Investment Buying’s objective is fundamentally different from turn related inventory optimization. With normal inventory optimization, the main objective for retailers and distributors is to have the least possible investment in inventory while still meeting their service goals.
When products are considered for investment, profit maximization is the overriding factor (reaped through lower acquisition costs).
Investment Buying for Inventory Overview
For a successful round of investment buying to take place, certain prerequisites are required: cash, warehouse space, management buy-in, and a software solution that integrates forward buying into regular replenishment buying decisions. Do you have a software solution that can do all of this?
First, cash is needed to make investments in inventory. This contrasts with the traditional replenishment model, where a retailer or distributor is using the manufacturer’s money (via payment terms of 30 days) and generally receives customer payment before paying its suppliers. With IB, the buyer purchases extra weeks or months of supply and bears additional carrying costs. See the changes in buying quantity and inventory on a classic “saw-tooth” curve representation of inventory and dollars over time when a forward buy is executed.
Second, without available Warehouse space, making an Investment buy could cause operational problems if there is no place to store the goods. If a deal is particularly generous it might make sense to rent more space or pay additional charges for outside storage or trailer rentals.
Thirdly, successful Investment Buying requires senior management and C level executives who understand the concepts and opportunity to create an appropriate IB strategy for the organization, because they are ultimately responsible for the incremental costs and benefits. Additionally, their input is required into some of the economics values used to optimize forward buy calculations:
Additionally, the software solution needs to be integrated into the regular replenishment buying so you can optimize service while still taking advantage deal buying opportunities. While it might be possible to execute a forward buy program manually, your buyers will never be able to fully exploit the opportunities without an appropriate software solution.
The IKIS Deal / Forward Buy Module capitalizes on profit opportunities such as price increases, discounts, or extended dating on cash terms. For each available deal, the most profitable quantity order quantity is calculated and included with Due orders for the buyer. This module efficiently integrates buy-in quantities with normal replenishment.
Types of Investment Buying
Investment buying deals are given different names by buying organizations, but some of the most common categories are:
Investment Buying Scenarios
- Off-Invoice Deals: A supplier applies the discount directly to the price of the product, and this is reflected in the invoice price. Example: If the normal product cost is $20.00, and the allowance or discount for 30 days is 5%, the deal cost of the product is $19.00.
- Bill-Backs: No discount is shown on the manufacturer’s invoice; The buyer bills the manufacturer back for the 5% discount on everything purchased. The purchase orders are flagged so a debit memo can be easily created and for the buyers to track their bill back dollars.
- Price Increases (Regular): With most price increases you are given advanced notification of the date and amount of the increase which will then allow you to make additional purchases prior to the price change going into effect . By “buying-in” prior to the vendor increase, there will be additional inventory on hand on the effective date. In most distribution companies, on the effective date, all of the inventory will be revalued and a new selling price will be calculated based on the higher inventory value, creating additional margin dollars.
As in the previous example, if the old price was $19.00 and the new price was $20.00, an inventory gain of $1.00 would be realized on product on hand or on order on the effective date.
- Price Increases (Speculative): With most price increases you are given advanced notification by vendor prior to notification, in the case of the speculative buying the vendor generally provides no lead-time and no opportunity for buying-in. Based on history, market formulas or raw material cost trends the buyer is able to anticipate a price change and build additional inventory over a period of time. In contrast with the regular price increase this is much riskier since you do not know the amount of increase or the effective date. This is in sharp contrast with a regular price buy-in where you know the amount or margin generated and the selling down carrying costs of the incremental inventory.
In most companies this type of buy-in requires the approval of senior management since the risk and reward factors are considerably higher than any other type investment buying.
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Extra Dating: The buyer receives no discount on product cost but instead receives extended cash terms from the supplier provide incentive to buy more inventory. If normal cash terms were 2% 30 the buyer receives a 2% discount if the supplier is paid on or before the 30th day. With extra dating, an additional number of days are added to the normal 30 day period. If the vendor offered cash terms of 2% 90, the product would not be paid for until the 90th day. Essentially the vendor is financing the inventory for that period and the size of the investment buy would be based on lower inventory carrying costs.
- Dynamic or Alternate Source: This type is identical to an off-invoice deal except the product is purchased through an alternate channel such as a diverter at a lower price. For example: The product itself was a brand name bottled ketchup, manufactured by the same vendor normally used for replenishment. The dynamic source is essentially another distributor or wholesaler who has purchased inventory on a deal and is now having that inventory shopped by a third party at a price lower than current list price.
- Permanent Deals: Dynamic source buying analysis requires attention to permanent deals. A supplier might offer a buyer a guaranteed 5% rebate (i.e. a kicker) on a products list price at the end of the suppliers fiscal year if volume goals are met. If a deal from a dynamic source was offered during the year for a 3% discount from list price might be executed if the 5% permanent deal is not in the deal file, losing the 2%. Therefore all permanent deals such as rebates and allowances based on volume need to be inputted into the Deal File so they can be factored into daily buying decisions.
Investment buying is a complicated activity. Buyers working a manual system will not succeed. Success requires a system with a Deal file, a repository for all available deals so that all available deals are evaluated and executed in a timely manner. Additionally the system should be able to track the incremental investment in IB through each layer of inventory. The basic layers include safety stock, cycle stock, forward buy inventory, and dynamic or alternate source inventory.
Utilizing IKIS 5.2 to evaluate and balance a buy’s incremental profit against the carrying costs, buyers can optimize the investment buying ROI while maintaining or improving customer service levels. The result is investment buying excellence.