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Open to Buy Retail Planning Done Right

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If you have ever planned a family budget, you will easily understand Open to Buy (OTB). There are two types of families in household budget planning: those who operate on a tight budget, where planning is essential, and those for whom purchasing what they like at the moment is a priority, with budgeting taking a back seat. A similar scenario exists in retail.

In some organizations, the OTB (budget) serves more as a guiding or advisory tool. If buyers encounter the next great product, they may choose to exceed the set budget. We refer to these as Merchant-driven organizations. In contrast, other organizations are more pragmatic, requiring buyers to comply with budgetary constraints.

Regardless of the organization, however, the budget has to be calculated.

So how do we do it?

Step 1: Define your OTB budget scope.

Before diving into the specifics of the budget, it’s crucial to establish a clear framework for where and how the budget will be allocated. A household budget might be divided into monthly funds for clothes, food, bills, etc. Retail budgeting is sectioned off in much the same way.

1. Decide at which level the budget will be set.

OTB is a company budget segmented into smaller pieces. One way that OTB funds can be managed is by categories, such as women’s wear in the apparel department. OTB can also be allocated for a group of products with shared attributes known as product clusters, for example, men’s polo shirts, Christmas pajamas, or Valentine’s Day flowers.

2. Determine the time interval for which the budget is set.

It’s essential to determine the time frame over which the budget will apply. This could range from short-term periods, such as a few weeks during a holiday season, to longer periods, like a full season or an entire fiscal year. Each time frame has implications for planning cycles and purchasing dynamics.

3. Confirm how much of the business the budget will encompass.

Consider whether the budget is for the entire company or specific segments, such as the e-commerce division or the wholesale part of the business. This decision should align with the overall business strategy and operational focus.

4. Set your budget review interval.

Determine how often you will compare the budget to the actuals in-season. This will dictate how you break up the budget—whether you will be reviewing your numbers weekly, monthly, etc. If you opt for monthly, for example, at the beginning of each month, you will need to compare what you need to buy that month versus how much of your budget is available. – Remember household budgeting?

Step 2: Layout your plan

Once the OTB scope is defined, it’s time to get specific. The goal of the budget is to purchase the necessary quantities of products that will satisfy consumer demand. At home, the gift budget may need to be significantly higher in December than in January to account for holidays. So, naturally, it’s necessary to start with an accurate understanding of the expected events and demand for the sales period.

1. Know Your Demand:

While some organizations use last year’s data to predict consumer demand, more advanced organizations usually start with the Baseline forecast and adjust for any imperfections and anomalies that may have occurred the year before, such as:

  • Lost sales
  • Late shipments
  • Ad hoc promotions
  • Changes in assortment

Many other factors can impact the accuracy of the consumer demand forecast. To learn more, check out our article on demand planning.

2. Anticipate the activities for the sales period:

If you are aware of upcoming promotional activities, you’ll need to adjust to reflect demand accordingly. If you plan to mark down products at a certain stage of the product lifecycle, such as the last trimester of the season, you need to adjust the numbers to account for markdowns. This can be done manually, using last year’s data, or using a markdown strategy plan that utilizes Price Elasticity of Demand (PED) to calculate the true effect of markdowns.

3. Accounting for Ending Inventory:

Just as a well-planned household grocery budget includes maintaining certain pantry staples for the upcoming month, a sophisticated Open-to-Buy (OTB) system must account for Ending Inventory in retail settings.

This concept is crucial because it ensures that there is always a strategic reserve of products. In retail, not all inventory is expected to sell out by the end of a sales period. For example, while perishable goods like food items may aim for an ending inventory of zero to avoid spoilage, non-perishable items such as furniture might retain display or safety stock.

This buffer allows stores to maintain appealing, fully stocked displays and ensures customer satisfaction by having products readily available. Ignoring the need for Ending Inventory can lead to potential sales losses or diminished customer experience, as stores may find themselves understocked before the next replenishment. Therefore, integrating Ending Inventory into your OTB planning is essential for aligning purchase and sales strategies with the realistic turnover of different product categories, safeguarding against the risk of empty shelves or excess perishables.

Step 3: Know your limits – plan within them.

Just like every household, every retailer has unique goals, constraints, and needs. A family may decide to limit their entertainment budget to allocate those funds toward a vacation. This is similarly reflected in OTB, as company strategy and commitments are considered.

1. Company Strategy

OTB plans need to reflect company-driven strategy and goals. For example, a retailer may decide to increase spending in some areas or limit the budget in others. This strategic decision may come from a financial plan set by the CFO or a marketing plan intent on hitting a goal, such as increasing the Gross Margin by a certain percentage.

By integrating these strategic decisions into the OTB process, retailers ensure that the OTB accurately reflects not just future needs, but also the current realities that impact spending and inventory. Ultimately, a well-aligned OTB plan enhances the company’s ability to navigate market changes, leverage opportunities, and sustain financial health over time. 

2. Previous commitments

In the fashion industry, for instance, it’s common to plan and commit to certain expenditures well in advance. Fashion organizations, particularly those dealing with seasonal collections, may need to purchase key materials such as fabric up to 18 months ahead of a product’s release. This early commitment is driven by the long lead times required to design, produce, and distribute clothing effectively.

The implications of such early commitments are twofold. Firstly, these pre-ordered items represent a financial commitment that has already been deducted from your available budget, reducing the amount you have to allocate in the current period. Secondly, they influence stock levels and inventory planning, as the items on order will eventually add to the inventory, affecting how much new stock can be purchased within the budget constraints.

Step 4: Doing the calculations.

Here is the initial formula for OTB for a particular period:  Initial OTB Formula

Note 1: The forecast should include all types of products – repeat or evergreen products, new products (placeholders), and old de-listed or devaluated products with still existing inventory.

Note 2: Account for when you actually pay – Consider whether you pay for your inventory at the time of the order, upon receipt, or through a deposit (partial payment). The formula above assumes that you pay when you place the order.

Let’s look at the formula in action using household budgeting:
Table demonstrating OTB formula in use, with the headings Family Food Budget (February), Costs, and Retail Terms

If, at the end of your OTB planning, the numbers don’t match the target, you may need to adjust one of the inputs described above or reallocate the budget from other periods or categories.

What-if Scenarios

It’s important to note that before the sales period starts retailers can take advantage of a feature that can save them a great deal of time and reduces costs. Seasoned OTB systems have the capability to create and compare various scenarios.

By simulating various configurations of inventory distribution, product assortment, quantities, and pricing strategies, retailers can effectively predict and refine their approach for an upcoming sales period long before it begins.

Step 5: In-Season Adjustments

You may have done all your calculations perfectly, but ‘the best-laid plans,’ as they say, ‘often go awry.’ Unexpected events may derail your food budget. An unannounced guest, a last-minute school bake sale, or a broken fridge spoiling your food can cause you to incur greater costs. Or perhaps you are invited to a couple or unplanned dinners, allowing you to spend less.

Managing inventory levels is key to reducing carrying costs. So, regular inventory tracking of turnover rates and weeks of supply enables an agile retailer to anticipate and respond quickly to unexpected changes to the plan, such as:

1. Outperforming the plan

An unforeseen weather emergency, for example, may cause an early run on winter inventory, causing the retailer to outperform the sales forecast.

To avoid empty shelves and lost sales, retailers use agile AI-driven OTB tools to readjust the forecasts and, in real-time, suggest which stock to pull forward, replenish, or, if possible, re-buy.

2. Falling Short of sales goals

Conversely, if unforeseen circumstances cause sales to lag, an agile OTB tool can help retailers avoid the pitfalls of overstocking and drastic price cuts.

Up-to-date inventory data readjusts the forecasts and recommends revised next steps, such as rebalancing inventory to better locations and optimal markdowns and promotions, are recommended.

Step 6: What differentiates a seasoned MFP / OTB system?

In selecting your Merchandise Financial Planning (MFP) or Open-to-Buy (OTB) system, it’s essential to recognize what characterizes a mature, professional system built by retailers for retailers. A well-designed MFP/OTB system encompasses a wide array of functionalities that cater to the specific needs of your business.

1. Optimal, reliable results Derived from Advanced Analytics:

Retalon AI platform allows the OTB system to integrate, clean, and process data from various sources, providing coherent and actionable insights. By synthesizing complex data sets, retailers can make informed decisions that are based on comprehensive analysis, enhancing accuracy in inventory planning and financial forecasting.

2. Flexible in Metrics selection:

Retalon MFP is capable of providing you with dozens of historic and forecast metrics and business-specific elements, like Terminal Stock (end of Season), Safety stock due to late receipts, Markdown effect due to PED, and many others.

3. Attribute-Based Planning:

Retalon MFP allows you to plan by attributes. This is paramount to enable planning by any alternative hierarchy, such as Themes, Colors, Vendors, Price ranges, Product clusters, or any other attributes of your choice.

4. Support for Specific User Flow:

The Retalon MFP/OTB system supports your specific User Flow, such as the ability to delegate segments of the plan to other participants in the planning process, communicate, approve, and merge back. The actual use of the tool depends on user preferences. Some users prefer to consolidate all the information into one extensive workbook that may span hundreds of columns and hundreds of thousands of data points. At the same time, others prefer to keep each segment as a separate view. Retalon’s OTB tool allows you complete flexibility in configuring your plan view to suit your preference.

5. Integration with Purchasing Systems:

Finally, the Retalon system is connected to the purchasing module, which allows users to compare the OTB with the suggested order quantity (SOQ), helping them decide on the best actions to take in the case of a constrained budget.

While OTB works in much the same way as your household budget, elevating your OTB planning to the retail scale requires a boost from an AI-driven tool.

For an in-depth understanding of how Retalon can help you optimize your MFP / OTB process get in touch with one of our experts!

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