In retail inventory management, the concept of a Sales Threshold plays a crucial role in determining how stock is allocated to stores based on the desired Service Level. This article explains what the Sales Threshold is, how it works in practice, and provides best practices for its application to maximize stock efficiency and prevent overstock situations.
Sales Threshold, what is it?
The Sales Threshold is a parameter that helps regulate the amount of stock sent to stores based on the target service level defined within your business. Any value between 1% and 99% can be configured and, essentially, it is translated into the formula:
Sales Threshold = 1 - Desired Service Level
Service Level, on the other hand, refers to the proportion of demand that can be satisfied from existing stock. For example, an 80% service level target means aiming at not ending with a stockout 80% of the time. In order to obtain a 80% service level, the sales threshold for a product should be set at 20%.
Therefore, the lower the sales threshold, the higher the service level, meaning more stock is allocated to ensure that customer demand is met, resulting in fewer missed sales due to stockouts.
Best Practices for Using the Sales Threshold parameter
1) Leverage the Sales Threshold for Warehouse Scarcity:
- During periods of warehouse scarcity, this parameter can help optimize limited stock by allocating it where it is needed most.
By increasing the sales threshold, those stores where each product is performing best will be prioritized - automatically preventing units from being hoarded in underperforming locations and maximizing this way full price sales.
2) Balance Service Level and Inventory Costs:
- Setting the sales threshold too low (targeting a very high service level) can lead to excessive overstock, which ties up capital and leads to markdowns and higher holding costs.
- On the other hand, a higher threshold (targeting a lower service level) could lead to stockouts and missed sales.
Having a good strategy defined that strikes a balance is crucial. Therefore, investing some time at the beginning of each season defining what your Threshold strategy will look like is highly recommended. If you are interested in this topic, continue reading the next section “How to build a Service Level Matrix”, where we share some tips and best practices on nailing the usage of the Sales Threshold.
How to build a Service Level Matrix
1º) Segment products thoughtfully: Not all products should be treated equally. Differentiate products based on aspects like:
- Their role in your assortment: core, seasonal, promotional, luxury… and use that segmentation to set different service levels.
- Their margin:
- For high margin products, where each sale contributes significantly to profitability, retailers can afford to maintain a higher service level (90-95%). This ensures you don't miss out on sales opportunities for more profitable products.
- For lower margin products instead, you may aim for a moderate service level (75-90%) to balance stock investment and risk. Overstocking these items ties up more capital without a significant profit return.
- Their Warehouse stock situation:
- When warehouse stock is limited, prioritize high-performing stores by increasing the sales threshold.
- If stock levels are high in the warehouse, you can afford to maintain higher service levels across the network through lower thresholds.
2º) Monitor and refine: Allow for flexibility in your service level settings as the season progresses. A dynamic strategy that allows you to refine your matrix in response to shifts in consumer behavior, product performance and inventory levels is more effective than a static one.
3º) Collaborate across departments: Align service level goals with both merchandising and buying teams, ensuring that demand forecasts, sales goals, and purchasing plans are integrated into service level decisions.
Example of what a Service Level Matrix could look like
