Macy’s and Nordstrom Ditch Retail Inventory Method

December 23, 2024

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In December 2024, two of the biggest department stores in the United States, Macy’s and Nordstrom, had to abandon the old Retail Inventory Method (RIM) they had been following for so long. Experts are witnessing significant changes in the industry as the two largest department store chains adopt a new approach called “cost accounting.” Dive deeper into the reasons behind their choice and explore why other successful brands are altering their policies and what it means for the future of commerce.

How RIM Streamlines Inventory Valuation, but with Limitations

The Retail Inventory Method was developed by Malcolm McNair, a retailing expert, in the 1920s to help his colleagues quickly estimate the value of their stock. Before computers and bar codes, vendors needed an efficient way to calculate stock value. RIM was based on the cost-to-retail ratio, which made it faster for large department stores to get approximations without counting every item.

RIM is especially beneficial for firms with stable fees and large quantities of products. It allows for quick calculations for tax purposes and is suitable for annual and interim reports as it does not require detailed record-keeping of purchase expenditures. However, since it relies on averages, it may need to be more accurate if costs fluctuate frequently. This makes RIM less suitable for trades with a complex stock of many items with varying values. 

For example, suppose a business owner has stock worth $50,000 and is selling it for $125,000, with a 40% cost-to-sales ratio. In that case, they can determine their cost of goods sold (COGS) = beginning inventory + purchases during the period—ending inventory without needing to count items. Managing it becomes more effortless.

Additionally, RIM is straightforward to use. It becomes more accurate when pricing remains consistent or when a shopkeeper offers a diverse range of products. Procedures like FIFO are suitable in the book value form to keep track of stock more efficiently.

However, the old-school method has faced criticism as technology has improved due to its inaccurate results. It relies on markups, markdowns, promotions, and changing prices. The agility can result in better decisions, incorrect pricing, and stock mismanagement, causing vendors to hold wares at the correct fees.

RIM’s Disconnect: When Fast Calculations Lead to Costly Mistakes

Recently, RIM has become helpful due to advanced data systems and real-time inventory management technology. Paula Rosenblum from RSR Research, co-author of a related study on The Rising Importance Of Sentiment Analysis For Demand Forecasting, says: “This is one of the reasons why merchants want to keep RIM; it allows them to engage in complex strategies.” While this flexibility is helpful, it has serious downsides, like inaccurate financial statements and misguided tactics.

Using retail prices for demand estimates is problematic, especially in fashion retail, where demand often changes due to frequent discounts. For example, when stores offer markdowns, RIM can lower the perceived value of goods, leading to unnecessary restocking. The bottom line is that it could result in more sales than actual demand and sometimes push deeply discounted products to boost revenue.

Additionally, RIM must provide detailed information on subcategories, making it hard for companies to track inventory losses from theft, damage, or administrative errors. As a result, these organizations struggle to identify the source of missing stock, which affects their ability to prevent losses.

From POS to Profits with Cost Accounting in Retail Strategy

Retail experts, like Oliver Chen from TD Cowen, have suggested that the firm use cost accounting methods to reduce the risk of fraud. Unlike traditional commodities management, this type of bookkeeping focuses on the actual value of goods instead of what they sell them for. The exact price tag stays constant despite market fluctuations, leading to more accurate payoff figures based on actual fees.

Chen explains that calculation should have started when stores began using point-of-sale (POS) systems that track stock-keeping units (SKUs). Now, stores can track products in real-time, providing them with better reports. By switching to a new system, retailers no longer need to estimate inventory based on unreliable rates; they can rely on the constant charge they pay for goods.

Additionally, this transition provides better insight into profit margins. Merchants get essential information about how prosperous a specific product is, allowing them to adjust pricing more efficiently according to market demands.

Macy’s CFO, Adrian Mitchell, is very interested in this evolution. Earlier this year, he said, “With these changes, we will be able to buy it, sell it, and make better decisions about inventory.”

Cathy Smith, Nordstrom’s CFO, explained that the organization adopted the expense method to build a solid foundation while focusing on its business strategies. Analyzing expenditures allows both companies to understand profitability by item better and make improved findings.

Restriction, Effectiveness, and Problem of Operation

However, moving from RIM to cost accounting is challenging on many levels. The shift thoroughly revises the established culture in reckoning systems, including inventory management and purchasing processes. As a result, owners may face short-term losses. For example, Macy’s noted that this change would affect its inactive merchandise and gross margin rates for 2024, but they accepted these downsides for the long-term benefits.

Despite the challenges, switching to outlay bookkeeping can significantly improve service delivery and provide more accurate financial data. Vendors will better understand their profit margins, manage product distribution more effectively, and make better judgments about pricing and discounts.

Beyond RIM as Retail Giants Rewrite the Rules

Thirty of the 100 largest companies on the National Retail Federation’s list use RIM. About a quarter of these companies use it exclusively, while others use it along with RIM for mergers or acquisitions. However, many firms use cash discounts less often because they recognize the downsides.

Macy’s and Nordstrom are making a big splash with the news, and others follow their lead. This is not just a one-time event. These waves of change are essential for any business that wants to keep up with modern standards, especially in sales and the automotive industry.

Retailers should take the plunge as soon as possible and apply new technologies to ensure their inventory management can keep up with market requirements and competition. While this may be challenging initially, any corporation that wants to succeed in the future must adopt these strategies to stay afloat.

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