Monday, September 17, 2012

Removing the fixed average margin % goal at IKEA .

A rough outline for a planning system for IKEA.

Removing the average gross margin % (percentage) goal from retail planning, execution and evaluation.

The normal method for store planning is, take the sales and gross margin percentages from last year and set goals for next year.

Past results old method

For example year 1 results: Sales € 100 000 000,- , Markup percentage 40 % , Markdowns 2% -> Average gross margin percentage = 38% . Gross margin in euros is 38% of € 100 000 000 equals € 38 000 000,-
Operating expenses (SGA costs) are € 35 000 000,- = 35%
Planning for future old method

In year 2 the company decides to lower prices to increase market share. Markup percentage is 39% instead of 40% , markdowns remain 2% , average gross margin percentage is projected to be 39% - 2% = 37% , to achieve the same gross margin in euros € 38 000 000,- , sales have to be € 38 000 000,- / 37% = € 102 702 703,- .

Management then estimates whether this is realistic based on previous experience with price elasticity of demand in the market.

Much attention is then spent during the year to make sure the average gross margin percentage doesn't fall below the new target.

Below I describe a new planning method for IKEA without an average gross margin percentage target.

Past results new method

Sales were € 100 000 000,- if articles had sold at original prices then the margin would have been € 40 000 000,- but a total of € 2 000 000,- was marked down. The total gross margin was € 38 000 000,-.

Planning for the future new method

In the new method there is no binding top down percentage target for gross margin.

The goal is to increase the total gross margin amount in euros. A final gross profit percentage can be used as rough indication, but shouldn't be tied to management evaluation or compensation.

The gross margin in euros an article produces is the selling price minus the buying price times the number of units sold. In other words: volume x margin.

IKEA has around 10 000 different articles or SKU's (stock keeping units).
These are spread over 10 business areas. That means 1 000 articles per business area.
The vast majority of gross margin and sales derive from less than 200 articles per business area.

Sales managers need to look at their assortment and plan which prices and sales they expect per article next year and this will result in a forecast of sales, margins in euros and the total number of units to sell.

The total gross margin, the sum of the margins of all 10 000 SKU's for the new year needs to be more then € 38 000 000,- (last year's result).

Country management might set upper or lower limits on the volume of articles to be sold (for example due to capacity restraints in the distribution centers).

To maximize profit, daily sales steering (merchandising) should never be based on gross margin percentages, but on gross margin in euros. Many of the most profitable articles have lower than average gross margin percentages.

Markdowns could be limited to an absolute amount in this case for example € 2 000 000,-

Finally, please note:

If an article marked up at 30% sells much better than planned (even when average costs were planned to be 35% of sales), that only increases bottom line profit.

That works as follows, total sales increase as does gross margin in euros. The gross profit percentage will dip slightly, but so will the operating expenses expressed as a percentage of sales. For example from 37% to 36% and from 35% to 34% respectively.


I would be interested in any feedback people have about this idea.

E-mail: ajbrenninkmeijer (a)


Mickel Reemer said...

This idea leaves room for flexibility, which I very much like. I am concerned over one part that I do not see covered in the article: stock holders.

All that stock holders seem to care about is % growth. The easiest way to do that, seems to be playing with % gross margin. Educating stock holders seems to be in order.

Ansgar John said...

Thanks Mickel, A good point. At IKEA that would be the charitable Ingka Foundation which owns IKEA and in which INGvar KAmprad is very important. See his view: "What the hell are percentages ?" below.

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