Dynamic systems development method. At the same time the new DSDM manual recognised the need to operate. This does not mean that an unfinished product is. Of Direct Product Profit and Existing Measures of SKU Productivity NORM BORIN and PAUL FARRIS Darden Graduate School of Business. (FMI OPP manual). Publication » “An Empirical Comparison of Direct Profit and Existing Measures of SKU Productivity”. of Direct Product Profit. (FMI OPP manual). Autodesk Revit Systems www.autodesk.com/revitsystems 2 intelligent than it really is. But because the model isn't computable, the elements and systems don't know how.
An Empirical Comparison of Direct Profit and Existing Measures of SKU Productivity”Page 1. An Empirical Comparison of Direct Product Profit and Existing Measures of SKU Productivity NORM BORIN?
PAUL FARRIS? Darden Graduate School of Business? University of Virginia? Charlottesville, Virginia? DPP (direct product profitability) has been heralded as one ofthe more important advances in supermarket shelf management, yet its acceptance by managers in the industry has been slow. Not only is DPP complex and expensive to calculate, but some question exists about whether decisions based on DPP are different from those based on traditional criteria such as gross margin and movement. A data base of nine dry- grocery categories is used here to compare DPP with other SKU indices. DPP is shown to lead to significantly different rankings in some categories, but not all.
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A Merchandising Attractiveness Index (MAl) is devised, based on a linear regression of gross margin, dollar sales, unit sales, and shelf area occupied, which yields predicted values of. DPP that are virtually identical to DPP in the nine categories studied. This MAl may be a far less expensive way to implement the basic concept of. DPP. It may also be more transparent to managersfor basic merchandising decisions (price, space allocation, promotions). Several trends have emerged over the last 1. In 1. 98. 8, 5,6. The authors would like to express their gratitude to the editor and anonymous reviewers for their helpful comments on an earlier version of this article.
Page 2products and 1. Swasy 1. 98. 9). These new products crowd shelves and warehouses and force retailers to review category assortments on an almost daily basis. Although some industry analysts believe that the "average supermarket, with proper space allocation, could probably increase the number of items carried by 2.
Matthews 1. 98. 9). The introduction of most new items is at the expense of the space allocated to existing ones and every new item accepted is a reason to review the category for candidates to drop.
In addition to add/drop decisions, managers in charge of the thousands of individual stock- keeping units (SKUs) need a method to evaluate specific items for promotion. Indices of SKU productivity that have been used for these purposes include: movement. SKU and, most recently, direct product profitability (OPP). Because no single index is perfect most merchandising decisions require looking at several indices simultaneously.
There are so many SKUs to be managed, however, that only a few indices may be used at anyone time. Furthermore. even if retailers could practically look at all the different indices simultaneously. How important, for example, should gross margin be as compared with movement?
How should movement be measured (cases, dollars, standardized units)? Some SKUs may earn high gross margins. Implicitly, OPP represents a scheme for combining all of these considerations. OPP reflects inter- item differences in sales, margins, and costs associated with storing, transporting, shelving, and labor- intensive merchandising activities (such as pricing individual items). Although it initially received widespread acclaim. OPP concept have become disillusioned (Matthews 1.
OPP may not be the sole, or necessarily even the single best. Assuming that OPP is the better conceptual tool for making certain merchandising decisions, would using other criteria lead to different rankings of SKUs? In those instances that OPP is believed to be a truly superior conceptual and practical merchandising tool.
OPP concept on an everyday basis than using the complicated systems now available? Page 3. This paper uses data from a large supermarket chain to address these questions. First, we show that, depending on the category in question, commonly employed merchandising indices such as movement and gross margin mayor may not be good predictors of DPP. Second, we use regression analysis to develop a multi- criteria merchandising attractiveness index (MAl) that is a surprisingly accurate predictor of DPP, may be calculated with far less effort, and is managerially intuitive. This report concludes with a discussion of some of the shortcomings of the particular research approach and how these might be addressed in the future, followed by a discussion of the management implications of our findings. SUPERMARKET SHELF- MANAGEMENT DECISIONS AND DPP The concept of allocating variable costs to each item and calculating specific contribution to fixed costs and profit has been around for a long time. I With improved models and technology came a plethora of retailer and manufacturer models designed to measure DPP.
IN 1. 98. 5 a unified dry- grocery- goods model was released by the Food Marketing Institute and this model has since become a standard for the industry (FMI 1. Since then, FMI has released DPP models for magazines, meats, produce, and bakery products.
The FMI models have been adopted (and adapted) by many manufacturers for use in their sales presentations, to optimize package design, and to tailor delivery systems (Bishop 1. Calculation of DPP Figure I presents a simplified view of the FMI DPP model for dry grocery products.
The required input data are of two types: (l) cost components, which are the expenses incurred for specific operations such as shelving, shipping, warehousing, and pricing, and (2) product inputs, which include information about a specific SKU such as weight, volume, sales rate, delivery method, and pallet dimensions. I For a discussion on managerially controllable costs see Levy and Ingene (1. Cost components are generally constant across all products within a given type of product, but different models are needed for different classifications (e. Product inputs must be entered for each SKU. The model then combines the product inputs and the cost components to calculate direct product cost (OPe) and OPP figures.
Commonly used OPP figures include OPP/unit/SKU. OPP/week/SKU and OPP/square feet/SKU. Spreadsheet programs can be used to perform the input and analysis (FMI OPP manual). Page 4. DPP and Merchandising Decisions The study classifies merchandising decisions into three general categories: the add/drop decision, the pricing/space allocation decision, and the promotion decision. In general, the add decision is made only once for an SKU (seasonal products are obvious exceptions). Frequently, drop decisions for existing SKUs must be made when new products are added to the assortment. SKU pricing and space allocations are reviewed periodically (new planograms, new stores, and resets), and decisions on promotions are made frequently (even if the decision is to reject a promotion offered by the manufacturer).
Add/Drop The primary application of DPP that has been reported by some is to make add/drop decisions (Touche Ross 1. However, for new items the only DPP figures available would be projections and subject to the optimism of the manufacturers. Selecting items to drop or reduce in shelf space in order to make room for the new items is quite a different decision.
Although actual sales and OPP are potentially available for these decisions, when Farris, Olver, and De. Kluyver (1. 98. 9) surveyed buyers on the decision criteria used to select particular SKUs to drop the survey showed that OPP was rarely used, even by those buyers with DPP systems in place. Movement, gross margin, and even "service from the supplier" dominated OPP considerations. For those buyers surveyed, it appears that OPP is relevant to drop decisions only when used to further differentiate between items with low rates of sales.
If an SKU is selling well, but earning low OPP, an obvious solution is to raise prices. If sales remain stable, the increased price and margin would lead to improved DPP. Only if sales fall and OPP remains low should the item be dropped. For theoretical and practical reasons movement is the primary criterion used for selecting items to drop; OPP is secondary (Jacober 1. Weiss 1. 98. 7; Merrefield 1. Thus, if OPP is not a primary criterion for drop decisions and if only projected figures are available for add decisions, it may not be sensible to employ full- scale OPP analysis in these situations. Pricing/Space Allocation DPP/SKU/unit (percent of selling price or dollar amount) sold is a variable that is conceptually superior to gross margin for setting prices, especially for items that do not have significant traffic- building effects and/or affect total category sales.
If direct costs are associated with handling. Page 5. FIGURE 1 Direct Product Profit Computation plus IIi nus DIRECT PROOUCT PROFITABILITY * Dea. Ls, allowances and other di rect revenues SKUs, then gross margin would generally overestimate the true marginal revenue from incremental sales.
This outcome would lead to errors in pricing levels and structure. On the other hand, if revenues other than those reflected in its selling price are associated with sales of a given SKU (as in the case of traffic builders, for example), then either DPP or gross margin could underestimate marginal revenues. In that case, DPP, being generally less than gross margin, could make errors in pricing based on gross margin even worse. Movement and number of customers buying a particular SKU give some indication of how likely an item is to play such a traffic- building role for the retailer.
A similar problem relates to using DPP as the sole criterion for allocating shelf space. If too little space is allocated, stock outs will occur, and even if short- term category sales and profits do not suffer, long- term category sales may. Furthermore, if a customer is lost to another retailer, the loss is far greater than the lost revenues from a single category would. Page 6predict. Similarly, if promotion of an item increases sales in other categories, neither gross margin nor DPP will reflect these benefits. DPP's Prospects for the Future The evidence on acceptance of DPP is conflicting.