An open-to-buy is a tool that in the hands of a fully committed small retailer can profoundly improve financial performance. It allows a retailer to manage inventory, plan purchases, and budget effectively. Find out what goes into a good open-to-buy and how you can put it to use in your business.
In the world of retail, open-to-buy is quite a buzzword. Do a Google search on “open-to-buy” and over 100,000 references come up, many that are for consultants and software vendors offering open-to-buy programs. Many small retail software packages offer an open-to-buy module as an add-on option. But there are few retail software packages that include an open-to-buy function as part of the core package. As a result, many small retailers struggle to find some way to effectively budget their merchandise dollars. Frequently when I’m talking with a potential client, they’ll ask, “Do you think I need an open-to-buy?” without really knowing exactly what an open-to-buy is.
So what exactly is an open-to-buy?
The clearest and simplest definition is that it is a financial budget for retail merchandise. Let’s look at this more closely.
- An open-to-buy relates directly to retail merchandise, is structured specifically to address the needs of retailers, and is a tool designed to help retailers manage and replenish their most significant asset, their inventory investment.
- An open-to-buy is a budget, and involves the full range of budgetary functions. It begins with the planning process, is future oriented, provides guidance on how much to buy, and provides benchmarks for evaluating progress and adjusting plans.
- An open-to-buy is a financial tool, in that the units of measure are typically dollars, usually retail dollars but sometimes cost dollars, and that it can be tied back to the financial control process.
- An open-to-buy can work on any level that a retailer needs it to. It can be used to track merchandise at the company, department, classification, or sub-classification level. In rare cases for a small retailer, it can even be used to track an individual item.
Fashion and Seasonal Merchandise vs. Basic In-Stock Items
It’s important to note from the start that, as a replenishment tool, an open-to-buy is not appropriate for all categories of merchandise. It’s most appropriate for fashion merchandise where the specific items may change, but the departments, classifications, and sub-classifications remain relatively stable, and seasonal merchandise, where inventories are brought in at the beginning of the selling season and need to be managed down to a predetermined ending level at the end of the selling season.
In the case of fashion or seasonal merchandise, an open-to-buy answers the question of how much to buy, but not necessarily the question of which specific items to buy. For that, a detailed assortment plan is necessary, one that lays out exactly what items will be coming in and when, and provides a plan for how all of the individual items come together to form a compelling merchandise assortment
In contrast, an open-to-buy is not appropriate as a replenishment tool for day-in and day-out basics. These staple items are more effectively replenished using an automatic replenishment program running off predetermined minimum and maximum inventory parameters. In the case of these in-stock basics, an open-to-buy may still serve a valuable budget and control function at a department or category level.
The Planning Process
Like any budget, an open-to-buy starts with a plan, then compares actual results to that plan and quantifies any variances. Carefully considered planning is the critical first step in constructing an open-to-buy.
The planning process begins with building a sales plan. For small retailers, most sales plans are broken out by the month, although in some cases, especially highly seasonal businesses or categories, it may be more appropriate to plan sales by the week. The question to ask is a very basic one: “What is the most likely level of sales from stock (excluding special orders) by month (or week)?”
Once a sales plan has been developed, the next piece of the planning process is to build an inventory plan. The question to ask is this: “How much inventory do I need at the end of each month to support the next month’s sales (in some cases the ending inventory may need to support more than just one month of future sales), as well as maintain effective merchandise displays?”
From there, other things like inventory adjustments and markdowns need to be planned.
Finally, from the plans that have been developed, an inventory receipt plan can be arrived at. For any given period (month or week), the planned inventory receipts are the planned ending inventory, plus the planned sales, markdowns, and inventory adjustments, less the prior month’s ending inventory. Stated another way, the planned inventory receipts answer the question, “How much inventory do I need to bring in to cover my sales, markdowns, and adjustments, given my planned beginning inventory, in order to end up with my planned ending inventory?”
The inventory receipt plan serves several important functions. First, it serves as the inventory purchasing plan for future months. While it doesn’t tell you specifically what to buy (you need an assortment plan for that), it does tell you how much you need to buy each month. Second, because inventory purchases are typically the most significant cash outflow for a small retailer, the inventory purchasing plan serves as a critical input into a financial cash flow plan.
The completed open-to-buy plan also enables a small retailer to evaluate, before the season starts, critical inventory productivity metrics like inventory turnover and gross margin return on investment (GMROI). These are critical measures of the productivity of the inventory investment, and evaluating the planned turnover and GMROI allows the small retailer to proactively manage these metrics for continual improvement.
A completed open-to-buy plan establishes the critical benchmarks for evaluating exactly where you are once you get into the season. It’s after the season gets underway that an open-to-buy truly earns its keep. In season, key decisions have to be made about what to reorder, what to back off on, and how to allocate any remaining open-to-buy dollars.
A well-structured open-to-buy will present both the plan and actual results, and allow management to track the progress as the season goes along. Actual sales can be compared to planned sales, actual receipts to planned receipts, actual ending inventories to planned ending inventories, future open purchase order quantities to planned receipts for each month.
Like any good budget, an open-to-buy needs to have a future orientation. It needs to be able to tell management how much inventory is needed in any future month to make the sales and ending inventory plans, given the current purchase order commitments for that month.
The open-to-buy through any given month is the planned ending inventory less the projected actual ending inventory. For prior months it quantifies whether the company was over-inventoried or under-inventoried. For future months, it identifies through any given month whether additional inventory is needed or whether too much inventory has already been committed to.
The open-to-buy within any given month is the planned receipts for that month less the current purchase commitments. For prior months it measures the efficiency of the buyers and vendors in providing inventory as planned. For future months, especially for future seasons, it quantifies any remaining available open-to-buy for that specific month.
Like any management tool, an open-to-buy is merely a tool to help a small retailer better manage their inventory. It requires an initial investment in time and attention to build out a realistic plan, and diligence to maintain it as you go through the year or a season. But it can yield dramatic results quickly in most situations, from increased sales to leaner inventories and reduced markdowns and overstocks. It’s a tool that in the hands of a fully committed small retailer can profoundly improve financial performance.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
Copyright Ted Hurlbut 2007