Felipe Caro interview around omnichannel trends

Game changers in retail Felipe Caro Image

In this Game-changers in Retail series, we had the pleasure of sitting with Felipe Caro, Professor of Decisions, Operations, and Technology Management. Felipe Caro leads UCLA Anderson's new MS in business analytics (MSBA). His well-documented collaboration with Zara spans almost a decade. In particular, the mathematical model Felipe Caro developed to support the decisions fast-fashion retailers face each clearance period resulted in increased revenues of 3-4 percent for Zara. He has won multiple awards and contributed significantly to the international academic literature on supply chain management.

In this interview, we caught up with Felipe Caro to discuss the importance of planning in fashion retail, the emergent trends in 2022, and how inventory optimization is pivotal to retailers’ success in the omnichannel space. He shared with us what he’s seeing in fashion retailing and what’s helping retailers become more effective and successful.

Retailers are going through an omnichannel transformation. How do you see the changing retail dynamics?

Many omnichannel trends were already present in the retail world, but COVID-19 has supercharged the pace of the transformation. The pandemic has changed how consumers interact with retailers, accelerating and intensifying the shift to digital.

As a result, consumers started shopping in new ways that they might not have done two years ago. People are used to and comfortable using different channels. This confirms that Omnichannel is here to stay.

Secondly, we’ll also see more business models in the retail industry. Retailers will evolve their business models and operations to meet the different needs and address niche markets or supply chain challenges in omnichannel retailing. Some of these retailers will become successful players, and some will not even be big, but they’ll still be able to satisfy a niche market.

What are the fundamentals of any retailer’s success in an omnichannel era?

To answer this question, retailers need to go back to the basics of knowing who they are. In today’s retail world, each retailer still needs to make a positioning choice, including where they’ll be in. This is all about strategy, and many retailers realize it is very challenging to get omnichannel retailing right.

Retailers have three different options

First, retailers need to decide whether to offer an omnichannel service. Some will choose to become omnichannel, but others might avoid having an omnichannel presence. This means some will choose traditional brick-and-mortar retailing, and some will be pure online businesses. Retailers can still have a successful business model by staying in the physical space or being pure online.

Option 1: Stay traditional

Sticking to the traditional retail strategy takes courage, but Primark is a good example of a company that has chosen to be mostly brick-and-mortar. They buy in large quantities in advance, offer their products at low prices, and do well.

Option 2: Become pure online

On the other hand, there are pure online retailers such as Amazon. We all know that Amazon won during the pandemic mainly because the company has been exploiting all its logistics capabilities and gained market share by ensuring its products arrived at customers' doorsteps quickly.

Option 3: Go omnichannel

Some retailers are in the middle. They have to make the omnichannel promise work, and that’s when they start thinking about how to do it successfully. Customers search for and receive products wherever they want, but delivering this promise is a huge challenge.

Retailers need to find a meaningful positioning for their customers, and then, of course, they should be able to deliver it. The ones that get omnichannel right, leveraging the combination of stores and online presence, will become the big players in the future.

What are the most significant inventory optimization challenges or opportunities in omnichannel retail?

Challenge 1: Assortment decisions

Some inventory optimization challenges have always been there and become more complex in omnichannel.

For example, I can make the right assortment decisions. Consumers expect more variety today, and assortment has always been challenging for retailers, but now online removes all the space constraints. Retailers can’t fit too many products in physical stores, whereas online stores have no limitations. They can carry as many items as they want -at least theoretically. Then the questions for retailers become: “Do you want to carry as many items as you want?” and “Which ones do you carry, or do you offer?” This is a classic assortment problem, but it's significantly more challenging to solve today.

Challenge 2: Forecasting and fulfillment

There is also a forecasting and fulfillment challenge. For omnichannel retailers, demand forecasting and fulfillment are connected. When retailers are forecasting, they need to consider both in-store and online shopping demand.

This adds a layer of complexity to demand forecasting. Once retailers make their forecast and commit some inventory to the stores, the next question becomes, “Do you keep this inventory in the stores for a customer that comes to the store to buy that item, or do you use it to fulfill an online sale?”

We wouldn’t have discussed these issues 10 or 20 years ago, yet they are challenges that arise with omnichannel retailing.

How important is it to have accurate, granular-level demand forecasting?

Demand forecasting will always be the holy grail of retailing. It is what drives everything in retail, and it will continue to be extremely important. It is almost impossible to get forecasting right. Therefore, what matters is to keep records of the past to fix future mistakes and even turn them into opportunities. Let me give you an example. Let’s say a retailer made incorrect forecasting and had excess inventory. Could they use that excess inventory to fulfill the online demand? Again, forecasting and fulfillment are two challenges that go hand in hand in omnichannel retailing.

Felipe Game Changer Inside

What are your thoughts on forecasting the demand for the new items in the new season?

Fashion retailers do not have a magic formula for ensuring that forecasts for an item introduced to the market a year from now are accurate. However, they can improve their forecasts by incorporating new information when it becomes available or using machine learning (ML) and advanced regression models.

Once retailers accept that they can’t get forecasting 100% correct, they can consider what else they can do.

Not risking too much.

I have been collaborating with Zara for many years and am obviously biased by how the company operates and approaches these problems.

Of course, Zara thinks forecasting is essential, and since our collaboration began, they have invested more in prescriptive and predictive analytics. But even so, Zara knows that forecasting will never be absolutely correct, especially regarding fashion items.

So they don’t risk too much on any fashion item. When it comes to buying decisions, they usually buy more or less the same quantity. They make many small bets.

Keeping assortment fresh

And for these fashion items, they play the game of rotating the assortment. Those items that do well stock out quickly. The items that don’t do well are removed from display, and another product is introduced.

There will always be hits and misses, but even the misses shouldn’t stay in the store for too long. Zara keeps the assortment fresh, which incentivizes people to always come to the stores and creates continuous traffic. They also use their knowledge to make more informed product decisions in the next season.

Keeping lead times short

Another successful strategy Zara uses is keeping its lead times short. The shorter the horizon, the more accurate the forecast. When the pandemic hit, demand slowed down initially. Zara was able to reduce the amount of inventory immediately. Then, stores were closed to foot traffic, people started to shop online, and demand increased again. At that time, Zara used the stores for online fulfillment.

This is an excellent example of flexibility and agility. Zara uses its short supply chain to adjust inventory levels based on whether demand is going down or up. When the demand for fashion items goes down, they buy less. When demand picks up again, they buy more. Since their customers mostly shop online, they use the stores to do online fulfillment and get their products to their customers quickly.

What are the top 3 key elements or must-haves in successful inventory optimization today?

Allocation and replenishment

Successful allocation and replenishment are the number one must-haves for successful inventory management. There is no excuse for getting that wrong these days. Sophisticated ML-based advanced analytics solutions are available for retailers today.

Initial allocation

The second key element to success is the initial shipment, which is harder.

However, it can still be done successfully with advanced tools available today.

Buying decisions

The third is deciding how much to buy—this is the most challenging. Ideally, once retailers get the initial allocation and replenishment right, they can make pretty informed decisions about how much to buy.

How important is it to have a clear markdown and price optimization strategy in today’s retail world?

First, the focus should be on making the right inventory decisions. If retailers solve the three inventory management challenges I’ve mentioned (initial allocation, replenishment, and buying), they will rely less on markdowns. They will buy the correct quantity and then allocate and replenish it as efficiently as possible.

Getting these three inventory decisions right makes markdowns less critical, which is already good. But there will always be leftovers, especially with fashion items. When I think of markdowns, I think of clearance. Clearance sales are a well-understood revenue management problem. Leveraging that is another must for retailers. They should use established models and leverage analytics to the fullest.

What do you think will be the key trends shaping the retail industry in the coming years?

I see two key trends.

First, there will be more competition from different business models. Today, pure online retailers such as Shein are taking the fast-fashion business model to an extreme. They introduce many new products daily and renew their assortments daily. They produce the products in small quantities. The products are affordable, and they ship anywhere in the world. Companies like Shein will challenge incumbent retailers such as Zara and H&M.

Companies that make dynamic decisions will adjust to these new competitors, but others might not. Shoppers will favor new specialty brands such as Dechatlon. More specialized stores will become more common, and some will grow. Eventually, the market will become more fragmented.

Second, there will be challenges regarding environmental and social responsibility. I hope this becomes very important to shoppers. The big brands will have to think and act on sustainability because they will be the first ones to receive any backlash about how responsible their supply chains are. Retailers should become more conscious of their impact on the planet.

Finally, what should be the top inventory planning strategies for retailers who want to become tomorrow's omnichannel retail champions?

Retailers leveraging the advantages of each channel and optimizing their portfolios can achieve success in the omnichannel space. I think of omnichannel as financial portfolios. The most successful portfolio is the one that allocates the right amount to the different assets that have various risks and returns. The same logic applies to omnichannel. Whoever finds the sweet spot, the right combination of online and physical presence will stay ahead. The retailers that optimize their portfolio, channels, and how they reach the consumer to provide the information and deliver the product will be tomorrow's winners and omnichannel retail champions. Learn more about how to improve your revenue by connecting with an expert in retail at invent.ai today.

Wendy Mackenzie

Head of Marketing

Game-changers in retail: Felipe Caro