CATEGORY ASSORTMENTS, STOCK LEVELS, AND MARGINS: A
PARTIAL REPLICATION AND EXTENSION OF A RETAIL MODEL INTO
A WHOLESALE CONTEXT
Jack Cadeaux and Larry Lee
University of New South Wales
Track: Distribution and Logistics Issues in Marketing
Abstract
This is a study of cross-category effects of assortment variety on category
performance in a cash-and-carry wholesale operation. In a retailing context, Chiang
and Wilcox (1997) explored cross-category effects by examining 209 categories at a
US supermarket and examined the relationships between category shelf-space
allocation, variety, and retail margins. This study of 146 categories at an Australian
cash and carry wholesaler partially replicates and extends Chiang and Wilcox’s
analysis, by substituting stock level for space in adapting to the wholesale
environment. It finds support for a general positive effect of assortment on stock level
and on margin.
Development of Theory and Hypotheses
The decision on what to stock and how much to stock within a category is not
trivial and has uncertain and potentially complex effects on performance for retailers
and other merchants, such as wholesalers. There has been much research concerning
the relationship of retail assortment variety to shelf-space allocation. More recent
studies include those of Borin, Farris, and Freeland (1994); Borin and Farris (1995);
and Chiang and Wilcox (1997). Recent research in this area has started to move away
from a basic view of assortment variety as such and focused more on (1) the customer
decision process for assortments (Fader and Hardie 1996; Broniarczyk, Hoyer, and
McAlister 1998; McIntyre and Miller 1999; Koelemeijer and Oppewal 1999;
Simonson 1999; Lee and Steckel 1999), (2) the effect of assortments on the
competitive relationship across stores (Stassen, Mittelstaedt, and Mittelstaedt 1999;
Grewal et al. 1999), and (3) assortment effects across categories in relation to
performance (Chiang and Wilcox 1997; Cadeaux 1999). Cash-and-carry wholesaling
is in some respects similar to (bricks and mortar) retailing. Some differences include
the customers served and the minimal concern about in-store presentation of
merchandise. Retailers sell to the ultimate consumer, whereas the cash-and carry
wholesaler sells to retailers or other customers who use the products as ingredients or
components of a final product that is then sold to consumers. Demand facing a
wholesaler, derived from demand facing its customers, can be relatively volatile
making performance particularly sensitive to assortment and stocking decisions.
Chiang and Wilcox (1997) explored cross-category relationships between
assortment variety, shelf-space allocation, and margins. They found that variety is
negatively correlated with margin, and that there were lower relative margin
percentages in categories where brand loyalty was high. This study replicates their
study by also taking a cross-category focus on assortment variety and margin but
extends it to the wholesale situation by substituting stock level for shelf-space
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723
allocation and an indicator of manufacturer brand power for brand loyalty. We
assume that these two variables are more applicable to the wholesaling industry.
A simple definition of assortment is that it is the number of items in a
merchandise category (Levy and Weitz 1995). Manufacturers offer merchandisers a
set of product lines which consist of a number of SKUs. In cash-and-carry
wholesaling, the main SKUs are those such as flavours and package sizes. Yet the
merchandiser only chooses a subset of those SKUs offered, which they feel is the
optimal assortment demanded from customers. In general, the assortment of goods
that is optimal for a manufacturer to produce will most of the time not be the same as
what is optimal for a retailer to stock (Alderson, 1965; Cadeaux, 1992; Cadeaux,
1997).
Recent research has shown various and sometimes inconsistent effects of
assortment variety. At the manufacturer level, relatively wide assortments attract
relatively greater margins (Scherer 1979). This result can be explained both by the
relative brand differentiation effect of wide assortments and by their increased retail
level shelf space allocations and resulting higher brand shares, which, in turn
arguably have a positive effect on brand market power and margin (eg, Porter 1976).
However, it is not easy to extend such manufacturer brand level results into a retailing
context, let alone a wholesaling context. It has been suggested that assortment variety
can affect consumer utility and value (Cadeaux, 1992; Cadeaux, 1999). Boatwright
and Nunes (2001) examined the effect on sales of a reduction of assortment and find
that sales are affected by changes in the available number of SKUs, by the market
share of items that are eliminated, and by the number of brands eliminated. They
further find that decreasing the number of SKUs tended to increase category sales, yet
this effect decreased as more SKUs were deleted (Boatwright and Nunes 2001). Yet
that study was conducted on an online grocer, and thus the implications to the bricks
and mortar retail environment or cash and carry wholesale environment may be
questioned. Grewal et al. (1999) suggest that assortments are a way to attract and
retain customers, as well as to appeal to variety seekers. Bergen, Dutta and Shugan
(1996) argue that by increasing the number of SKUs within a category, there will be
an increase in shoppers who may face increased search costs. Thus, retailers of high
variety categories may provide higher levels of service (Bergen, Dutta and Shugan
1996). This differs from the argument of Cadeaux (1992), who claims that variety
reduces search costs. Chiang and Wilcox (1997) find that a greater category variety
has a positive effect on sales, but a negative effect on retail margin. Ryzin and
Mahajan (1999) show that a larger assortment has a positive impact on performance
when it is likely that customers will not purchase when the item that they want is not
available (ie, when SKU demand rigidity is high). Ryzin and Mahajan (1999) also
suggest that higher margins create incentives for retailers to stock a wider variety of
products. These differing results of Ryzin and Mahajan (1999) and Chiang and
Wilcox (1997) are possibly due to the fact that Chiang and Wilcox (1997) did not
factor the total number of SKUs into the total number of brands and the total number
of SKUs per brand. Further, Ryzin and Mahajan’s (1999) study implies that retailers
who offer greater assortments will expect greater margins, since they are providing a
service to customers who in return pay greater prices.
Assortment variety affects stock level. As the number of variants (SKUs)
within a category increases, category stock levels need to increase in order to gain
sufficient sales volume (Pessemier 1980). It can be easily assumed that a larger
assortment requires increased inventories because of the need to avoid stock-outs and
due to variability of sales (Pessemier, 1980). Hise et al. (1983) have shown that total
Distribution and Logistics Issues in Marketing Track
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storewide stock levels have a positive effect on total storewide sales across chain
branch stores. To replicate and extend Chiang and Wilcox (1997), we replace shelfspace with stock level, in order to make it more applicable to the wholesale cash-andcarry industry. Stock level may be more critical to wholesaling due to larger lot sizes
and more severe advance ordering requirements (Pessemier 1980).
In order to control for the effect of assortment variety on retailer margin,
Chiang and Wilcox (1997) employed a measure of category-level consumer brand
loyalty. They argued that in some categories consumers are relatively more brand
loyal than in others. Chiang and Wilcox (1997) find that retailers receive lower
margins in categories where consumers have relatively higher brand loyalties. This is
because items which have high brand loyalties are less risky for merchandisers to
stock. Thus, to the extent that margin can be seen as the reward gained from
merchandising risk, retailers gain lower margins. Yet, in the wholesale situation,
customers of cash-and-carry stores (e.g., retail store buyers) are not likely to exhibit
their own brand loyalties in an analogous manner to consumers, but rather purchase
on the basis of what they feel their own downstream customers require. Yet, there
may be a similar pattern of category-varying relative manufacturer brand power.
Thus, as a substitute factor that might influence margin in a wholesale situation, we
substitute a broader construct of category-level manufacturer brand power for
category-level brand loyalty.
Cadeaux (1999) has argued that retailers are more dependent on brands that
have relatively higher sales or category share levels. Further, Pessemier (1980) argues
that manufacturers have power to force margins down due to an items’ popularity and
its fast turnover. Thus, broadly speaking, brand loyalty is related to brand
differentiation and manufacturer brand power, all of which should be regarded in
relation to retailer economic power and retailer margin (Porter 1976). If we can
plausibly extend these ideas directly into the wholesaling context, we can conclude
that higher levels of manufacturer brand power tend to have a negative effect on
margin percentages. Figure 1 summarises the implications of theory and research
Merchandising Actions
Control Variable
Assortment
Variety
Category Performance
(Dependent Variable)
Manufacturer
Brand Power
Margin
Stock Level
discussed to this point:
Figure 1: Preliminary Framework based on Chiang and Wilcox (1997)
Chiang and Wilcox (1997) found that assortment variety had a negative effect
on category margins. Yet, as argued previously, increasing assortment variety should
have positive effects on customer retention and attraction (Grewal et al., 1999).
Arguably, merchandisers who offer greater variety will expect greater margins in
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725
return through charging higher prices (Cadeaux, 1992). We can visualise this as the
price customers pay for being provided with a larger assortment and for reducing
their search costs. Thus we hypothesise that:
H1: Greater category assortment variety will lead to higher category margins.
Customers pay a price for increased stock levels and the risk merchandisers,
who will expect an appropriate reward, take in the form of perishability of inventory
assets (Pessemier, 1980; Cadeaux, 1992). The relationship between stock levels and
margins can also be viewed as an indirect effect of assortment variety, since margin
expectations of assortment variety will have factored in increased stock level costs.
Thus we hypothesise that:
H2: Greater category stock levels will lead to higher category margins.
From the previous discussion of the stock level variable, assortment variety
will directly influence stock levels due to need to avoid stock outs (Pessemier, 1980),
although quick response systems may have helped lessen this effect in more recent
times. Thus,
levels.
H3: Greater category assortment variety will lead to higher category stock
Chiang and Wilcox (1997) took brand loyalty into account in their study in
order to control for margin effects and found it to have a negative relationship to
margin. We take a similar approach, but instead use manufacturer brand power as
discussed before. We believe that manufacturers who have higher brand power in
categories can effectively increase merchandise costs since merchandisers are limited
in their ability to raise prices proportionately. Thus, the merchandisers’ margins
associated with categories that contain high manufacturer brand power are
‘squeezed’. In order to control for these effects, we hypothesise that:
H4: Greater category-specific manufacturer brand power will lead to lower
category
margins.
Research Method and Measurement of Variables
To test the proposed model, we analysed one cash-and-carry wholesaler over
the period of one year (2002). We were allowed full access to sales reports over a
three month period, which reported sales at price for all SKUs, and the stock
valuation reports, which reported the total assortment variety and stock levels at cost
at one particular point in time. The sales report showed all sales for each SKU over
the months of May, June, and July. Four stock valuation reports were used in order to
be able to average out re-ordering and purchasing effects and gain a more accurate
and meaningful picture of merchandising decision making. The data consisted of 146
categories, which were pre-defined by the wholesaler. The total number of SKUs
stocked across the store was approximately 7700. Customers of the wholesaler
included convenience stores and food service outlets. The types of products stocked
Distribution and Logistics Issues in Marketing Track
726
included foods (frozen fish, confectionary, sauces, spices, etc.) as well as nonfood
convenience goods (stationery, insecticides, toiletries, etc.).
Assortment Variety
Assortment variety is defined as the principle merchandising decision, and is
measured by the average number of SKUs stocked in a given category. This is the
same variable as that of Chiang and Wilcox’s (1997). The average in this
measurement refers to the averaging of assortments over the four stock valuation
reports, in order to control for product volatility (item additions and deletions). The
preliminary analysis of one test stock valuation report showed at the outset that there
would be enough variance in category’s assortments to justify a category level of
analysis. This can be seen in Figure 2.
350
No. of SKUs
300
250
200
150
100
50
0
0
50
100
150
Number of Categories
Figure 2: Assortment across categories
Stock Level
Stock level is defined as the average amount of inventory dollars for a given
category. The average refers to averaging stock level dollars over the four stock
valuation reports in order to account for obvious sales and re-ordering of goods over
the period of analysis. Also, the dollar unit of analysis is taken since we want to
portray stock levels as the risk that merchandisers take for having a higher variety.
Margin
Chiang and Wilcox (1997) define margin as the average category retail margin
expressed as a percentage of price. This is basically a standard measure for margin,
and our study uses the same measure. Thus margin is equal to average category price
minus the average category cost, all over the average category price. Average in this
case refers to averaging margin over the four stock valuation reports.
Manufacturer Brand Power
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Here manufacturer brand power measures the extent to which a category was
dominated by a manufacturer’s brand, in terms of customer purchases. This was
found by attributing whether a category is wholesaler dominated/no brand dominance,
or multi-brand dominated, or single brand dominated. These categories were given a
score of 0, 1, or 2, respectively. Single brand dominance was a brand that had greater
than 50% market share in the category, multi-brand dominated categories had a few
main brands that had greater than 20% market shares, and wholesaler/no brand
dominance had shares of less than 20% or the wholesaler had own-brand dominance.
Findings
Figure 3 summarises the main results of tests for Hypotheses 1, 2 and 3. The
coefficient from the path analysis is shown adjacent to each hypothesis with the
respective t-value shown in parentheses.
Assortment
Variety
H3
0.74
(13.14)
H1
0.24
Margin
(1.92)
H2
- 0.32
(- 2.56)
Stock
Level
(n=146, critical t=1.66 with 144 d.f.; p<.05)
Figure 3: Path Model to test H1-3
Finally, a one-way ANOVA revealed that the level of manufacturer brand
power in the category did not have an effect on margin as hypothesised by H4.
Discussion
The result supports Hypothesis 1. This basic result disconfirms Chiang and
Wilcox’s (1997) finding that a greater category assortment variety leads to lower
margins. However, the indirect effect on margin through stock level and the resulting
total net effect implied in Figure 3 actually lends some support to an extension of their
finding to cash and carry wholesaling.
Hypothesis 2 claimed that greater category stock level will lead to higher
category margins in that a greater stock level increases risk and thus expected margin
reward. The findings from the path model show that this direct relationship was
instead negative. One explanation could be that relatively greater stock in a category
creates a “volume” rather than margin orientation for the wholesaler’s marketing
effort in a category. However, such an inference is hard to validate in a study of one
wholesaler.
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Hypothesis 3 claimed that greater category assortment will lead to greater
category stock levels. This argument was based on the need to avoid stock outs
(Pessemier, 1980). This hypothesis was strongly supported. Thus, Pessemier’s (1980)
argument of the positive relationship of retail assortment variety to retail stock level
seems to extend to the wholesale context, at least at the category level. In spite of the
use of quick response systems, wholesalers may still have to increase total stock in
categories with larger numbers of SKUs, in that that they face relatively volatile
derived demand.
Hypothesis 4 claimed that greater category-specific manufacturer brand power
will lead to lower category margins. This was based on the belief that margins would
be squeezed. This was not supported. Perhaps the effect of brand power on margins
does not extend so well into the wholesaling area. That is, to the extent that brands
may generally have a stronger effect on consumers’ buying at the retail level than on
retail and organisational buying at the wholesale level, margin outcomes at the two
levels may similarly differ.
A basic limitation of this study is that it is limited to one wholesaler, although
as a replication and extension, it shares this scope limitation with Chiang and Wilcox
(1997) who examined only one retailer. This study also potentially contributes to the
retailing literature because of the closeness of the cash-and-carry wholesaling
situation to that of supermarket retailing, although the total number of SKUs (7700)
that this cash and carry wholesaler stocks only represents about 17% of the 45,000
SKUs that Chaing and Wilcox (1997) cite as being stocked by a typical supermarket
such as the one they examined. Nevertheless, these findings represent a step towards
understanding how some basic retail merchandising relationships might extend into
the much less well-understood field of cash and carry wholesaling.
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