A Step-By-Step Guide to Open to Buy in Retail Merchandising

Open to Buy (OTB) is an essential retail merchandising budgeting technique used by retailers to plan, track, and analyze purchasing levels for upcoming seasons. It determines the optimum dollar value of inventory available for purchase based on sales forecasts, stock levels, and other key inputs.

OTB helps retailers avoid overbuying and underbuying. It brings discipline to purchasing and keeps inventory balanced to expected consumer demand. OTB is typically calculated at the department or category level for seasonal planning horizons.

In this step by step guide, we will cover:

• The key goals and benefits of Open to Buy
• Detailed step-by-step calculations with examples
• Incorporating OTB into seasonal retail planning cycles
• Best practices for implementing OTB
• Leveraging AI-powered retail merchandise software

Goals and Benefits of Open to Buy

What are the strategic goals and benefits that a well-executed Open to Buy process aims to deliver for retailers?

• Match inventory to forecasted sales demand – The core objective is ensuring enough inventory to achieve sales plans, without overbuying. This reduces risk of forced markdowns due to excess unsold merchandise.
  
• Improve full-price sell-through – Careful OTB management minimizes discounting needs by keeping most inventory aligned to sales trends. This allows more full-price selling at optimal margins.
  
• Reduce aged merchandise – With tight OTB controls, less inventory carries over unsold between seasons, allowing faster responsiveness to new trends.
  
• Decrease retail markdowns – Markdowns directly erode profit margins but are required to clear unsold goods. Good OTB helps minimize their use through better inventory management.
  
• Limit stockouts and lost sales – Though the goal is to curb overstocks, OTB also provides enough budget to prevent losing sales due to stockouts.
  
• Free up working capital – Lower unsold inventory means less cash tied up in warehouses and stockrooms, improving retailers’ working capital position.
  
• Better supply chain relations – Smoother OTB merchandise ordering reduces supply chain volatility from erratic changes in purchase volumes.

Now let’s walk through the detailed step-by-step OTB calculations…

OTB Step 1: Forecast Total Retail Sales

The first critical step in the OTB planning process is developing a forecast of total retail sales for the upcoming season. This top-down dollar sales forecast serves as the starting point for all other OTB inputs to align against.

Several factors go into building an accurate sales forecast:

• Historical sales data and trends – Statistical analysis of seasonal sales history provides an important baseline for future projections. Growth, declines, cyclical trends over prior years are examined.
  
• Planned promotional events – Major promotional events like holidays, annual sales, or product launches that are planned for the season must be incorporated into the sales forecast. These are adjusted from historical averages based on planned strategy.
  
• New product introductions – Sales lift expected from new products or product line expansions scheduled for the season are added to the forecast.
  
• Competitive intelligence – Competitor analysis helps estimate increases or declines versus historical trends when factoring what competing retailers might do that season.
  
• Macroeconomic conditions – Current economic, political, or market conditions that could impact consumer spending are considered.
  
• Cannibalization impacts – Introduction of new products or brands that may displace a retailer’s existing product sales are factored in.

Let’s walk through an example sales forecast for a retailer’s swimwear department for the upcoming summer season:

• Prior year sales for swimwear department = $1.75 million
• Post-season analysis shows sales grew approx. 2% annually past 3 years
• Three new product lines launching this season forecasted to provide a 4% sales lift = $70K
• Major new competitor opening stores expected to take 6% market share = -$105K loss
• Planned 20%-off promo event in July expected to drive 10% incremental sales = $175K lift
• No other macroeconomic or cannibalization impacts identified

Total forecasted sales for swimwear department:
$1.75 million prior year sales
+$70K for new products
-$105K loss in share to competitor
+$175K for planned promotion
= $1.89 million total sales forecast

OTB Step 2: Factor in Planned Markdowns

The next step is to remove any planned markdowns or permanent retails price reductions from the total sales forecast to yield an adjusted net sales forecast.

Markdown dollars represent inventory that must be sold below planned retail prices, subtracting directly from profit margins. A certain level of markdowns may be required to adjust retail prices over a season to keep inventory fresh for consumers.

To properly state the OTB, these expected markdown dollars must be deducted upfront in order to prevent overbuying. OTB will limit buying to support the planned net sales at original retail prices.

For our swimwear example:

• $1.89 million total sales forecast
• $125,000 budgeted for planned markdowns throughout season to keep inventory fresh and drive sell through
• $1.765 million net sales forecast after markdowns

OTB Step 3: Identify Current Inventory On-Hand

The next major OTB calculation is determining the current retail value of inventory on hand for the target merchandise category or department.

An accurate inventory count must be conducted and valued at planned retail pricing (not at cost of goods sold). Inventory that is unsellable due to damage or obsolescence must be excluded. Out of season merchandise being liquidated from the prior season should also be removed.

Accurately costing out all valid on-hand inventory provides the starting point for assessing how much more inventory can be purchased while balancing to the sales forecast.

For our example swimwear department:

• Total on-hand swimwear inventory valued at planned retail prices = $850,000

OTB Step 4: Factor In On-Order Merchandise

The next deduction accounts for merchandise already on-order for the upcoming season based on past purchasing decisions or commitments.

Any merchandise currently in-transit or planned delivery to the retailer up to the start of the OTB planning period must be valued at retail and deducted. This provides a clear picture of the true open purchasing capacity vs. what is already obligated.

For our swimwear example:

• $1.25 million prior unreceived orders at retail.

OTB Step 5: Calculate Open to Buy

Now we calculate OTB by taking the net sales forecast for the target period and subtracting current on-hand inventory, planned markdowns, and on-order arrivals.

OTB Formula:
Open to Buy = Net Sales Forecast – (On-Hand Inventory + Planned Markdowns + On-Order)

For our example swimwear OTB:
OTB = $1.765M Net Sales Forecast – ($850K On-Hand Inventory + $125K Planned Markdowns + $1.25M On-Order)
= $1.765M – $2.225M
= -$460,000

This large negative OTB indicates that current on-hand inventory plus merchandise already on-order exceeds the net sales forecast for the season. This signals that purchasing has already overbought vs. the forecast and no further buying is recommended.

OTB Step 6: Compare OTB to Merchandising Budget

The next step is comparing the calculated Open to Buy against the retailer’s merchandise buying budget allocated for the season.

Ideally the OTB will align closely to the planned budget. Shortfalls must be identified and addressed by adjusting sales forecasts or reallocating budget. Excess OTB should prompt reforecasting or consideration of higher purchase volumes.

In our example, the large negative OTB points to a major overbuy against budget that requires revised plans.

OTB Step 7: Translate into Units to Purchase

For retail buyers to action the OTB directive, the OTB dollar amount must be converted into estimated units to purchase. Units give clear direction on quantities to buy.

Unit OTB is calculated using the planned cost of goods sold and required gross margin for the category. For example:

• OTB dollars authorized for purchase: $250,000
• Retail margin goal: 50%
• Planned retail price for swimsuits: $50
• Cost of goods sold per unit: $25 ($50 retail x 50% margin target)
• Units to buy = $250,000 OTB / $25 planned COGS per unit
  = 10,000 units authorized to buy

OTB Step 8: Adjust to Shelf Capacity

Another key step in implementing OTB is comparing planned units to actual shelf and display capacity.

Unit OTBs must be adjusted downward if the quantities exceed available selling space based on store merchandising layouts and planograms. Available shelf space ultimately limits maximum purchasing.

This ensures OTB aligns to retail floor realities so unsold stock does not overflow to backrooms, squeezing margins.

OTB Step 9: Issue OTB to Buyers

The authorized OTB dollar or unit amounts per category are now issued to retail buyers as their purchasing budget for the season.

Providing buyers this clear OTB directive is crucial for guiding and controlling purchasing to approved levels that align with sales forecasts.

Buyers must be given reporting templates for tracking purchases against OTB to ensure compliance. Buyers would be requested to provide justification for any overages versus their authorized OTB.

OTB Step 10: Continuous Monitoring & Adjustments

The last critical step in OTB management is continuous monitoring of sales and inventory levels as the season progresses to adjust OTB up or down accordingly.

If sales significantly exceed forecasts, OTB should be increased quickly to avoid lost sales from stockouts. If sales lag plans, OTB must be reduced to prevent overstocks.

Making small, frequent OTB adjustments is preferred over large shifts late in the season that create volatility. Agile OTB management requires analysis of weekly reporting on sales, weeks of supply on hand, and inventory retail value vs. plans.

Now let’s discuss how OTB integrates into overall retail seasonal planning and buying processes…

Incorporating OTB into Retail Seasonal Planning Cycles

While the math of calculating OTB may seem straightforward, effectively integrating OTB into overall retail planning cycles takes skill and cross-functional coordination.

Here is an overview of key activities in the seasonal retail planning timeline and how OTB budgeting fits in:

1. Set high-level sales forecasts and merchandising strategy – Executive leadership develops the seasonal sales forecasts, merchandising themes, and product strategies that set the direction for OTB planning.
   
2. Create assortment plans – Merchandising and buying teams work with designers to conceptualize product assortments by department or category that align to strategies. Initial pricing is set.
   
3. Build sales forecasts by category – The high-level total sales forecast is now broken down into category-level forecasting based on planned assortments, trends, promotions, and inventory strategies.
   
4. Finalize markdown plans – Planned markdowns and promotions are confirmed by category/department to deduct from sales forecasts establishing net figures for OTB.
   
5. Calculate OTB by category – OTB dollar amount authorized for ordering is determined for each category based on steps outlined earlier.
   
6. Issue OTB to buyers – Buyers are provided their authorized OTB to guide purchasing along with templates for tracking orders against OTB.
   
7. Convert OTB to units – Buyers translate OTB into concrete unit quantities to order and begin sourcing from vendors.
   
8. Refine with shelf limits – Unit OTB’s are adjusted based on confirmed store merchandising plans and shelf limits.
   
9. Place initial purchase orders – Buyers begin releasing planned purchase orders to commence sourcing and production.
   
10. Adjust OTB throughout season – OTB is continuously monitored versus sales and adjusted up or down accordingly to balance inventory in-season.

This demonstrates how OTB is woven into the broader sales forecasting, merchandise planning, and buying rhythms annually for each retail season. When executed seamlessly, OTB provides the crucial link between high-level planning and actual purchasing.

Best Practices for Effective Open to Buy Execution

What are some proven strategies and tips for ensuring an Open to Buy process delivers strong results for retailers vs. becoming just a budgeting exercise on paper?

• Gain executive support – Having clear endorsement from company leadership ensures proper adherence to OTB by all. Present OTB as a competitive advantage.
  
• Invest in accurate reporting – Timely sales reporting, inventory tracking, and order status visibility are essential for making good OTB decisions. Automated data feeds are ideal. AI merchandise planning software with Open to Buy capabilities like OmniThink.AI can be a big help here.
  
• Train planners and buyers – Educate teams on OTB objectives, calculations, monitoring techniques so they have skills to execute the process right.
  
• Start OTB early – Introduce OTB in the planning process as early as possible, at least 4-6 months before season start, to allow enough lead time for purchasing.
  
• Link to planograms – Incorporate store planogram finalization into OTB steps to determine shelf limits before buying.
  
• Apply OTB rigorously – Consistently enforce OTB compliance rather than allowing frequent overrides. Require buyers to obtain approvals for any overages.
  
• Automate where possible – Seek to automate OTB calculations using retail software. This reduces errors from manual work and provides real-time OTB visibility.
  
• Review exceptions weekly – Have planners and buyers review every OTB overage weekly to identify root causes and adjust plans quickly as needed.
  
• Do post-season OTB analysis – After each season, analyze OTB performance by category for opportunities to improve forecasting and purchasing compliance.

Now let’s explore how AI-enabled retail merchandise planning systems are transforming OTB agility and precision…

AI-Powered Retail Merchandising to Revolutionize OTB

Sophisticated retail merchandising software solutions are now leveraging artificial intelligence (AI) and advanced analytics to take OTB planning to new levels of speed, automation, and forecast accuracy.

Here are some key ways AI is impacting Open to Buy:

• Automated OTB calculation – AI systems can fully automate complex OTB math, freeing planners from tedious manual work while providing real-time OTB visibility.
  
• Rapid scenario modeling – Planners can quickly generate, compare, and adjust endless OTB scenarios to optimize plans vs. slow manual methods.
  
• Hyper-accurate forecasting – AI algorithms ingest billions of historical data points and detect subtle demand patterns that vastly improve sales forecasting precision – the very foundation of OTB.
  
• Market-aware OTB – AI systems incorporate external market signals like social media trends, weather, competitive moves into continuously updated forecasts that refine OTB.
  
• Autonomous OTB updates – As sales unfold, AI retail platforms autonomously raise or lower OTB budgets by item in near real-time vs. periodic manual adjustments.
  
• OTB compliance tracking – Ongoing OTB performance analytics highlights overages or underperformance for specific buyers for coaching and accountability.
  
• Shelf/space-aware OTB – Computer vision algorithms factor in real store conditions and planogram compliance to tailor OTB to true shelf limits.

The collective impact is revolutionary for enabling retailers to execute OTB with a level of speed, precision, and automation never before possible. AI becomes a retailer’s digital assistant amplifying planners’ capabilities.

The Bottom Line on OTB

When leveraged effectively as part of an integrated retail planning cycle, Open to Buy budgeting provides retailers with tremendous control over their purchasing and inventory investment.

Careful OTB management and continuous monitoring keeps inventory balanced to consumer demand through the season. The result is improved sales at planned prices, minimized markdowns, and more agile response to trends.

But only with the rapid automation and forecasting capabilities of AI can retailers realize the full benefits of OTB in today’s fast-changing retail environment. AI-powered retail merchandising solutions enable a new level of data-driven OTB planning excellence.