GMROI Indicator: Cash Gains in Sight for Retail and Distribution
Better Integrate “Cash Flow” Into Decision-Making
When a distributor wants to optimize his operating cash flow, he most often thinks of reducing his inventory and negotiating longer payment terms.
The improvement in Free Cash Flow that can be achieved through this approach is limited and short-term for three reasons.
First, extending payment terms is a relatively weak lever. In fact, payment terms are most of the time already at the legal maximum and their lengthening generally results in an increase in purchase prices by the supplier.
Second, and most importantly, this approach does not integrate the margin dimension into the equation. However, the margin level is one of the most impacting levers on the “cash health” of a distributor.
Finally, and this is related, the decline in inventories can be counterproductive on cash flow if it is done to the detriment of sales and therefore of the mass of margins.
It is therefore by jointly optimizing cash “generated” by the margin and cash “immobilized” by stocks that a distributor can truly optimize its cash flow over time.
And that’s where the concept of GMROI comes into play.
The 5 Strengths of the GMROI Indicator
An Essential Indicator for Those Who Use It
We may be surprised that the GMROI is not used by all distributors. It is the only indicator that integrates both margin and inventory, which allows teams to make the right trade-offs operational.
An Indicator Appreciated by Shareholders ...
A shareholder will always listen if you tell them about GMROI and CAPEX. Indeed, these are the two operational indicators to follow to optimize Free Cash Flow: GMROI to optimize cash flow from operations and CAPEX to control cash flow from investments.
GMROI: An Indicator That is Simple to Calculate and Quick to Set Up
GMROI is the acronym for “Gross Margin Return On Inventory”
The calculation and appropriation of the indicator by the teams does not pose any difficulty. The time required to obtain the indicator is limited to that of data collection.
The GMROI corresponds to the margin generated by each euro of average immobilized stock.
In the example of Plate 1, Category 1 has a GMROI of € 7.04: each euro of average stock generates € 7.04 of gross margin annually.
After decomposition and simplification, the GMROI depends directly and only on two parameters:
the margin level (as a % of turnover) and the level of average stocks (in number of days of rotation). Plate 2 positions the same categories according to these two parameters:
An Almost Immediate Capture of Quick-Wins
Following the implementation of the indicator, the first gains are generally identified and captured in the very short term. In general, the only joint visualization of the level of margin and the level of stocks leads in effect to immediately consider the first corrective actions. While these quick-wins usually only represent around 15% of earnings, they alone justify the implementation of GMROI and have the merit of quickly leading teams to action and early wins.
Three types of corrective action are generally responsible for these quick wins. These quick-wins are often identified through the GMROI benchmark analysis. Indeed, it is at this level that one can make very quick decisions, without having to conduct a lot of additional analyzes. The example on Plate 4 shows the GMROI of 65 references from a leading supplier in its category.
A Significant Improvement in Performance in the Short / Medium Term
After capturing the first quick-wins, the GMROI allows substantial gains in the short and medium term if it is integrated into the first annual trading campaign which follows the implementation of the indicator. About 35% of the total gains can thus be captured in 3 to 12 months.
Plate 5 illustrates the type of tool that a buyer can use in the box during their negotiations. Here again, it shows the GMROI of the leading supplier by reference, but this time accompanied by that of the references of the other suppliers. The buyer’s power of conviction will be all the greater as the first quick-wins have already led to product de-listing for this supplier.
3 Conditions Necessary for the Success of the Negotiation Phase:
- Solid preparation of negotiations based on factual quantitative elements,
- Flawless support for negotiators by top management
- Real ability to change the sales mix and therefore the post-negotiation purchase mix.
Plate 6 outlines the steps and timeline for successfully integrating GMROI into negotiations:
Building a More Resilient Economic Model in the Medium / Long Term
Beyond the quick wins and the gains of a successful trading campaign, the GMROI can also be medium / long-term value creator if it is integrated into the company’s strategic decisions. With about 50% of earnings over 12-24 months, the GMROI makes it possible to increase the resilience of the economic model by integrating cash at the heart of strategic ambitions.
Four Strategies Can Benefit From Using GMROI:
1 / The Categories Strategy
In order to put the cash dimension at the heart of the strategy, the GMROI can be used in the upstream construction of the category role matrix. The company thus ensures allocate resources and orient the sales mix towards the categories that generate the most cash
(linear spaces, promotional intensity, communication, etc.).
Failing to be able to integrate the GMROI as soon as the role matrix is built, it is possible to carry out a posteriori verification to ensure that the priority categories are not destroying cash.
2 / The Purchasing Strategy
We saw above that the GMROI is a great argument for negotiating with industrialists. Its use to improve purchasing policy can go much further.
Indeed, the GMROI can be used upstream to redefine the supplier base by contributing to the definition of thebest sourcing mix between the different production areas and importers. Thus, the GMROI allows arbitration for each type of product between local purchases, close area and large import.
3 / The Offer Strategy
Beyond the role matrix, the GMROI is also a very useful indicator in the supply strategy and in building the assortment itself.
Indeed, the GMROI gives quantitative indications on the sizing of the offer
(number of references per family) in addition to traditional competing benchmarks and analyzes of the number of units of need to be covered. The GMROI also allows decisions to be made on the construction of the triptych (PP / MDD / MN) and on the selection of references.
4 / The Supply Strategy
Finally, the GMROI has value in being integrated into all reflections concerning the Supply chain strategy.
Indeed, it helps to clarify the choices between the different options of logistics flows(stored / stretched / direct store) and help define and configure upstream (OMS) and downstream (re-stock / web) supplies.
Projects Integrating the GMROI Indicator
As the implementation of the indicator is not an objective in itself, most projects that include the GMROI indicator start with a first phase of setting up and calculating the indicator itself, then focus on the following phases to exploit the results of the calculation in the improvement of the business, whether it is the Category strategy, the construction of the Offer, the optimization of Purchases or the improvement in terms of Supply Chain.
A First Phase to Implement the Indicator
As mentioned earlier, the implementation of the indicator is generally not a problem and is limited to the time required for data collection. Nevertheless, some points must be mastered in order to define the relevant management rules for the calculation of the GMROI. In particular, the level of margin used for the calculation and valuation of stocks must be carefully defined.
Four Examples of Projects Integrating GMROI Into Business Decisions:
Role and Strategy of Categories
For a BtoB distribution brand: mapping of all categories and definition of their strategic roles.
Formalization of the strategic roadmap of 4 pilot categories and determination of the associated quantified ambitions (including GMROI).
Definition of the deployment plan across all categories and multi-business governance (Marketing / Purchasing / Supply / Sales / Finance).
Purchasing Optimization
For a specialized multi-brand group: global negotiation program with the TOP 100 suppliers based on a 360 ° assessment approach.
Integration into the process of several financial models including the GMROI, with very convincing results on purchasing gains in year 1.