Efficient Frontier and Optimizing Retailing Decisions

One of the most interesting discussions I have had in the recent past has been with Jiri Nechleba, the CEO of 4R Systems ( a  software company based in the US, which was founded by Dr. Marshall Fisher of Wharton  Dr. Ananth Raman of HBS. The heart of their approach is the concept of a retailer as a kind of portfolio manager and individual products as a kind of stock to be selected for a portfolio. In essence, 4R argues that rather than make sticking decisions on traditional supply chain/inventory optimization factors, retailers should optimize their portfolio of products much as a financial manager optimizes a stock portfolio. In other words, select products for stores so that you maximize return for a given point in a continuum of risk. Of course, in finance this known as the Efficient Portfolio Theory (EFT) developed by the Nobel laureate Harry Markowitz. 4R’s approach is worth a serious consideration by both retailers specifically but also by product managers in many other industries. All too often decisions about what products to keep in a portfolio are made on the basis of outmoded and arbitrary decisions with little correlation to how individual products create value for shareholders. Approaches like those of 4R attempt to move what has been largely a flawed art forward to a more rigorous basis. This is progress. The more companies consider their decisions about which products to sell, and which customers to service, from the perspective of value and risk, and not just material optimization, the higher the yield the huge investments made in retail (and so many other) supply chains will yield.

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