Inventory Management

Several major retailers in the U.S. use a century-old accounting practice known as “the retail inventory method,” which relies on retail prices to estimate inventory, even though it fails to take full advantage of modern technology and distorts business metrics and tactics.

“It also creates a lot of games,” said Paula Rosenblum, a retail analyst and co-founder of RSR Research, who has criticized the practice for years. “One of the reasons merchants don't want to give it up is that they get to play some serious games with it.”

Judging by explanations given by multiple companies in their annual reports, the retail inventory method, or RIM, is employed because of its “practicality” and widespread use in the industry. However, at least one retailer, Dillard’s, also pinpoints the very aspects that many experts see as problematic.

“Inherent in the retail inventory method calculation are certain significant management judgments including, among others, merchandise markon, markups and markdowns, which significantly impact the ending inventory valuation at cost as well as the resulting gross margins,” according to financial filings from the department store. 

What that means, experts warn, is that the retail inventory method interferes with sound merchandising and pricing decisions. RIM can even muddy the picture when it comes to inventory shrink.

However, there is a superior alternative, known as “cost accounting.” This method is more dependable because it makes the most of 21st-century data systems, and because, as its name implies, it’s based on what a retailer paid for inventory — which, unlike what inventory sells for, doesn’t waver.

Oliver Chen, managing director and senior equity research analyst at TD Cowen, for years has touted the value of replacing RIM with the cost method of accounting.

“These companies need to get faster, more agile, and they need merchants and inventory planning and everybody to be more connected,” he said by phone. “The retail inventory method is a more manual process, designed when we didn't have barcodes or computers.”

How it started, how it’s going

The retail inventory method is an accounting practice developed by Shakespeare scholar-turned-retail expert Malcolm McNair in the 1920s to enable a retailer to calculate the value of its inventory without having to manually count it — a godsend before the age of point-of-sale systems and computers. RIM provides an estimate of inventory based on retail prices, including permanent markups or markdowns. It was especially handy for larger businesses like department stores with lots of merchandise of various types.

By 1970 it was prevalent, and it remains in use despite the advent of digital technologies that provide speed, precision and granularity. Along with Dillard’s, Target, Walmart, Kohl’s, J.C. Penney and Dollar Tree are among retailers that still employ the retail inventory method, according to their most recent annual reports.

Nearly a third of companies on the National Retail Federation’s top 100 list still use RIM to some extent, with about a quarter only on RIM and the rest using a hybrid model (the byproduct of mergers and acquisitions and/or PE firms that have multiple brands), according to PwC. Abroad, far fewer retailers use RIM because it’s only accepted under International Financial Reporting Standards (akin to GAAP) under certain conditions, according to Suni Shamapande, partner at PwC U.S. In the U.S., both RIM and the cost method align with generally accepted accounting principles or GAAP.

But retailers in the U.S. are increasingly rethinking RIM because the cost method’s specificity provides a clearer picture of inventory and margins, with implications for a host of retail functions, Shamapande said by video conference.

“Today, retailers have perpetual inventory systems and computers that can do the calculations, which we didn’t have in 1920,” he said. “If you tried to do it at the item level way back when, that would have been too much for a bookkeeper, particularly in department stores. But today systems and computers are doing it for you, calculating real-time cost at the item level.”

Trading in RIM for a cost method is a daunting task, entailing an overhaul of accounting, inventory management and buying that affects operations and financial reports. Two major retailers that have done so say they are happy they did.

In February, Adrian Mitchell, Macy’s Inc.’s chief financial officer and chief operating officer, told analysts that Macy’s department stores had fully converted from RIM to cost accounting, saying, “I'm really excited about what it means” for buying, selling and other decisions. In March, Nordstrom Chief Financial Officer Cathy Smith similarly announced a transition to the cost method in a Q3 2023 earnings call.

“This shift to operating in units and cost lays the foundation for us to deliver on our business priorities more effectively,” she said.

RIM versus cost

The breakdowns of these accounting methods are simplified for this article and charts are based on cost accounting using weighted average cost; variations like “first in, first out,” also known as FIFO, or “last in, first out,” also known as LIFO, among others, aren’t discussed.

RIM’s formula hinges on the cost complement — also known as the cost ratio or cost-to-retail ratio — which is equivalent to the cost of goods available divided by the retail price of goods available (multiplied by 100 to get a percentage).

The fluctuating nature of pricing puts the cost complement, and therefore RIM, on shaky ground, experts say.

“There's where the games are, because what's the retail price? What if you're having a promotion? And what if you put something on promotion for six months?” Rosenblum said by video conference. “You’re imputing this number, this cost complement number, not computing it. And there's so many reasons why it's messy.”

Cost accounting, by contrast, relies on the costs of goods, which remain the same, no matter if the retail price changes over a week, a month, a quarter or a year.

"In RIM accounting, if retailers conduct a permanent markdown, we have to update the cost-to-retail ratio, and, effectively, you would have reduced the cost of goods sold or COGS and the value of the inventory. You must reflect that in your financials immediately,” Shamapande said. “In cost accounting, it only affects margin and COGS when the item is sold, unless you mark it down below cost." 

Inventory planning and productivity

The main advantage of RIM is its relatively easy math, which provides a quick approximation of inventory without waiting for a physical count; even today, that is done only a few times each year. One major disadvantage is that it can send the wrong message: Retailers using RIM estimate their ending inventory based on price, so markdowns distort how much is really left.

This affects buying behavior that often isn’t conducive to business outcomes, according to several experts, including analysts and retail veterans.

Inventory planning will always be an art to some extent because buyers must sometimes bet on an item, color or design that has never been on the market before; because macro forces like the economy change; and because consumer behavior is generally fickle. If a retailer brings in too much, inventory bloats and leads to discounts. Bringing in too little means missed sales, so most buyers will order somewhat above their plan. In fashion and other sectors where changing tastes, styles and/or seasons affect demand, this is especially tricky. 

To manage this, buyers make periodic adjustments in their orders from vendors, depending on what sold versus what’s left. Using the cost method, the value of their inventory remains constant because it’s based on historical fact: what they paid for it. Using RIM, though, the value of inventory fluctuates with price. If an item doesn’t sell and is marked down, the lower price will drive down the value of the inventory that is left. Paradoxically, that’s a signal to buy again.

“In retail inventory method accounting, if you take a markdown, you devalue your inventory,” Kelly Pedersen, PwC global retail leader, said by video conference. “That means you have less inventory, and that means, based on your plan, you can receive more inventory.” 

By the same token, when buyers operate under RIM and want to finish out a quarter on a high note, with bigger margins, they might avoid markdowns until the quarter ends, experts said. Just as a markdown drives down the value of the inventory and signals a “buy,” avoiding a markdown keeps inventory up and precludes a buy, including orders of fresh merchandise. 

For TD Cowen’s Chen, this is the main reason why retailers should bite the bullet and switch to cost accounting. 

“Sometimes buyers, just because they're in a category, are incentivized to buy for their category,” he said. “You need a system and a structure to identify when it's not a good idea to buy tops or bottoms, and also have the computers to help inform you. That's the big thing this unlocks.”

Seeing a shrink

Although retailers have talked less about shrink, or lost inventory, in recent quarters, the industry has been preoccupied with it for the last few years. While a retailer is unlikely to adopt a new method of accounting just because of shrink, the inventory noise created by RIM does make it a factor when there’s confusion around missing inventory and its causes, according to PwC’s Shamapande.

RIM’s reliance on estimates based on selling-price changes is a problem here, Shamapande said. Plus, because those estimates are limited to the department or class level, there is a dearth of item-level accuracy, which makes it difficult to determine whether items are stolen, damaged, expired or missing for other reasons, he said.

A lack of inventory visibility has vexed the industry. Many retailers have blamed theft, while some loss-prevention experts believe that administrative mistakes are undercounted. In its most recent shrink report, the National Retail Federation estimates $112 billion worth of inventory was lost in 2022, with nearly two-thirds due to internal causes, including employee theft and process errors.

The intricacies, implications and expense of switching to cost accounting dissuade some retailers, according to Joe Schmitt, managing director at Berkeley Research Group. For any grappling with a major shrink problem, though, taking the leap is probably wise, he said by video conference.

“I think that's muddying the waters a bit from the perspective of retail accounting method clients that we have, is they just really don't know what's going on until it's too late,” he said. “A cost-accounting method would probably be better operationally to address that shrink issue. It would just depend on how much that's actually impacting a particular client, whether we would go down that path.”

Seeing a profit

The switch from RIM to cost accounting may whipsaw year-over-year comparisons that can temporarily skew financial reports.

This fiscal year at Macy’s, due to the conversion to cost accounting, neither gross margin nor inventory have been directly comparable to prior periods, contributing to a year-over-year gross margin beat in Q2 but a miss in Q3, executives said. For 2024, the shift to cost accounting will be responsible for most of an anticipated gross margin rate decline and will have inventory flat, rather than down by low single-digits, according to CFO Mitchell.

In addition, Nordstrom’s transition to the cost method of accounting pinched a little early in 2024 because it threw its markdown recognition out of whack, creating what CFO Smith said was “a slight headwind in our 2024 results.” Specifically, under the retail inventory method, Q1 2023 “benefited modestly” from the timing of markdown recognition in Q4 2022, she said.

As previously noted, inventory under cost accounting is the same regardless of markdowns. That means that weighing the cost of inventory against the various prices of an item — in other words, calculating margins — is simplified because, rather than RIM’s inconsistent, markdown-inflected estimates, the cost is always the cost.

This “unlocks gross margin return on inventory (GMROI) and gives merchants the tools to measure and buy against markdowns occurring in real-time versus overbuying and cushioning against markdown allowances,” Chen said in a 2023 client note.

Or as Nordstrom’s Smith said: “We will see profitability at the item level, guiding us in executing with intention and speed.”

This also allows for more effective pricing strategies, according to Shamapande.

"Generally, cost accounting provides a more finished view of margin at the item level, and not having to worry about the accounting implications of a markdown allows retailers to better price goods for their customers,” he said.

While Chen said he is pleased that Macy’s and Nordstrom have finally moved on from RIM, he laments that cost accounting is not more established in the industry, writing in 2023 that it “should have been implemented once point-of-sale systems that identified SKUs were in-store, but better late than never.”

Dive Brief:

• Advance Auto Parts is conducting product line reviews to identify unproductive SKUs in a bid to improve inventory management across its network, according to a Nov. 14 earnings call.
• The auto parts company expects to undertake 200 to 250 line reviews in 2024, and to increase that number over the next two years, President and CEO Shane O’Kelly told analysts.
• “Our ability to bring parts to the market faster also depends on the speed at which the parts are set-up in our system,” O’Kelly said. “Our goal is to bring this timeline down significantly by breaking down existing processes and leveraging automation.”

Dive Insight:

Advance Auto Parts manages more than 90 million unique store SKU combinations in its network, O’Kelly told analysts. He added that the company aims to address any SKU gaps to expand customer availability.

“This will also support higher labor productivity as our frontline team can reduce time chasing parts from surrounding stores that they do in order to complete an order,” the CEO said.

Conducting line reviews will also help the auto parts company evaluate private versus national brands, introduce new products and assess supplier diversification to improve market speed, O’Kelly said during the Q3 earnings call. The reviews also will enable the company to capture demand signals more quickly and ensure accurate availability of parts, the CEO added.

Advance Auto Parts has been undergoing an efficiency overhaul across its supply chain, with inventory productivity being a focus area.

In July, the retailer implemented a new inventory management system that manages more than 300,000 SKUs. The retailer also transitioned to a new warehouse management system at a distribution center in Georgia earlier.

Advance Auto Parts has also been consolidating its distribution network into a single operation, and aims to have 14 large distribution facilities operating on a single WMS by the end of the 2024. All remaining distribution centers will either be closed or converted to market hubs — another critical move in its larger supply chain overhaul.

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By RFgen Software

Inventory management is the backbone of a successful supply chain operation, but it’s often a source of persistent frustration. Relying on manual processes and outdated technology leads to costly errors, inefficient workflows and a lack of real-time visibility, ultimately impacting the bottom line.

Today, manual methods are simply unsustainable. Without accurate, real-time inventory data, businesses operate reactively, constantly playing catch-up. Mobile inventory management empowers proactive decision-making, optimizing stock levels, streamlining workflows and ultimately, boosting profitability.

The pain points of traditional inventory management

Traditional inventory management methods often create more problems than they solve. These outdated processes, reliant on manual data entry and paper-based tracking, lead to a cascade of inefficiencies and inaccuracies that hinder warehouse operations and impact the bottom line.

Inaccurate data: Human error is inevitable in manual data entry. From misreading handwritten notes to accidentally transposing numbers, mistakes creep in at every stage. These inaccuracies lead to inventory discrepancies, stockouts, overstocking and lost revenue.

Inefficient workflows: Think about the time wasted searching for paperwork, manually counting items and walking back and forth between the warehouse and the office. This lack of real-time data creates delays throughout the entire operation, from receiving to production to shipping, leading to bottlenecks, reduced throughput and increased labor costs.

Lack of real-time visibility: Without up-to-the-minute inventory data, businesses are forced into a reactive mode. Delays in receiving critical stock can disrupt production schedules and lead to late deliveries, damaging customer satisfaction.

Integration challenges: Many older inventory management systems struggle to integrate with modern ERP platforms. This creates data silos, hindering communication and making it difficult to gain a holistic view of your operations. The lack of seamless integration increases inefficiencies, compounding the problems of traditional inventory management methods and requiring manual data reconciliation, further straining resources.

The power of mobile inventory management

Mobile inventory management offers a powerful antidote to the challenges of traditional methods. By leveraging mobile devices, barcode scanning and real-time data synchronization, businesses can transform their warehouse operations, achieving significant improvements in accuracy, efficiency and visibility.

Real-time data capture: Mobile devices equipped with barcode scanners allow warehouse staff to record inventory data instantly at the point of work. This eliminates handwritten notes, manual data entry and delays in system updates, delivering real-time accuracy and visibility.

Streamlined workflows: Mobile apps automate critical inventory tasks, such as receiving, cycle counts, stock transfers and order fulfillment. By eliminating paper-based processes, workers complete tasks faster and with fewer errors. This can reduce task completion times by up to 65%, freeing employees to focus on higher-value activities.

Enhanced visibility and control: Real-time data synchronization provides visibility into inventory levels, locations, and movements. This allows businesses to make data-driven decisions, optimize stock levels, and anticipate demand more effectively. 

Enterprise-ready integration: Advanced mobile inventory solutions integrate seamlessly with ERP systems like SAP, Oracle and Microsoft Dynamics. This eliminates data silos and ensures smooth data flow across the organization, enabling teams to work with unified, accurate information.

Keep working, even when off-network: Mobile solutions with offline capabilities allow your workforce to continue operations without disruptions, even in areas with limited or no connectivity. Inventory data is captured and synchronized once the network is restored, ensuring critical operations remain efficient and effective.

How companies are winning with mobile inventory

Here are a few examples illustrating how leading companies have optimized inventory and warehouse operations to improve customer satisfaction:

Clif Bar adopted RFgen’s mobile solution to achieve 100% paperless inventory tracking in its in-house bakeries, supporting sustainability goals while providing real-time, accurate inventory data. Enhanced visibility improved ingredient traceability, ensuring product quality and safety. Additionally, Clif Bar increased productivity by 20% and reduced supply chain costs by 25%.

Boyd Corporation partnered with RFgen to implement a mobile solution that preserved critical manufacturing processes during an ERP transition. RFgen provided real-time inventory control, seamless shop floor continuity, instant remote label printing for compliance and in-house capabilities for app modifications.

Take control of your inventory

Traditional, manual methods simply can’t keep pace with the demands of modern supply chain operations. The costs of inaccuracy, inefficiency and lack of visibility are simply too high.

Mobile inventory management offers a powerful solution. By leveraging mobile devices, barcode scanning, real-time data synchronization and offline capabilities, businesses can eliminate errors, streamline workflows and gain unprecedented visibility. These advancements lead to improved accuracy, productivity and efficiency, ultimately boosting profitability and customer satisfaction.

Bel Group, maker of Babybel and The Laughing Cow cheeses, is using Kinaxis software to boost operational performance and improve supply chain visibility, the food company announced Dec. 9.

The food company has deployed the Kinaxis Maestro platform across all of its operations, a spokesperson told Supply Chain Dive. The integration is meant to help Bel Group improve its scenario planning capabilities. 

The software helps planners mitigate disruptions by allowing them to leverage, create and run various scenarios, use digital twins and capture historical data. Doing so in real time can help Bel Group better meet consumer demand.

“For example, if a recipe featuring one of Bel’s iconic products unexpectedly goes viral – Bel will have internal and external data as a single source of truth, real-time insights, and the predictions and adaptive solutions needed to understand and respond quickly to the sudden change in demand,” the spokesperson said.

Bel Group also aims to use Maestro for short-term shelf-life management, multi-level distribution and transportation optimization for its fresh products, according to the press release.

Additionally, by working with Kinaxis’ solution extension partner 4flow, a supply chain consulting and software company, Bel Group can improve truck management to reduce transportation costs and carbon emissions, per the release.

Kinaxis introduced the Maestro platform at its Kinexions 2024 event.

In a Q2 earnings call, Kinaxis President and CEO John Sicard described Maestro as an “AI-infused supply chain orchestration platform that provides real-time transparency and agility across the entire supply chain.”

Other companies using Maestro include tumbler manufacturer Stanley 1913, which leverages the platform to predict and prevent supply chain disruptions.

Dive Brief:

• Hasbro has made efforts to improve its end-to-end planning capabilities, bringing aged inventory down to “historic lows,” EVP and CFO Gina Goetter said during a Q2 2024 earnings call.
• The EVP noted the toy and game company’s upgraded planning proficiencies have helped it better determine where to source inventory according to customer demand.
• Despite shrinking its product backlog, Hasbro will ensure “suitable inventory levels to support sell-through for the holidays,” according to Goetter.

Dive Insight:

Hasbro has been undergoing a supply chain transformation recently, with Goetter crediting its “major wins” in Q2 2024 in part to Stephanie Beal, who was promoted to chief supply chain officer in July.

The toy and game company did not go into details regarding its end-to-end planning improvement and did not respond to a request for comment by the time of publication. However, during a Q1 2024 earnings call, Goetter said that Hasbro implemented a major inventory overhaul in 2023 that benefited the company during Q4 of that same year.

“Also, within our supply chain, we are building new capabilities within planning and forecasting to ensure that inventory levels, both owned and retail, remain within the desired threshold,” Goetter said during a Q4 2023 earnings call. “We made significant progress coming out of 2023 and these updated processes and tools will ensure that we maintain a healthy inventory position”

The toy and game company also focused on reducing logistics costs, Goetter told analysts during a Q3 2023 earnings call. She added that Hasbro is planning to target procurement and manufacturing in 2024.

To reduce complexity, Hasbro is focusing on efficient SKUs and reducing costs during product design to generate savings and improve the profitability of its toy business, Goetter said in Q3.

For example, Hasbro planned to release a lower cost version of Jenga, based on a “fresh design for cost model,” which the company is replicating throughout its production line, CEO Chris Cocks said.

In Q3 2023, Cocks said that Hasbro’s supply chain alone was driving roughly $100 million of the year’s expected savings, with logistics and production costs down to the mid-single digits.

“Our revamped supply chain is helping us get smarter on inventory management,” the CEO said at the time.

Dive Brief:

• Albertsons expects 30% of its distribution volume to be automated by the end of 2025, CEO Vivek Sankaran said on a Jan. 8 earnings call.
• The grocery retailer is already finished implementing automation at three of its 22 dedicated distribution centers, according to Sankaran, with more to come in early 2025. It also plans to roll out a new warehouse management system across the company before 2026.
• “These supply chain initiatives improve in-stock conditions, differentiate our fresh quality, lower our cost to serve and improve our end-to-end data analytics capabilities,” Sankaran said.

Dive Insight:

Technology advancements, such as distribution automation, is a key driver of performance and productivity at Albertsons, Sankaran told analysts.

Improving productivity is a primary goal of the grocer as it seeks to compete with growing grocery footprints of national retailers like Walmart, Amazon and Costco, particularly in the wake of a failed merger with Kroger.

“We have continued to develop our productivity engine, designed to systematically improve the efficiency of our business and improve costs,” Sankaran said. The CEO added that Albertsons plans to deliver $1.5 billion in cost savings across the company over the next three years.

Albertsons is joining a growing list of regional grocery chains turning to automation, especially as Walmart bets big on the technology to continue picking up market share in the grocery space.

Giant Eagle opened its first automated micro-fulfillment center in Pittsburgh in January 2024, while Kroger, Albertsons former merger partner, attributed delivery sales growth to its automated fulfilment facilities.

Beyond its automation investments, Albertsons bulked up its e-commerce capabilities in recent years. The company, which has partnerships with Grubhub and Instacart, reported its investments drove e-commerce sales penetration to more than 7% of grocery revenue in Q3 of 2024. However, the company sees room for improvement.

“While we have grown this business significantly and faster than the market, it is still under-penetrated compared to industry benchmarks and is one of our biggest growth customer acquisition and customer retention opportunities,” Sankaran said.