Controlling the Flow with Open to Buy

Open to Buy controls are a key element in the effective financial and merchandise control of a modern retailer. A properly implemented Open to Buy system works like an aqualung’s oxygen regulator, allowing greater or lesser amounts through depending on the demands created by the ambient circumstances and the activity level. The challenge in retail is to make sure that we regulate the supply appropriately, potentialising sales by bringing in stock levels that provide the desired service level without incurring wastage from mark-down.

What is an Open to Buy control?

An Open to Buy control serves to drive the intake of merchandise so that stock availability matches planned sales as closely as possible whilst ensuring that the planned closing stock levels for the end of a period are not exceeded.

As a safety control it fulfils two functions. Firstly it acts as a financial restriction upon the buyer that ensures that the company will not be exposed to a stock level greater than that planned. Secondly it ensures that a sufficient amount of stock is available at the right time to maximise sales potential.

Open to Buy systems normally operate using a flow calculation. This is shown in the following simple example where the closing stock for the first period is a result of adding the opening stock, on order and open to receive, and then subtracting the forecast sales. This closing stock then becomes the opening stock for period two and so on

P1 P2 P3 P4 P5 P6
Forecast Sales 100 150 200 150 100 100
Periods’ Forward Cover 3 3 3 3 3 3
Stock Required 500 450 350 300 300 300
Opening Stock 200 500 450 350 300 300
On Order 200 100
Open to Receive 200 0 100 100 100 100
Closing Stock 500 450 350 300 300 300

Each period is therefore dependent on the previous periods’ stock levels in the determination of its own Open to Buy. The Elements of an Open to Buy System

Let us look in more detail now at the elements that make up the Open to Buy.

Forecast Sales

In order to prime the system we need to make an estimate of the sales that will occur by period. Usually this is achieved by creating a financial budget for the entire season and then breaking it down (or “phasing” it) by period.

Periods’ Cover & Stock Requirement

The entry in “periods’ cover” is critical to the operation of the system. “Cover” means the amount of stock that you will hold, and it is normally related to forecast sales for a given number of periods, hence the term “periods’ cover”.

In very simple Open to Buy systems the calculations are performed using “flat cover”. Thus if 3 periods cover is required and the forecast for the current month is 100 then the stock requirement will be 3 x 100 or 300.

In more sophisticated systems “forward cover” is used. This means that rather than multiplying the current period by 3, the system would add up the next three periods’ sales. With seasonal merchandise this can make a large difference. Consider the effect of the two different methods where the sales forecast is 100, 200, 300 for the next 3 periods. Flat cover in the first period would produce a stock requirement of 300, whilst forward cover would produce a requirement of 600.

Opening Stock

The value of opening stock is a flow calculation. In Open to Buy planning the first entry will be an estimate, resulting either from user input or from the last forecast from the previous season. From the second period onwards, the figure is the closing stock from the previous period.

Intake Requirement

The intake requirement is calculated by subtracting the opening stock from the stock requirement.

On Order

The on order quantity is normally fed from summaries provided by the central merchandising system, and shows the items due for delivery in the relevant period.

Open to Receive

The open to receive is calculated by subtracting the on order quantity from the intake requirement. It is important to realise that we are looking at the intake of goods here and not the placing of an order. The goods in any given open to receive may be ordered in any number of preceding periods, depending on lead times.

Closing Stock

Is normally calculated by taking the opening stock, subtracting sales, and adding the on order and open to receive quantities. Although some systems omit the open to receive and thus generate a cumulative open to buy.

Flat or forward cover – Which is right?

One answer to this question is related to lead times and re-order cycles. In a simple and ideal world we would order merchandise to come into the business exactly when the previous stock is sold out. In reality we cannot forecast demand so accurately, and if we allow stocks to fall to near zero at, for example, a product group level, we have stock outs and lost “eye appeal”. The trick is to strike the right balance.

A common solution is to drive the open to buy by using forward weeks cover. If you re-order weekly, the lead time for the products in question is 6 weeks and you require a minimum of 4 weeks worth of stock to maintain an unfragmented range, then you would operate on a forward cover of 10 weeks until such a time as you need to sell out of the product, at which time the cover would be reduced. Of course if your re-order cycle were 4 weekly, then you would need higher cover at the beginning of the cycle.

One of the problems with forward cover is that it can create logistical headaches. The obvious example is the Christmas period where there is a combination of increased demand and finite capacity for processing and storing stock in the warehouse. In this case it may be necessary to increase or decrease ideal cover requirements to allow for these constraints.

Another problem is that forward cover relies on the availability of a sales forecast. In the example above we would need forecasts for periods 7,8 & 9, and so the time and effort required for forecasting is greater.

Value or Units

Should the open to buy be done using units, selling value or cost value? You can make a case for all 3. Creating a unit based open to buy means that the output can be related to logistical constraints such as warehouse and store capacity. However, as a financial control it appears more appropriate to use values. As sales are made at retail the most common approach is to create a retail value based sales forecast, apply stock mark downs and generate a retail value of open to receive. This can then be converted to a cost price spend available using estimated average margins. The same logic can be used to convert to units using average prices.

As can be seen from the above, there are a considerable number of ways of varying the way an Open to Buy is calculated. The flavour that you choose will depend on how complex you wish to be and the software tools that are available to you. What is beyond a doubt is that Open to Buy plays a pivotal part in leveraging your company’s investment in stock.

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