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Mood · 18 October 06, 02:26

I recently had a conversation on this topic with some other supply chain people. One of them had outsourced their manufacturing to SE Asia and in doing so had considered the GMROI (Gross Margin Return on Inventory) number for his business. This is also known as the "Turn & Earn Index". Its a rough profitability measure that tells you how hard your inventory is working for you; I understand it's commonly used in the retail sector.

It works like this:

Business profitability is determined by many factors. One critical trade off is the margin earnt by a SKU and how often that SKU turns over. An antique dealer traditionally has very low stock turns so needs high margin products to be profitable. In contrast a grocery retailer has very fast stock turnover and can be profitable with low product margins.

The Gross Margin Return on Inventory Investment [GMROI] represents the amount of gross profit or margin earnt for every dollar of average inventory investment. It is a measure of gross profitability of an item, line, category or total business. It identifies areas of stock that are not covering their costs. Where the margin can’t be increased then need to reduce inventory to ensure item at least pays for itself

GMROI is calculated as - Gross Margin (as % of Sales) X average inventory turns = GMROI
It can be calculated at a business, product family or item level. If the result is greater than 100 then it is contributing favourably to profitability and to offsetting the indirect costs of the business. So if it's a lot more than 100 great. If it's less than 100 then chances are that product is eroding profitability.

In the latter case you need to either improve your margin or reduce your inventory!

So, what happens when you increase the length of your supply chain? Most businesses go to international sourcing to reduce their costs (COGS) so they will see an increase in their margin as a result, all other things being equal. But extending the supply chain will inevitably increase your inventory. To maintain the same GMROI then, there is a finite increase in inventory that can be supported before you start to erode profitability.

Try this example:

If your current GMROI is 200 i.e 40% GM X 5 turns, and you were to get a 10% improvement in GM by moving offshore then how much more inventory could you stand to have before your profitability started to slide?
So, redoing the calculation 50% X 4 = 200. We could stand for turns to go from 5 down to 4. To see the effect of this convert the turns figure to days of inventory and see how many days of extra inventory you could hold for the same GMROI. If the extra inventory is less than the pipeline fill for the offshore sourcing then you WILL erode profitability!!

Try it for the numbers in your business.

18 October 06, 02:26	#5 (permalink)
Mood Regular Member Join Date: Oct 2005 Posts: 11	Re: Sourcing from China I recently had a conversation on this topic with some other supply chain people. One of them had outsourced their manufacturing to SE Asia and in doing so had considered the GMROI (Gross Margin Return on Inventory) number for his business. This is also known as the "Turn & Earn Index". Its a rough profitability measure that tells you how hard your inventory is working for you; I understand it's commonly used in the retail sector. It works like this: Business profitability is determined by many factors. One critical trade off is the margin earnt by a SKU and how often that SKU turns over. An antique dealer traditionally has very low stock turns so needs high margin products to be profitable. In contrast a grocery retailer has very fast stock turnover and can be profitable with low product margins. The Gross Margin Return on Inventory Investment [GMROI] represents the amount of gross profit or margin earnt for every dollar of average inventory investment. It is a measure of gross profitability of an item, line, category or total business. It identifies areas of stock that are not covering their costs. Where the margin can’t be increased then need to reduce inventory to ensure item at least pays for itself GMROI is calculated as - Gross Margin (as % of Sales) X average inventory turns = GMROI It can be calculated at a business, product family or item level. If the result is greater than 100 then it is contributing favourably to profitability and to offsetting the indirect costs of the business. So if it's a lot more than 100 great. If it's less than 100 then chances are that product is eroding profitability. In the latter case you need to either improve your margin or reduce your inventory! So, what happens when you increase the length of your supply chain? Most businesses go to international sourcing to reduce their costs (COGS) so they will see an increase in their margin as a result, all other things being equal. But extending the supply chain will inevitably increase your inventory. To maintain the same GMROI then, there is a finite increase in inventory that can be supported before you start to erode profitability. Try this example: If your current GMROI is 200 i.e 40% GM X 5 turns, and you were to get a 10% improvement in GM by moving offshore then how much more inventory could you stand to have before your profitability started to slide? So, redoing the calculation 50% X 4 = 200. We could stand for turns to go from 5 down to 4. To see the effect of this convert the turns figure to days of inventory and see how many days of extra inventory you could hold for the same GMROI. If the extra inventory is less than the pipeline fill for the offshore sourcing then you WILL erode profitability!! Try it for the numbers in your business.