Many retail organizations have begun moving away from traditional profit- and product-focused strategies

AMR Research Custom Executive Summary in Collaboration With JDA Software The Trend Toward Consumer-Centric Merchandising Requires Assortment Management and Space Planning Investments September 2009 by Heather Keltz and Kevin Sterneckert Many retail organizations have begun moving away from traditional profit- and product-focused strategies and are striving to compete in a consumer-driven marketplace. Conventional assortment analytics and space tools do not deliver the optimization capabilities needed for success. Recent market data collected by AMR Research confirms that assortment management and space planning investments to support consumer-centric merchandising is top of mind for retailers. This past June AMR Research surveyed 100 retailers in the United States and 50 in Europe in order to examine the key business processes and underlying technology investments that retailers are currently prioritizing, using, and planning to use as merchandising processes expand and evolve. Results of the 150 surveys span four major retail segments: Specialty hard lines and consumer electronics (18%) Mass merchant and department stores (15%) Fast-moving consumer goods (37%) Specialty soft lines and fashion/apparel (29%) All respondents were director-level or above and screened for involvement in their company s decisions to purchase retail planning technology. Roles include store operations, merchandising, marketing, and IT. The target group of retailers report at least $250 in annual revenue with roughly one-third of the sample reporting less than $1B, one-third $1B to less than $5B, and one-third $5B or more. The European sample includes only fast-moving consumer goods and specialty soft line and fashion/apparel retailers. All European figures are based on only those two segments. Process maturity When asked to give a description of their assortment management and space planning process, retailers tend to group themselves in the upper maturity tiers (Levels 3 and 4 see Figure 1) indicating they use bottom-up planning combined with corporate objectives to narrow their assortment and space allocation plan. Considering the actual technology installed throughout these retail companies today, it is likely that respondents have inflated their true maturity level. Very few companies have achieved Level 4 where the retailer is examining consumer insight data along with syndicated sources to determine the bottom-up objectives combined with corporate objectives to deliver a localized assortment and space allocation plan. While components of Level 4 are underway, delivering true localized assortments and space plans are degrees away from reality for most. When looking across the different sample segments, the study revealed the following: FMCG and soft line retailers believe they have a better perception of category initiatives. Over twothirds in these retail segments believe their company has achieved Level 3 or 4. 2009 AMR Research, Inc. 1

There is a significant gap in the perceptions of maturity depending on the respondent s role. 77% of respondents with IT titles categorize themselves as Level 3 or 4 versus 39% in store operations roles, and 61% in merchandising. Although IT may believe they ve accomplished objectives, their counterparts express they don t have what they need. U.S. retailers are quicker to consider themselves Level 3 or 4 retailers than those in Europe. Nearly 70% of FMCG and soft line U.S. retailers rate themselves in the upper maturity tiers compared to just 44% of their European counterparts. Europe, however, leads the United States in converting consumer insights as fact-based inputs to assortment and space decisions. Figure 1: Process maturity 100% 15% 4% 21% 19% 26% 43% 10% 14% 33% 41% 48% 30% 26% 22% 28% 19% Hard lines/ electronics Mass merchant/ dept. stores FMCG Soft lines and fashion/apparel Level 1: We record the merchant decisions and forecasts and use as a guide throughout the buying process. Level 2: We receive top-down corporate goals and objectives. All decisions are intended to deliver on these objectives. Level 3: We receive top-down corporate goals and objectives and combine these with bottom-up planning through item planning activities. Level 4: We examine consumer insight data along with syndicated sources to determine the bottom-up objectives. This is combined with corporate objectives to deliver a localized assortment and space allocation plan. Q. Which of the following gives the best general description of your company s assortment management and space planning process? 2 2009 AMR Research, Inc.

Consumer demands to drive decisions There has been a misconception among retailers that profit and sales should guide assortment and space improvements. Notably few have accomplished this. Good decisions begin with the customer in mind. A differentiated consumer shopping experience encompassing customer needs can motivate the shopper to buy more. If retailers can successfully connect with the customer, profit and revenue increase will inherently follow. Globally, retailers that focus on assortment management are realizing greater product availability. Retailers such as Tesco, The Home Depot, Metro, and HEB are realizing improvements in on-shelf availability as they achieve improved assortment localization. Building a better business case 64% of companies surveyed expect to increase their consumer-centric capabilities. Retailers in Europe report they are using consumer demand signals more often and at higher degrees of execution than U.S. retailers. In both regions, however, the economic environment continues to slow the pace at which retailers are able to progress. Limited funding, competing projects, and balancing projects with operational demands register as the most significant challenges companies face in terms of their assortment management and space planning initiatives. The time for planning, however, is now. In fact, our study results strongly indicate that retailers expect to allocate funding for these types of projects in the next budget cycle (outside of 12 months). As retailers wade through planning, a strong business case should consider these key elements: The quantifiable benefits assortment management and space planning investments can bring to their balance sheet. Investments should include technology and process changes as a new level of data capture may be required. However, consider the enterprise impact of removing up to 15% of SKU counts (not through long-tail elimination) and attaining the same or improved revenue. Companies working to eliminate SKU and brand duplication and improved localization are achieving these results. The expected payback period in which they will start to see a return in their investment. Our sample of retailers expect payback within 12 months (53% overall in the United States). European retailers expect an even faster payback (up to 9 months). The organizational changes necessary to facilitate and enhance assortment management and space planning initiatives. For many retailers, centralizing the merchandising organization across business units, regions, and product categories and/or the creation of a chief merchant position is crucial to their project s success. 2009 AMR Research, Inc. 3

Figure 2a: Assortment management drivers versus benefits realized Improve overall profitability 58% 69% Reduce stock levels Tie assortments to financial goals Improve product availability 47% 49% 51% 48% 57% 59% Deliver differentiated consumer shopping experience Provide unique solution for consumers of a given location 39% 39% 48% 47% Improve overall sales per sq. ft. Improve decision accuracy via advanced processes Improve business process time/speed to market 45% 41% 45% 46% 45% 40% Maximize vendor marketing and promotional spending Achieve early visualization of range 24% 35% 34% 35% Drivers Benefits realized Reduce need for approval escalation/improve auto approval 31% 29% Q. What benefits have you realized from your assortment management initiatives? 70% 4 2009 AMR Research, Inc.

Figure 2b: Space planning drivers versus benefits realized Improve overall profitability Improve overall sales per sq. ft. Reduce stock levels 43% 43% 42% 45% 51% 54% Improve product availability 32% 40% Deliver differentiated consumer shopping experience 28% 34% Maximize vendor marketing and promotional spending 21% 31% Drivers Achieve early visualization of range 31% 31% Benefits realized Improve decision accuracy via advanced processes 29% 28% Improve business process time/speed to market 28% 28% Tie assortments to financial goals Provide unique solution for consumers of a given location Reduce need for approval escalation/improve auto approval 25% 24% 25% 29% 24% 20% 60% Q. What benefits have you realized from your space planning initiatives? 2009 AMR Research, Inc. 5

Figure 3a: Challenges to assortment management initiatives Limited funding/costs Quality of data Competing projects Coordinating goals across the organization 45% 44% 40% 38% Most significant (Top 3) 17% 13% Customer relationships Balancing project w/ operational demands Lack of available technologies Lack of defined assortment process Lack of IT resources or support Size and length of project Aggregating and analyzing data 34% 33% 33% 30% 29% 27% 25% 11% Lack of managerial support/direction 18% 50% Q. What challenges do you currently face in terms of your assortment management initiatives? Which would you say is your most significant assortment management challenge? 6 2009 AMR Research, Inc.

Figure 3b: Challenges to space planning initiatives Competing projects Limited funding/costs Lack of IT resources or support Size and length of project Aggregating and analyzing data Balancing project w/ operational demands Quality of data Customer relationships 37% 34% 33% 32% 32% 30% 28% 28% Most significant (Top 3) 15% 11% 12% 15% Lack of managerial support/direction Coordinating goals across the organization Lack of available technologies Lack of defined assortment process 24% 23% 23% 21% Q. What challenges do you currently face in terms of your space planning initiatives? Which would you say is your most space planning management challenge? 40% 2009 AMR Research, Inc. 7

Understanding consumer demands One proven method of gauging where companies need to improve is to test the importance of associated merchandising functions versus how well they re currently being performed. The gap between these two metrics demonstrates the extent of the current shortfall. While there are several notable discrepancies between where retailers are today and where they would like to be, U.S. and European retailers agree that the largest functional gap (24% gap in the United States, 16% in Europe) occurs in their software s ability to determine product assortments by mining consumer buying preferences (what consumers have bought, what they will likely buy, and forecasted expectations of consumer spending) from one store to the next. In other words, the largest gap is consumer demand preferences. Bridging this gap is the essence of consumer-centric merchandising. Most available application providers use the term consumer demand science (CDS) to describe this capability. While first appearing in the optimization of retail prices, CDS is now appearing in products that offer optimized assortment and space recommendations. Each retail segment will leverage this technology differently. For example, a fashion retailer will not apply CDS in the same way an FMCG retailer will. Further gap analysis by segment shows the following: The gap in consumer demand preferences is largest in hard line/electronics and FMCG retail segments (41% and 31% gaps, respectively). With a gap of 29%, soft line apparel retailers cite assortment planning as their top improvement area. Mass merchants and department stores post fewer functional deficits than the other three retail segments. The most notable gap for this group is in item and flow planning (13% gap). By role, challenges in consumer demand preferences again bubble to the top particularly in marketing (40% gap), store operations (28%), and merchandising (23%). Larger organizations with $5B or more in annual revenue post higher gaps in consumer demand preferences than companies with less than $1B (40% versus 28%). 8 2009 AMR Research, Inc.

Figure 4: Merchandising functional gaps Performance Gap Consumer demand preferences 41% 65% 24% Assortment planning 42% 58% 16% Item/flow planning 42% 58% 16% Allocation 45% 52% 7% Assortment visualization 45% 52% 7% In-season re-forecasting 37% 50% 13% In-season OTB management 40% 46% 6% Store clustering 34% 40% 6% Size and pack profiling 35% 39% 4% 70% Importance Performance Q. How important are the functions your assortment management and space planning process (10=Extremely important/1=not at all important) How well would you say your organization performs these today? (10=Extremely well / 1=Extremely poor ) 2009 AMR Research, Inc. 9

Retailers are ready to invest Currently, the prevailing tools for communicating decisions on assortments, space allocations, and insights from consumer shopping behavior include email, MS Excel, and internally developed solutions. There is significant opportunity for retailers to connect plans with execution in both the United States and in Europe. Europe, in particular, lags behind in delivering decisions through methods other than e-mail. Figure 5: How decisions are communicated to store E-mail 34% 54% Store software solution that provides view to plans and instructions 14% 26% Store web-based solution with assortment and space plans 12% 18% Europe Paper-based 2% 10% United States Store workforce management and task management solution 10% 14% Video with paper/e-mail instructions 3% 6% 60% Q. How are assortment management and space planning decisions primarily communicated to stores? N = 50 European retailers / 50 U.S. retailers 10 2009 AMR Research, Inc.

Retailers recognize that business as usual is not going to deliver success for the future. Optimization of merchandising process through technology tools is valuable and available. Consider the successes of Tesco and Kroger as evidence of retailers that are focused on their customers and working to align all activities to the needs of their clientele. During a recent AMR Research symposium on consumer-centric retailing, one participant said, What got us here is not going to be what will get us there. Consumers have a new level of expectations combined with vastly more choices (including online options) that put the power in the hands of those companies that can best read what consumers need to buy. Study results confirm that savvy retailers are now thinking about upgrade and new solution projects over 60% of U.S. retailers plan to replace or improve their existing assortment management tools in the next 24 to 36 months, and 50% will replace or supplement space planning applications. European retailers have the same attitude. In fact, over half (57% to 65%) of the U.S. and European retailers we surveyed expect to increase spending on assortment management in the next 12 to 24 months. Products that deliver consumer demand analytics, demand forecasting, store clustering, pack optimization, allocation, and space optimization will be the focus of retailers in the next two budget cycles. Among the spending trends uncovered by our study, the most notable are as follows: U.S. retailers on average expect to spend $5.7M on assortment management and $5.6M on space planning in 2009 (this spending includes internal labor and head count, technology, third-party content, and outsourced services). Roughly one-third of this spending will go toward technology such as software, integration, and hardware. Those based in Europe report a similar 2009 spend in support of their assortment management projects ($5.5M), with a somewhat higher budget for space planning initiatives ($8.6M). Across retail segments, department stores tend to be the largest spenders, with a significant percentage continuing to increase this expenditure over the next two years. Although FMCG retailers have spent less on merchandising strategies than their industry counterparts, over 60% plan to increase spending on assortment management in the next 12 to 24 months. FMCG retailers in fact display the greatest increase in spending in space planning over the same time period. 2009 AMR Research, Inc. 11

Figure 6: Use of technology to support assortment managment and space planning Demand forecasting 67% 15% 13% 5% Preseason allocation In-season allocation and replenishment Assortment management 64% 14% 16% 6% 60% 25% 10% 5% 59% 22% 11% 8% Assortment planning Pre- and in-season merchandise planning Traditional consumer trend analytics 58% 28% 11% 3% 57% 26% 15% 2% 57% 16% 13% 14% Consumer demand analytics 55% 22% 11% 12% Micro space optimization 46% 23% 11% 20% Size optimization 44% 26% 14% 16% Store clustering 44% 22% 16% 18% Pack optimization Consumer-based assortment optimization 42% 23% 19% 16% 40% 29% 13% 18% Macro space optimization 39% 28% 16% 17% 100% Currently use Plan to implement in 12-24 months Plan to implement in 24-36 months No plans Q. Indicate your company s use of technology tools to support your assortment management and space planning initiatives. 12 2009 AMR Research, Inc.

Figure 7: Spending trends Average 2009 spend: 100% Assortment Management $5.7M $7.8M $4.0M $5.7M 9% 9% 7% 13% Space Planning $6.4M $7.6M $3.8M $5.1M 22% 22% 21% 25% 39% 22% 32% 50% 35% 30% 21% 56% 52% 70% 61% 38% 43% 48% 57% 19% Hard lines/ elect. Dept. FMCG Soft lines/ apparel Hard lines/ elect. Dept. FMCG Soft lines/ apparel Increase No change Decrease Q. What is the total dollar amount your company will spend to support assortment management and space planning in 2009? How will this spending change in the next 12-24 months? 2009 AMR Research, Inc. 13

Optimization is key to success Leading capabilities for success vary significantly by region. U.S. retailers focus on the importance of understanding the impact of adding or removing items from an assortment within a category. European retailers are focused on the total store impact of assortment and space decisions. Nevertheless, our study results indicate that most retailers would prefer a best-of-breed approach. Excel, being flexible and cheap, continues to hold a significant market share. However, companies that rely heavily on Excel risk a messy maze of end results that are difficult to navigate and standardize across the business. Retailers universally believe that optimizing assortment management and space planning activities improve margins better than analytics alone (67% of U.S. and 70% European retailers agree). A decade ago, retailers were learning how optimization could improve the way they price their goods and services with the emergence of price, promotion, and markdown optimization. With over 150 retailers globally engaged in some form of price optimization, retailers now see that a similar approach of applying demand science to merchandising decisions can make improvements. The concept of optimization does not relinquish responsibility or control of the merchandising process, but it does offer more information that should be included in the process of understanding consumer behavior. Using the common approach of copying the plan of last year and modifying with a merchants best guess will not deliver a competitive advantage. Further, most retailers are not interested in using 2008 as a base for the future. Figure 8: Beliefs regarding advanced assortment and space optimization solutions Optimizing these activities allows us to improve margins more than analytics and execution could 19% 48% 3% 2% We believe we made the right decision to invest 22% 44% 7% 2% The cost was worth the returns achieved 20% 40% 7% 1% ERP solutions offer the same depth of functionality for assortment/space requirements as specialized packaged solutions 9% 35% 13% Strongly agree Agree Disagree Strongly disagree Q. To what extent do you agree or disagree with each of the following statements regarding advanced assortment and space optimization solutions? 14 2009 AMR Research, Inc.

Conclusion Retail 101 teaches that the customer is always right. How retailers choose to follow this rule may be the defining factor of their success. Through the largest and most in-depth research on assortment and space, AMR Research learned retailers are indicating a strong preference for optimizing these decisions within their organization. Many retailers will make significant investments in these areas within the next 12 to 24 months. However, with a tight control on investments, senior executives will expect a strong business case to approve these projects over other candidate projects. Alignment of business and IT are key to achieving the improvements that will make a difference for the consumer. Customers know what they want, and they have many choices. Optimizing your assortment and space plans will allow you to learn and know how to deliver what the customer says is right. We welcome comments at hkeltz@amrresearch.com and ksterneckert@amrresearch.com. 2009 AMR Research, Inc. 15