GMROI and Turn & Earn
By Bob Boyles, Principal
Smarter Distribution

There are numerous measurements of how well a distributor’s inventory performs. Some of the most meaningful that I’ve found over the years are GMROI and Turn & Earn. These measurements take into account the turns and gross margin and by combining these two measurements present an overall return on the investment that a company is getting from its inventory.

One of the age-old arguments in the distribution world is between sales and purchasing. This rivalry outdoes any competition you’ll see on a Saturday afternoon on a football field. Sales is constantly complaining that there is not enough inventory and purchasing is equally adamant that the company has enough inventory and the real problem are those salesmen that won’t go out and sell what the company stocks. These measurements are some of the best tools distribution management has for refereeing this battle.

Both measurements combine the company’s inventory and the sales margin that the inventory is generating to display an overall return on investment.

GMROI - GMROI is short for Gross Margin Return on Investment and is defined as: Gross Margin / Average Inventory. Let’s examine the components to make sure you’re using the correct data.

Gross Margin – First, it’s gross margin on stock sales. That means excluding directs and non-stocks. Gross Margin of course is year-to-date stock sales minus year-to-date stock cost

Average Inventory – This is an annual number and should be the average inventory on-hand over the course of a year. All of the components of GMROI should be annual numbers and this number itself should be thought of as an annual number.

The GMROI number is expressed in relationship to the number one. Anything under 1 and that line did not pay for itself, anything with a GMROI over 1 and the line paid for itself. GMROI can also be calculated as:

YTD Gross Margin % * Annual Turns = GMROI

The components of this GMORI formula are:

Annual Turns - Turns are calculated by dividing the cost of material sold by the average inventory value. Since this is a measurement of inventory investment non-stock items should always be excluded.

YTD Margin % On Cost – This is margin on COST. You usually see margin expressed as a percentage on sales. Here we’re interested in the percentage on cost.

This GMROI number now represents the number of dollars that our investment returned for every 100 dollars

Example – Taking a look at several sample product lines we can see that the return we get off a product line is not only a function of the turns we get from a product line but also a product of the gross margin we receive from the products that make up that line.

Turn & Earn - One of the first concepts that supply chain companies use to manage their inventory is the concept of turn and earn. A basic definition is that the more an item turns (sells) the lower the return has to be to offset the cost of carrying that item on the shelf. I like to use the analogy of a grocery store since it’s something we are all familiar with. That can of beans cost $0.59 cents and the cost may be $0.50 so the grocer is only making $0.09 on a single can of beans. To buy that can of beans on put it on the shelf not to mention the shelf it’s sitting on and the clerks to check you out at the cash register cost a lot more then the $0.09 the grocer is going to earn on that single can of beans. But the grocer doesn’t just one can of beans per year (1 turn). From that same spot on the shelf he’ll sell that same can of beans 52 times or more. That spot on the shelf now generates 52*.09 or $4.68 per year in profit. That amount of profit can go a long ways towards paying for the store and the salaries of the staff to keep the store humming.

Turn & Earn is defined as: Turns x Gross Margin Percent

Let’s examine the components of T&E to make sure we’re using the correct data.

Gross Margin % – Gross Margin of course is year-to-date stock sales minus year-to-date stock cost divided by year-to-date stock cost. This is the gross margin percentage that this group of products returned.

Annual Turns - Turns are calculated by dividing the cost of material sold by the average inventory value. Since this is a measurement of inventory investment non-stock items should always be excluded.

T&E Factor – The T&E factor is usually expressed in terms of dollars. Any group of products with a T&E above 100 and that group of products paid for itself. Anything with a T&E under 100 and that inventory group returned less than what it cost to put the inventory on the shelf.

Examples -Taking a look at several sample product lines we can see that the return we get off a product line is not only a function of the turns we get from a product line but also a product of the gross margin we receive from the products that make up that line.

Using GMROI and Turn & Earn - The GMROI and T&E numbers can point out those areas of stock that aren’t carrying their own weight. Take the data table above as an example. Line B is the only line that is achieving the desired T&E factor. Line A & C are having problems. For those product lines where the margin cannot be raised then inventory will need to be reduced.

Example: If you’re approached by the company rep for product line A and he/she is trying to talk you into adding some new products that his company has just come out with the answer that he/she is going to get is now very obvious.

Be careful to apply the GMROI and T&E measurements at the company, line or branch level and not at the product level. Then these types of measurements get too granular they can be misleading. There are number of factors that must be taken into account when making decisions at the product item level that are not reflected in the calculations.

The low GMROIs are obvious problems but are there GMROIs that is too high? This is like asking “Is it possible to make to much money?” The surprising answer is yes. If your GMROI gets above 200 you might not be stocking enough material and killing yourself with operating expenses. Also if your margins are too high they could be high enough to invite competition.

When ever you are looking at figures like GMROI it also helps to have other pieces of data like service level and adjusted margin to get the complete picture.

Weaknesses – Using the GMROI as a tool to measure your business is positive step in the scientific management of assets. However there are some areas that GMROI does not address.

1. Does not include the various carrying cost of various types of inventory.
2. Does not include the various handling cost of various types of inventory.
3. Does not include various dating and incentives from manufactures that may lower the cost and increase the return of a product line.
4. Does not consider the growth rate of and future profitability of a product line.

About Bob Boyles and Smarter Distribution:

Bob Boyles started his strategic consulting business in 2001 and has focused on the change that technology is forcing in the supply chain and how independent distributors can not only respond to that change but also maximize the return they are seeing on their investment. Bob has spent a significant amount of time as an Installation Consultant for several of the big name software companies in the distribution market. Working with hundreds of distributors across the country on installing, upgrading and utilizing their software. Bob also worked as Corporate Systems Manager for one of the largest electrical wholesalers in the country as that company moved from a completely manual operation to an on-line real-time system.

Bob is a graduate of Appalachian State University (BS - 1981) and University of North Carolina at Greensboro Graduate School of Business (MBA - 1985).

© Copyright 2002, Robert S Boyles, Jr. All rights reserved. This article cannot be reprinted or reproduced in whole or in part, without the express written permission of Robert S Boyles, Jr.