How Back-of-Mind Backrooms Rob Retailers of Profits

How Back-of-Mind Backrooms Rob Retailers of Profits

MIT CTL research shows that how backroom spaces are configured and managed impacts the profitability of stores

When designing the layout of their stores, retailers understandably pay close attention to the front spaces—the places where consumers purchase goods and interact with staff. The dynamics of these customer-facing areas are well understood. Backroom spaces, on the other hand, tend to attract less attention and are not as well understood, especially in the context of their impact on store performance.

However, our research shows that retailers have a substantial opportunity to increase revenue and improve customer service by increasing the efficiency of backroom operations—especially at a time when the rise of online sales and omni-channel business models is redefining the functionality of retail outlets.

Backroom spaces make a major contribution to store profitability. If the amount of inventory held in the backroom is too low, the retailer can lose sales because product is not available when customers wish to make a purchase. Too much inventory in the backroom, however, loads the store with excessive costs and waste, which eats into profit margins. Retailers therefore need to pay more attention to the amount of front and backroom spaces that will yield the maximum profit potential and how backrooms are managed to support the store’s demand profile.

Many factors affect the allocation of backroom storage space. Three that are especially important to consider are the size of the packs that are stored, the revenue yield of each individual item, and the importance of the item to the store’s operation.

Pack size. The size of the packs received by stores from suppliers might seem like a relatively mundane detail. However, pack size can have a big impact on the backroom’s ability to function effectively; the size of the units stored determines how much inventory can be shelved and how accessible the items are.

Revenue yield per item. Our research also highlights the importance of optimizing for profit—rather than simply minimizing cost—when modeling for backroom space allocation, owing to the close and direct links between store backroom and front room areas. For example, devoting too much backroom space to items that have a very low revenue yield can undermine the overall profitability of a store.

Importance of the item. The relative importance of ingredients and other types of supplies also needs to be considered when allocating backroom space. Some items—cups in a coffee shop, for example—are essential; the store can’t deliver the product without them. Other ingredients or supplies are less important because they are not an essential part of products, and therefore should be allocated less backroom space.

The way a retailer weighs these factors and builds these weightings into the operation of a backroom can have a huge bearing on the profitability of the store.

As part of our research we have developed a tool that helps retailers to understand the impact of factors such as pack size on inventory levels and a store’s ability to meet customer demand. The tool enables retailers to create a database of the factors that are critical to the performance of backrooms and to analyze these factors in relation to store profitability. It can be used to evaluate existing backrooms and to integrate the backroom space into the design of new outlets.

The models we have developed are now being extended to include a more sophisticated valuation of front room spaces. The idea is to help retailers capture the trade-offs between allocating backroom and front room square footage and to achieve the optimum balance between the two.

More research is needed on how backroom formats and management practices impact the upstream supply chain. Also, the retail industry needs to explore new, innovative backroom configurations, such as the concept of multiple stores sharing a hub backroom space.

This post is based on the article of the same title published by Supply Chain Quarterly. Read the full article here. 

The article was written by Lita Das, Research Assistant and Ph.D. candidate, MIT CTL, and Dr. Chris Caplice, Executive Director MIT CTL. For more information on this ongoing research contact Lita Das at: litadas@mit.edu

 

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