ANSWERS TO DISCUSSION QUESTIONS AND PROBLEMS
1. What are the key productivity ratios for measuring the retailer as a whole, its
merchandise management activities, and its store operation activities? Why are these
ratios appropriate for one area of the retailer’s operation and inappropriate for others?
One key measure for assessing the productivity of the retailer as a whole is the return on
assets (ROA). ROA is the profit generated by the assets possessed by the firm and is a
comprehensive picture of firm performance. Other general measures are net profit margin.
The measures used to evaluate retail operations are different depending on the level of the
organization where the decision is being made and the resources that the manager controls.
For example, the principle resources controlled by store managers are space and operating
expenses such as the wages paid to sales associates and the electricity used to light and
heat the store. Thus, store managers focus on performance measures like sales per square
foot and employee costs.
2. What are examples of the types of objectives that entrepreneurs might have for a retail
business they are launching?
Retailers can have three types of objectives: 1) financial, 2) societal, and 3) personal.
Examples of financial objectives for an entrepreneur might include sales or profit. In the
3. Buyers’ performance is often measured by their gross margin percentage. Why is this
figure more appropriate than the operating or net profit percentage?
A buyer can impact the gross margin percentage because he/she can, to some extent,
control the sales and cost of goods sold. Expenses, which do not play a part in determining
4. A supermarket retailer is considering the installation of self-checkout POS terminals. How
would the replacement of cashiers with these self-checkouts affect the elements in the
retailer’s strategic profit model?
The machinery involved in self-checkout POS terminals would be counted as a long-term
asset for the retailer. When adding additional assets, retailers have to maintain higher sales
5. Macy’s and Costco have targeted different customer segments. Which retailer would you
expect to have a higher gross margin? Higher operating expenses as a percentage of
sales? Higher operating profit margin percentage? Higher inventory turnover and asset
turnover? Higher ROA? Why?
Gross margin gives a retailer a measure of how much profit it is making on merchandise
sales without considering the expenses associated with operating the store and covering
corporate overhead. Macy’s should have a significantly higher gross margin than Costco.
Since department stores don’t typically have high turnover, they rely on margin to succeed.
Conversely, Costco focuses on high turnover to succeed.
6. Why do investors place more weight on comparable-store sales than growth in sales?
Comparable-store sales growth compares sales growth in stores that have been open for at
least one year. Growth in sales can result from increasing the sales generated per store or
7. Blue Nile is a jewelry retailer that only uses an Internet channel for interacting with its
customers. What differences would you expect in the strategic profit model and key
productivity ratios for Blue Nile and Zales, a multichannel jewelry retailer?
On the profit margin path, Blue Nile and Zales might have very different sales numbers, as
Zales is a much larger company than Blue Nile. Also, we would expect to see lower
operating expenses for Blue Nile as it has less overhead and labor costs than Zales. Perhaps
8. Using the following information taken from the 2016 balance sheet and income statement
for Urban Outfitters, develop a strategic profit model. (Figures are in millions of dollars.)
Net sales $2,734.8
Cost of goods sold $1,316.2
9. A friend of yours is considering buying some stock in retail companies. Your friend knows
that you are taking a course in retailing and asks for your opinion about Costco. Your
friend is concerned that Costco is not a good firm to invest in because it has such a low
net operating profit. What advice would you give your friend? Why?
When compared to Macy’s, Costco has a lower net operating profit but it is because the
margins on items sold at Costco is much lower than the margin on items sold at Macy’s.
Students should understand that fashion and apparel items like those predominantly sold at
ANCILLARY LECTURES AND EXERCISES
————–——–——–——————-
LECTURE # 6-1: THE STRATEGIC PROFIT MODEL (SPM)
Instructor’s Note: Instructors may wish to use this ancillary lecture in lieu of the annotated
outline. This is fairly complex material for students to grasp. This lecture is presented with a
simple example. Instructors might want to use this exercise as a stimulus to a class discussion
on the topic. The Chapter 6 Power Point slides can be used with this lecture.
————–——–——–——————-
Background
Purpose of the SPM
• The SPM serves two managerial purposes:
• Specifies that a firm’s financial objective is to earn adequate or target return on owner’s
equity—also known as return on net worth.
• Identifies three profit paths a firm can take to increase O.E. by increasing:
1. profit margin
2. rate of asset turnover
6. financial management
• Let us take each of the three categories and break them down.
Margin management
• This information is taken from the income statement:
• Invoice cost + freight in + work room costs – vendor’s cash discounts
• Cost of goods sold:
• Invoice costs
• Why are these adjustments made to cost of goods sold?
• Directly affect landed cost of merchandise
• Gross margin:
• Gross margin, gross margin percent, and inventory turnover are extremely important in
the world of retailing. They represent aspects of the business with which buyer has
direct control.
• Total expenses (two types—variable and fixed):
1. Variable—(varies with sales) — the cost of doing business; e.g., sales commission
and is thus variable with sales).
2. Fixed—cost of being in business. We have fixed expenses whether or not we sell
anything. For example, rent, electricity, administrative salaries, etc.
• Net profit (after tax):
• How to evaluate profit margin
3. Firm’s past history
4. Compare with similar stores or departments. Should be really much better than
average for industry considering there are many bad stores.
Asset Management
• To obtain a better idea of what asset management is about, examine the Asset
Management Model.
• Objective: The objective in asset management is to turn inventory into accounts
receivable or cash by making sales rapidly.
• Current assets—“cycle”
1. cash to inventory
2. inventory to cash or
6. maximize sales through
selection (depth + breadth)
minimize stock-outs (service level)
• Accounts receivable = Merchandise sold on credit. Want to minimize accounts
receivable because may be an unproductive asset. Most retailers offer credit because:
1. tradition
• Bankcard—Visa, MasterCard, or American Express (T&E—travel and entertainment
card); can be converted to cash immediately, but card company charges retailer a
percentage of sales.
• Proprietary—when a retailer keeps its own accounts receivable (private credit card, like
“Sears” card). The most common reason for doing this is to collect interest from
customers.
• The first two types of credit cards are the most popular with retailers because they
generally prefer to stay away from accounts receivable. Naturally, their main interest is
converting inventory into sales and profits.
• Cash: keep to a minimum
Fixed assets:
1. fixture
Asset turnover:
• Net sales/ total assets = Asset turnover.
Return on assets
• ROA uses both asset management and margin management.
• Used for evaluating and programming performance of profit centers (like stores), used
to evaluate managers, not owners because owners also have control over financial
leverage—to be discussed below.
• The question here is, how much profit are you able to generate from retailer’s assets?
• Return on assets is an extremely important measure of how a retailer is performing.
Financial leverage management
• Leverage ratio = Total assets/O.E. or (Total liabilities +O.E.)/O.E.
• How to manage leverage:
1. Too leveraged (too much debt) means financial instability, i.e., too much risk.
2. If not leveraged, then return on owner’s equity suffers
• More debt means higher leverage.
Conclusion
• Depending where one is in the firm, different managers will use different performance
ratios.
CONNECT ACTIVITIES FOR CHAPTER 6
Activity Title
Activity Type(s)
Topic
Financial Growth for
Hooper’s Outdoor
Adventure
Case Analysis
Profit Planning and
Paths to Financial
Performance
6-1 Review the
strategic objectives of
a retail firm.
6-2 Contrast the two
paths to financial
performance using
the strategic profit
model.