Mastering Retail Inventory: Applying Pareto’s 80/20 Rule for Optimal Stock Management

Pareto’s Principle: the 80/20 Rule

In 1906 an Italian economist by the name of Vilfredo Pareto created a math formula describing the unequal distribution

Classification Challenges in Inventory Management

Let’s assume that we have a classification where 80% of the sales are coming from 20% of the inventory a very common scenario. Most often I see this in a class that is overstocked and understocked at the same time. Contributing to the overstock situation is usually old dated inventory consisting of broken sizes discontinued styles poor color choices and even vendors that are no longer part of the merchandise assortment. In other words the class consists of a whole lot of nothing.

Understock Issues

Typically the same class will be understocked on items that are selling well and should be filled in but are not because “on paper” the class is overbought. This class will never reach full potential until this problem is diagnosed and remedied.

Misleading Benchmarks

Typical merchandising benchmarks of turn margin and GMROI can oftentimes be misleading if not thoroughly reviewed. In my opinion this is the very reason that shoe stores as a group have historically never experienced turns faster than 2-2.2 times.

Hypothetical Classification Example

Take a hypothetical classification with 10 styles. Let’s assume that 2 of the styles have just been received and are blowing off the shelves. Let’s further assume that 5 styles are just OK and that 3 styles are real dogs. In fact they are so bad that you had to check the purchase order to see if you really bought them in the first place.

• If the store is functioning efficiently the fast-selling styles get reordered immediately.
• The “dogs” get returned or marked down just as quickly.
• The so-so styles are scrutinized closely throughout the selling season.

If you are reviewing at the class level only and not drilling down to the SKU level in your POS system you may miss the hot sellers and the “dogs.” This is the very reason that good POS systems allow you to create fast and slow seller reports.

Narrow and Deep

If the reorders get missed sales begin to suffer because sizes become depleted and remaining styles are not as desirable. If the “dog” styles are not dealt with immediately by way of a vendor return or early in-season markdowns inventory levels become bloated slowing turnover and choking off open-to-buy.

In theory the cash generated from marking down the slow selling styles pays for the reorders of the faster selling ones. As the store approaches the peak of the selling season the assortment of styles offered at the beginning of the season would have narrowed while the styles in demand would be readily available in needed sizes and colors. If the store has effectively managed its open-to-buy plan it should now be in a position to land promotional merchandise to blend into the assortment at season end. If you are lucky or if you have negotiated well with the vendor upfront you might be able to buy the same styles that performed well during the season at a promotional price. This merchandise will serve to boost both sales and margins for the category.

Managing the 80/20 Rule

Managing the 80/20 rule is a continual process. The value of the Pareto Principle is that it continually reminds us to focus not only on the 20% that is the driving force behind the sales but also to manage the remaining 80% more efficiently.

If you accept the premise behind the 80/20 Rule then 20% of the people receiving this magazine will end up reading this article. If you have gotten this far you are part of the 20%. Out of this group 20% will actually DO something proactive relative to this concept while 80% will not. And so it goes.

If you are among 20%ers congratulations! Try shifting some of your focus to the 80% not working for you and see how quickly things improve.

Ritchie Sayner
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Ritchie Sayner

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