There is an increasing trend for retailers to move sourcing closer to home.

There is an increasing trend for retailers to move sourcing closer to home.

While some of the factors behind this trend are new, a fuller understanding of the real or ‘lifetime’ margin, rather than headline margin means many retailers would have benefited from pursuing this course sooner. 

Profitability must be based on the return made on investment – ‘How much has this stock cost me in all costs, plus financing and warehouse charges, when compared to the sales achieved?’

The principles of margin setting, dominated by intake margin, were largely set when retailers were sourcing from stable, local sources and other costs were less significant.

When retailers started sourcing from long-haul locations where other, less understood costs were more significant, they often failed to adjust their approach to margins accordingly.

The problem is that the traditional approach meant that retailers were attracted by the apparently high headline margin that low-cost, long-haul sources represent, without fully appreciating the lifetime margin. The trend towards more local sourcing is being driven by inflation in traditionally low-cost sources, but there are fundamental reasons why such a rebalancing is in fact long overdue.

Minimum order and shipping quantities tend to be higher in southeast Asian sources, which drive stock into the supply chain. Such high order quantities can produce a low unit value. The potential exists for over ordering. If the corresponding sales are not achieved at full price, what happens to the residual stock? Higher markdowns, or even write-offs, lead to a further erosion of margin.  

Setting the right opening price is key. Too high an opening price will flatter the intake margin and leave the business having to make downward price adjustments to clear the product.

Apart from the potential for missing a sales window by being out on price, the visibility of these margin-eroding markdowns will depend on how good systems and reporting are.

Many costs are not always included in cost: currency hedging, financing, quality control, regulatory and ethical intervention, not to mention the absorption of management resource.

Long-haul sourcing puts strain on the balance sheet. A letter of credit is a cost to the business and consumes bank facility when raised, easily six months ahead of receipt of the goods, whereas one may reasonably expect open account from a more local supplier.

Shipping times were always an issue but long-haul sources also bring other disruptions such as Chinese New Year and the continued juggling required to get a satisfactory production window in competition with larger competitors.

Small and medium sized businesses are particularly vulnerable. They do not sell sufficient volumes to make the minimum order quantities proportionate to the rate of sale throughout the product’s life, nor do they have the depth of management and analysis to manage a long haul supply chain.

There is certainly a trend of balancing the relative advantages of long-haul and local sources providing opportunity to benefit both retailers and consumers in the longer term.

Ian Gray, director, Baronsmead Consulting