The Operational Metric for Retail Supply Chains
“Tell me how you measure me, and I will tell you how I will behave.”
This quote by Eli Goldratt highlights how metrics shape the actions and behaviours of a company. The way success is measured drives focus, impacting everything from day-to-day operations to long-term strategy. In the context of a retail supply chain, choosing the right operational metrics is crucial because they don’t just track performance—they shape it.
Where strategic metrics guide long-term profitability and tactical metrics drive medium-term actions, operational metrics focus on immediate, real-time decision-making. Each plays a distinct role, but all are essential to ensuring that supply chain efforts—from product procurement to customer delivery, or from cash to cash—contribute to the overall business goal of 'making money'.
Operational Metrics: Driving Immediate Action
Retailers are generally well-versed in strategic and tactical metrics. Operational metrics, on the other hand, are designed to trigger immediate action. They provide real-time information that helps managers make quick decisions to prevent or fix problems. Unfortunately, many companies fall into the trap of using tactical metrics to solve operational issues, which can lead to missed opportunities for quick course correction.
For example, tracking a distribution center’s delivery performance over time may reveal trends, but it doesn’t help managers make fast decisions to improve cash flow in the moment. The right operational metrics fill this gap, helping to optimise the supply chain in real time by addressing immediate concerns like stockouts and excess inventory.
The Cash Gap: A Key Operational Metric
If the ultimate goal is to "make money", supply chains must continually maximise throughput (the rate at which products are sold and converted into cash), while controlling operating expenses and the cash invested in inventory. The formula for Return on Investment (ROI) in a supply chain is: ROI = (Throughput – Operating Expenses) / Inventory Investment
When focusing on the operational aspect of the supply chain, two main problems can arise:
- It fails to meet demand, wasting money, space and time, (not least the consumer's).
- It holds too much inventory, tying up money, space and time, (mostly yours).
Each of these create a Cash Gap—a gap between the cash you have and the cash you could have. Here’s how these gaps are measured:
- Throughput Cash Gap (TCG): This metric measures the cash lost when a product is out of stock. For example, if a high-demand item is unavailable for several days, the retailer loses potential revenue. The TCG helps quantify this loss by multiplying the average daily sales of that item by the number of days it’s out of stock.
- Inventory Cash Gap (ICG): This tracks the cash tied up in excess inventory. If too much stock is sitting in a warehouse, that money could be used for more productive investments. The ICG is calculated by multiplying the value of the excess inventory by the number of days it remains unsold.
When neither a Throughput Cash Gap nor an Inventory Cash Gap exists, the supply chain is in a state of operational balance, optimising cash flow with zero wasted resources.
The role of metrics in closing the cash gap
Operational metrics like TCG and ICG are essential for keeping the supply chain aligned with profitability goals. They help managers prioritise actions—whether restocking high-demand items to generate cash or halting the supply of slow-moving products to free up cash.
In essence, closing the Cash Gap ensures that every dollar invested in the supply chain is being put to good use, either by generating sales or freeing up capital for other opportunities. This kind of real-time responsiveness is critical for staying competitive in today’s fast-paced retail environment.
How we measure and help you close the Cash Gap
At Retail Twin Labs, we offer a simple yet effective way to measure the Cash Gap in your organisation and estimate whether it can be closed—and by how much. Our tools and expertise can help you pinpoint where your supply chain is losing money, and provide actionable insights to close those gaps, improving your overall cash flow and profitability.
A real example:
In this example, the total Cash Gap is calculated as follows:
- Throughput (cash margin): The margin generated from sales is €485, while the simulated margin could have been €589. This represents the additional cash the company could have earned if the supply chain were optimized more effectively.
- Inventory Cash Gap: The cash gap due to overstocking or inefficient use of inventory is €9.
- Overall Cash Gap: The total cash gap is €113, which means that due to stockouts and excess inventory, the company lost the opportunity to generate an additional €113 in free cash.
It's crucial to remember that this calculation is based on just one SKU—the impact across a retail location with thousands of SKUs is obviously significantly larger.
Yes, but...
There are two common arguments for accepting a certain level of stockouts and slow turns as 'facts of life'. Both of these reduce the opportunity to close the cash gap completely.
1) The cash gap doesn’t account for the substitution effect, where customers may buy an alternative product when the desired one is out of stock. This might not happen as frequently, especially in fashion, but if we assume that will happen in 50% of the cases, then it would reduce the cash gap by up to 50%.
2) Perfect execution in the supply chain is rarely achievable due to various operational challenges, which could potentially cut the gain by another 50% and reduce the actual potential to be closer to 25% of the calculated figure. In this case, the real gain would be around €28 instead of the full €113.
But still...
But while these are valid considerations to reduce the calculated cash gap, the goal of the supply chain is to meet customer demand while optimising inventory. Calculating and reducing the cash gap is a powerful way to help the business to improve, as all efforts to close this gap will always improve throughput and turns.
By using these metrics, companies can ensure that their operations are increasingly responsive and aligned with the overall goals of making money.
Interested in finding out how much your Cash Gap may be costing you—and how to fix it? Simply send an email to hello@retailtwin.com and one of us will reach out within 24 hours, or schedule a call with me via the calendar link below.
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