Trials and tribulations of inventory management
Holding inventory can be an advantage and a disadvantage. It can be both a competitive edge and an incredible headache. Some retailers choose to only drop ship and others sell only services. This article is not for them. But many of us battle inventory on a daily basis. In this article I will explore the balance achieved between increasing ROI and maintaining the needed items in stock.
Why Hold Stock?
The ability to hold stock has become extremely important for online retailers in the past few years. Retailers who hold stock have a competitive advantage, as keeping stock improves customer experience and the ability to deliver fast and free. In addition, it enables retailers to offer aggressive cut-off dates in high-volume, time-sensitive seasons.
A good example for the need to hold stock can be seen in the rise of Zappos. The initial business model involved drop shipping directly from distributors to customers. However, this approach quickly became problematic due to spotty availability and unpredictable delivery performance. Eventually Zappos had to carry inventory.
Why Not Just Buy Large Quantities of Everything?
Some online retailers consider that you have to order a lot and in bulk so that you never run out, with the assumption that it will equal more sales. It is true that if you do not have it you can’t sell it. But more money invested in inventory creates potential problems of less money available for operations.. Also, if a company is heavy in a certain item it may not have the cash on hand to buy another item that is also needed. Balancing your inventory for demand is critical to increasing sales. Also, the less inventory a retailer holds while maintaining the same revenues, the higher the return on investment and the greater the growth potential. For many retailers, holding inventory represents their greatest investment, so managing it specifically for your needs is an incredibly critical aspect.
Forecasting What They Will Buy
Now that we understand in theory why we should reduce inventory levels, the big question is how to do it without running out of what the shoppers are looking for. I’m a great believer in building simple systems that are easy to follow. The system we’ve devised at overstockArt.com is simple and does not require complicated math. The only tool we need is a spreadsheet. However, using an inexpensive supply chain software or database is the way to go.
We have a large variety of SKUs, a shallow inventory level, and a fairly long lead time. All of this complicates the management of inventory. Therefore we’ve invested a lot of time and effort at developing a simple solution.
- Step 1. Analyze annual sales and get an average daily sales value (ADS).
- Step 2. Calculate average Supply Time (ST). This is the time it takes from when you place an order to when the items are received.
- Step 3. Calculate sales per unit for the last month. This will be used as a comparison and also to gauge seasonality, especially unforeseen changes in demand.
- Step 4. Create an optimal stock level. The calculation is based on double your Supply Time in days multiplied by your daily sales:
Optimal Stock = 2 X ST X ADS
- Step 5. Order once a week. Set a regular ordering interval. By ordering once a week and ordering in small batches you reduce the chance of running out of stock.
- Step 6. Order to complete to optimal stock level.
- Step 7. Compare with last month sales. This is done as a point of reference. If you see that a certain item is selling more or less than expected, then you can adjust right away.
Reducing Slow Moving Inventory
For any company who holds stock, slow moving inventory (SMI) is a reality of life and a problem to contend with. We all want to increase the velocity of our inventory turns as it increases our return on investment. The number one strategy that we have to reduce SMI is not to have SMI in the first place. If you order in small batches on a regular basis (such as once a week), you’ll have the ability to identify trends quickly so that you are not likely to be stuck with large quantities of inventory on items that do not move well.
Other options to reduce or eliminate SMI are:
- Closeout category;
- Deal of the day;
- Sale on specific items;
- Cross selling SMI.
Buying in Small Batches
Many companies take the traditional route and try to order as late as possible so that they can make as large an order as possible. This provides them with potential savings from vendors. When we started ordering weekly I communicated with our vendors to make sure we did not pay higher prices. My main communication was based on annual volume. I told them our orders will shrink but will become more often. We promised the same annual volume, and highlighted the benefits of smaller more consistent orders from us, which were as follows.
- Predicable order schedule. Once a week they get an order.
- Smaller order batches. Does not put as much pressure on their operations.
- Improved cash flow. We pay based on the same agreed terms, they now get their payments quicker and in a more predictable fashion.
- Help with managing their inventories. We can supply an annual projection. Plus, by monitoring our orders, they can now get a better gauge of the volume.
Using this strategy will help make your company more profitable, increase cash on hand, increase return on investment and improve customer experience. Properly managing your inventory in a simple but powerful way can make a huge difference in your operations.
I hope to read how others manage inventory levels in the comments below. What methods have you found to be effective?