Guest Commentary: Increasing Profits by Lowering the Cost of Goods Sold

Through June of this year, the inflation rate in the US has been trending sharply upward. If the trend continues we could be on track to experience the highest rate of inflation so far this century. This is not news to consumers who are faced with inflation daily as they go to the gas station or shop for groceries. They know full well that non-discretionary items like gasoline, dairy and grain-related products have steadily gotten more expensive. Our customers in wholesale and retail across the board are receiving price increase notices from their suppliers at a growing rate.

Source: Manhattan Associates

Wholesale distributors and retailers get squeezed as consumer price competition makes it difficult to just pass the cost increases onto the selling price. One way to hedge against ever tightening profit margins is to take advantage of investment buy opportunities based on pre-announced price increases from suppliers. In other words, forward buy on the current cost just before the cost increase takes effect. While selling generates revenue, better buying generates better profit.

There are inherent costs associated with buying and reselling inventory, such as inventory carrying cost. There are also several points companies must consider when taking advantage of an investment buy opportunity, including the following:

Return target rate: This is the return you want to achieve on the last piece of forward-bought inventory. You don’t want to forward buy more inventory than you can profitably sell through in a reasonable amount of time because it costs you to hold inventory.

Cost of money: The amount to forward buy should be governed by the point when incremental profit on the forward buy is balanced with the incremental costs of carrying the extra inventory.

Cash requirements: Forward buys usually require more cash. This may require consultation with your CFO and the decision needs to take into account your cash strategy, cost of money and liquidity. Sometimes this can be mitigated by additional dating terms by extending the time you have to pay the invoice.

Investment alternatives: Another consideration before entering into a forward buy is investment alternatives. In what other areas, such as opening new facilities, can your company invest its capital in if not in inventory?

Finally, it all comes down to balancing the risk of investment buying. A forward buy usually takes extra cash, it may require extra space depending on the merchandise, and your demand forecasts need to be reasonably accurate.

Rodney Daugherty is Senior Director of Product Strategy for Demand Forecasting and Inventory Optimization at Manhattan Associates.