We could never say the latest earnings press release from footwear retailer DSW (NYSE:DSW) was too chatty. In fact, I can sum it up in a nutshell: A same-store-sales increase of 2.2% contributed to top-line growth of 9%.

Napoleon Dynamite : Do the chickens have large talons?
Farmer : Do they have what?
Napoleon Dynamite : Large talons.
Farmer : I don't understand a word you just said.

No, my friends, DSW isn't overly chatty in the press release, though it isn't overly confusing, either. But gosh -- in the spirit of Napoleon -- we want more, don't we? Sure we do. So let's open up DSW's hood and identify the company's secret to success. In this newest edition of Fool on Call, we will highlight DSW's distribution model in three ways:

  1. The importance of supply-chain efficiency.
  2. The benefits of having the right amount of the right merchandise.
  3. A continued leveraging of the model.

1. Supply chain efficiency reigns supreme
How important is an efficient supply chain for retailers? Well, can human bodies function properly with clogged arteries? Simply put, an efficient chain is vital to the health and success of a retailer. Just ask the folks in the Walton family how Wal-Mart (NYSE:WMT) was able to form a competitive advantage, and they will tell you that Wal-Mart's inventory-management system was one of the keys to victory. Not surprisingly, much of DSW's latest success can be attributed to the same winning recipe.

During the conference call, DSW President Peter Horvath had this to say on the topic:

We continue to benefit from efficiencies in our distribution center and through improved inventory planning. We've already shared with you our inventory position, down $9 million in cost to last year [down 13% on a cost-per-square-foot basis] with 28 more stores. Our [inventory] turn is faster than last year, and we should emphasize that the store inventories are on target to our capacity objectives.

He later added that supply-chain efficiency is one of the principal "levers" for the company's performance -- a critical factor "that will drive sustainable, profitable long-term growth" for shareholders.

2. The right amount of the right stuff at the right time
One way a company gains efficiencies is by keeping the right amount of the right merchandise on hand. Doing so leads to fewer markdowns, closeout sales, and inventory write-downs. Fewer markdowns mean more products are being sold at full price, and that leads to greater profits.

Another benefit of employing a targeted distribution strategy is that items are sold more quickly, and so inventories can turn over more quickly, too. And when inventory can turn over at a faster pace, the flow of merchandise to cash increases. That ultimately means the company has to use fewer cash reserves to pay for merchandise, so it's freed up to use cash on other more fruitful purposes. What did DSW do with the extra cash saved? It put it in tax-efficient investments and generated almost $2 million in interest income.

3. Continued leveraging of a successful model
The beauty of this entire model is that the company should be able to squeeze additional profit little by little out of this system, simply through continual operation improvements. Gross margins improved 60 basis points, from 27.6% to 28.2% for the quarter, thanks in part to DSW's ability to leverage the cost of its distribution systems as a result of improved operational efficiency.

We should see further leveraging through store expansion and the reduction of occupancy costs -- what it costs the company to occupy a retail store. As DSW continues to grow -- year-to-date, it has 12 new stores in operation with another 20 under construction -- it will be able to rake in greater profits by further leveraging the cost of its distribution center. In other words, more benefits from efficiency will accrue to the added stores, at minimal added cost.

As for reducing occupancy costs, DSW is seeking to offset higher energy expenses by making sure it has the right-sized stores in operation. Management is realizing that the existing chain average of 25,400 feet is unnecessary. In response, the new stores launched for 2006 are "on average, 20% smaller at 19,500 feet," according to the conference call. DSW has found that is able to squeeze more from less. As Horvath adds, "We expect mature sales in these smaller stores to surpass the chain average of $5.3 million."

Foolish final analysis
Retailers need many ingredients to work in concert to put together a winning recipe. Having the right merchandise assortment is obviously important, as is having a good marketing campaign that targets the intended consumer. But flashy goods and flashier advertisements are nearly worthless if the inventory distribution system isn't lean and efficient. The Walton family knew this when it was building up the Wal-Mart empire, and so, too, does DSW.

For this reason alone, DSW is worth an investor's attention of further analysis and consideration as a long-term investment opportunity.

Related conference-call analysis:

  • Nordstrom (NYSE:JWN) is employing the use of "perpetual inventory tools" as a part of its strategy.
  • Dick's Sporting Goods (NYSE:DKS) is also streamlining its inventory system.
  • But is it time for Pier 1 Imports (NYSE:PIR) to go to Plan B?

Wal-Mart is a Motley Fool Inside Value recommendation. For more coverage of great stocks trading at bargain prices, try out Inside Value free for 30 days.

Fool contributor Jeremy MacNealy has no financial interest in any company mentioned.