#5 Sell-Through Rate & Inventory Turns

iStock_000011959646SmallSell-through rate is typically calculated in one way — number of units sold in a period divided by the number of items at the beginning of the period — but has different uses and implications in different types of businesses.

In marketplace businesses, sell-through rate can also go by “close rate”, “conversion rate”, and “success rate”. Regardless of what it’s called, sell-through rate is one of the single most important metrics in a marketplace business. As investors, we like to see a relatively high rate so that suppliers are seeing good returns on the effort they put into posting listings on the marketplace. We also like to see this ratio improving over time, particularly in the early stages of marketplace development (as it often indicates developing network effects).

In businesses that buy any kind of inventory — retailers, wholesalers, manufacturers — the sell-through rate is a key operating metric for managing inventory on a weekly or daily basis. It can reveal how well you matched supply of your product to demand for it, on a product-by-product basis.

For many investors, however, inventory turns is a more useful metric than sell-through rate in inventory-based businesses, because it:

— Talks to the capital efficiency of the business, where more turns are better

— Provides clues as to the quality of the inventory, where slowing inventory turns over time can signal slowing demand as well as potential inventory impairments (which can lead to mark-downs or write-offs)

Inventory turns typically are calculated by dividing the cost of goods sold for a period against the average inventory for that period. The most typical period used is annual.

There are two different ways to improve inventory turns — (1) By increasing sales velocity on the same amount of inventory; (2) By decreasing the inventory needed to generate a given amount of sales. While both are fine, one caution on the latter: Managing inventory too closely can potentially impact sales negatively by not having enough stock to fulfill consumer demand.

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