ratio and profit margins are the primary drivers that directly impact return on capital (ROC), which measures how well a company uses its capital to generate returns. In general, a higher inventory turnover ratio is preferred, as it indicates that a retailer is efficient in turning its inventory to sales.

Advantages of high inventory turnover for a retailer:

• Better financing terms: Higher inventory turnover allows a retailer to rely on its suppliers’ capital to finance its inventory rather than its own capital. When inventory is turned over more rapidly, more inventories are financed through payment terms provided by suppliers rather than a retailer’s working capital.
• Lower risk of obsolescence: A higher inventory turnover serves as a moat for retailers’ profit margins. Should a retailer’s rate of inventory turnover dip, there is the risk of the inventory turning obsolete, or the risk of having to liquidate inventory at suboptimal prices.
• Higher operating leverage: Higher inventory turns means that operating costs can be spread across a larger revenue base. Retailers will be able to charge lower prices relative to their peers, which sets off a virtuous cycle of lower prices attracting customers to shop at their stores.

More sophisticated demand-planning solutions seek to address the underlying reasons that could lead to a low inventory turnover ratio, which include a retailer:

• Making inefficient inventory purchasing decisions.
• Keeping too much inventory on hand. Retailers that have excessive inventory on hand may need to sell off their obsolete inventory at heavily discounted prices, which depresses profit margins.