Shelf space limits the quantity and variety of products offered by a retail operation. The visibility of a particular stock-keeping unit (SKU) and probability of a stock-out are related to the space allocated to the SKU. Total contribution for the retail operation is influenced by how shelf space is allocated to the SKUs. For retailers, shelf space ‘is their life blood – and it’s very limited and expensive’. Shelf space, accordingly, can be treated as a constraint in retailing operations. The most attractive SKU is the SKU that generates the greatest contribution per unit of space (square foot or cubic foot). To calculate contribution, all incremental expenses are deducted from incremental revenue. Incremental revenues include retail price and other direct revenue such as deals, allowances, forward-buy and promptpayment discounts. Incremental expenses include any money paid out as a result of selling one unit of a particular item. Included in the incremental expenses would be the invoice unit cost and other invoiced amounts (shipping charges, for example) that can be traced directly to the sale of the particular item. Incremental revenues and expenses are found by dividing case values by the number of units per case.

If capacity is not changed, then the relevant costs are the incremental costs rather than full costs. The choice of low direct product cost items (i.e. a full product cost including a share of the fixed warehouse, transport and storage costs) over high direct product cost items is essentially a choice to use less of the capacity that has already been paid for. If the costs of capacity are fixed, then using less capacity will not save money. Like the product mix problem, the answer to the space management problem is how to allocate existing capacity so that profit is maximized. To maximize profits where profits are constrained by space limitations, capacity should be allocated on the basis of the SKU that generates the greatest contribution per unit of space.

Questions 

1 What are the relevant costs and revenues applicable to retail operations?