Sales Solution, as Taught by Eli Goldratt · Lesson 2 of 9
What the shopkeeper wants
Every shopkeeper is limited by two things, space and money. Work through the retailer's return on investment, see why shops can only ask for more margin and more credit, and find the one lever the company controls that beats any scheme.
Farida Shaikh’s electrical shop is four metres wide. Fans hang from the ceiling, switches fill the glass counter, cartons of wire are stacked to the door.
Farida: “Every week some company man comes in asking for more shelf. Look around. Where do I put it? And with what money?”
Ruth: “Then I won’t ask you for shelf. I’ll ask you something else. Why are you in this business?”
Farida: “To feed my family. What else?”
Ruth: “To earn more money from the money you’ve put in. Fair?”
Farida: “Fair.”
Two constraints in every shop
Every retailer, small or big, wants to earn more on the money invested in the business. And every retailer has two constraints:
- Space: shelves, counters, the back room.
- Funds: the money tied up in stock.
If space and funds are the constraints, then the best offer to any retailer is one that exploits them: more throughput per square foot, and a better return on the money invested. Not a better fan; a better business.
The retailer’s ROI
ROI = ( (selling price − cost price) × volume − expenses ) ÷ net investment
where net investment = the money in stock − the credit the distributor gives.
So how many ways are there to improve it? Ruth went through them one by one with Farida.
Ruth: “Can you raise your selling price?”
Farida: “The shop across the road sells the same fan. Customers check prices on their phones.”
Ruth: “Can you sell more?”
Farida: “If they walk in. That’s not in my hands.”
Ruth: “Cut expenses?”
Farida: “I have one boy and the electricity bill. Cut the boy and I can’t open on Sunday.”
Ruth: “And the money in stock. Why so much of it?”
Farida: “Because when a customer asks for something and I don’t have it, he goes across the road. And next time he goes there first. The distributor’s boy comes when he comes. So I buy more than I need. I’d rather sit on stock than lose a customer.”
Price isn’t in her control, volume isn’t, expenses hardly are. That leaves the shopkeeper only two moves, and every company sees them every day:
- Ask for more margin and schemes. That drains money from the company’s pocket. And it always comes with extra stock: the scheme pays only if she buys more.
- Ask for more credit from the distributor. That needs more investment from the distributor, and a distributor is also a businessman.
Pause and think: which part of Farida’s ROI can Kestrel actually influence, without spending a rupee more on margin?
- Her selling price, through a recommended retail price printed on the box
- Her investment: how much stock she must hold to never run out
- Her expenses
She holds so much stock because supply is slow and unreliable. If Kestrel makes supply fast and reliable, she can hold far less for the same sales. Same profit, less money: a higher return. That is in the company’s hands.
Margin or rotations?
A shopkeeper doesn’t earn margin once. She earns it every time the money in stock goes round: buy, sell, buy again. The yearly return on that money is, roughly, margin × the number of rotations a year.
Ruth put two offers side by side on Farida’s counter.
| A typical scheme offer | Kestrel’s new offer | |
|---|---|---|
| Margin | 10% basic + 4% scheme = 14% | 10%, no scheme |
| Stock | Bought in bulk to earn the scheme: lasts about 7 to 8 weeks | Replenished weekly: about a month’s stock |
| Rotations a year | 6 to 8 | about 12 |
| Return on money | at best about 100% | about 120% |
| Hidden assumption | The shop keeps the full 4% and sells everything | Some new items may sell slowly; but unsold items are taken back |
The scheme’s best case assumes Farida keeps every point of margin and sells every piece. The new offer’s figure is its worst case.
Farida: “Hm. And the four per cent scheme, I don’t keep it anyway. Half of it goes to the customer who bargains. The big shops pass all of it on.”
Ruth: “So the scheme mostly lowers the price on the street, and leaves you with the stock.”
Farida: “And with the stock comes the trouble. When my money is stuck in cartons, I sell below the price list just to get it back. Then the shop across the road does the same.”
Farida had just found something Kestrel’s sales team had argued about for years. What forces a retailer to break the market price? Additional margin, yes. But high inventory forces it even when prices are equal: money stuck in stock must be released, and the fastest way is a discount. The two are connected, because the extra margin always comes with the extra quantity.
Turning the tables
Rather than fighting competitors on margin, schemes and product features, where everyone fights and nobody wins for long, a company can offer the retailer an excellent return on money as a business model. It is the one parameter in the retailer’s equation the company can control, and it opens the door of every shop, small or big.
But it rests on one thing: supply so fast and reliable that the shop can safely hold little stock. That is the next lesson.
Check your understanding
Answer all five. Get four right to complete the lesson.
1. A retailer’s two constraints are…
- Price and brand
- Staff and rent
- Space and funds
- Customers and credit
So the best offer is more throughput per square foot and a better return on money.
2. Why does asking for schemes usually make the retailer’s problem worse?
- The scheme comes with extra stock, which ties up her money and pushes her to discount
- Schemes are illegal
- Schemes lower the company’s prices for every shop in the market
- Customers dislike schemes
Extra margin comes with extra quantity that isn’t consumed soon.
3. Margin 10% with 12 rotations a year gives a yearly return on stock of about…
- 10%
- 22%
- 60%
- 120%
Margin earned each time the money goes round: 10% × 12.
4. The lever in the retailer’s ROI that the company controls is…
- The retailer’s selling price
- The investment needed, through fast and reliable replenishment
- The retailer’s expenses
- The number of customers who walk in, through local advertising
Faster, reliable supply means less stock for the same sales.
5. What pushes a retailer to sell below the market price even when landing prices are equal?
- Greed
- Competition from online sellers who undercut every shop
- High inventory: money stuck in stock must be released
- Low margins
Which is why pushing stock into shops damages price discipline in the whole market.