All retail brands want to grow. But few do the one thing that all but guarantees growth: optimizing their inventory.
In the direct-to-consumer (DTC) industry, most retailers focus on growing their brands through marketing and sales.
But by doing so, they miss out on a massive opportunity for unlocking by ignoring inventory optimization.
That's because when brands optimize their inventory, they consequently better the way they operate.
As a result, they can more easily meet customer demand with immediately available stock, regardless of global supply chain disruptions. They can increase their fill rate (how many of the orders placed have been shipped) without racking up eye-watering holding costs. And they can boost customer satisfaction while freeing up working capital.
Let's break down why inventory optimization works (and how it helps retail brands grow).
What is inventory optimization?
Inventory optimization is the ecommerce beInventory optimization is the ecommerce best practice of keeping the right amount of inventory in stock to meet customer demand. Brands that practice inventory optimization typically avoid common inventory problems (like deadstock or stockouts) by stocking the right inventory, while keeping logistical costs such as raw materials and distribution centers low.
To do this, most retail brands use inventory optimization solutions like Cogsy to track inventory in real-time, handle demand forecasting, and automate inventory planning. That way, they can generate optimized purchase orders that consider order lead time and seasonality to only reorder units that will actually sell.
What is multi-echelon inventory optimization?
Multi-echelon inventory optimization is a process where brands and companies leverage technology to sustain optimal inventory levels across the supply chain. This holistic view considers the supply chain network as a whole, from manufacturer to distributor to customer (and vice versa), instead of seeing each stage of the supply chain as its own distinct process.
The implementation of inventory optimization software empowers businesses to take their supply chain planning to the next level by using artificial intelligence to automate aspects of supply chain management. Let's take a closer look at how inventory impacts revenue.
How inefficient inventory affects revenue
Optimizing inventory levels is an exercise that flows through the rest of the business, ultimately improving the bottom line. For example, brands that leverage this exercise:
- Have more cash on hand.
- See positive revenue growth.
- Report strong gross profits.
- Experience more consistent profitability.
But to do this, brands must first accurately forecast demand for the inventory they'll need and by when. This requires looking at historical inventory data and supply chain trends to predict future customer demand based on their product’s life cycle.
That way, brands can order just enough to fulfill customer orders—not too much, not too little. The ones that forecast effectively can better plan for surprising changes in customer demand, save money on warehousing, and fulfill their customers' needs.
Precise forecasting directly affects cash flow—for better or for worse.
Done right, inventory optimization feeds into business goals and strategies, improving the efficiency of stock levels, margins and profitability. Done wrong, and brands are stuck writing off warehouses full of unsold items or figuring out how to sell on backorder.
For example, the popular personal styling solution Stitch Fix has seen a jump in average order value (AOV) since implementing an algorithm to optimize inventory in 2019. To do this, the brand used a machine learning algorithm "[to push] up key engagement metrics including client spending and satisfaction." They also reported an increase in the number of items purchased per "fix."
4 Factors that influence inventory optimization
Now that we have an understanding of what and how proper inventory management affects business, let’s dive into the factors that influence your inventory optimization strategy.
Optimize inventory investments by balancing stock levels
The 80/20 rule applies as much to inventory management as it does everything else in life.
Consider these two striking statistics from a 2018 study:
- 89% of items are in the "tail" of inventory, meaning they're slow-moving items that only account for 20% of a brand's sales.
- About 10% of items in inventory generate 79% of a brand's sales volume. In comparison, the slowest-moving 50% generate less than 0.5% of all volume.
As a result, brands could most likely cull their worst-performing SKUs without negatively impacting sales. By doing this, brands cut down operational complexity and inventory costs.
By prioritizing the best-performing SKUs and culling others that aren't producing enough revenue, teams reduce the amount of inventory they need to optimize for and maximize the return on inventory investment. And they can better focus on keeping their product offerings in stock.
When a customer tries to buy an out-of-stock item and fails, brands leave money on the table. Specifically, the money that a customer explicitly wanted to pay them.
That's because 21-41% of customers will actually purchase the product from another retailer if it's out-of-stock instead. So, keeping items in stock eliminates this lost revenue.
Account for stockouts that will still happen from time to time
Even an optimized inventory will still experience a stockout from time to time. This is what many brands who've managed operational excellence are currently experiencing, thanks to the COVID-19 supply chain disruptions.
When these stockouts happen, brands can mitigate losses by:
- Putting up an email sign-up form for a waitlist. The customer understands that they'll be notified when the item comes back in stock by inputting their email. Sadly, these rarely work (conversion rate for these emails hover around 5-15%).
- Sell out-of-stock products on backorder. In this scenario, customers can purchase items regardless of their delivery status. Once an order is placed, brands then set expectations on when the product will be delivered from the start.
For example, Uplift Desk leverages the selling on backorder option by noting when each color ships on the product page.
Conversion rates for the latter method are significantly greater than back-in-stock notifications. In fact, brands report a negligible drop in conversions when they sell on backorder compared to in-stock.
A product on backorder sells nearly as well as a product currently on hand.
Reducing overstock to lower costs
Having too much stock on hand bloats costs in warehousing, increases write-offs, and multiplies the time needed for inventory management. When considering both time and money invested, overstock costs add up quick. So, brands that reduce overstock also reduce expenses.
In fact, businesses that optimize their entire inventory portfolio instead of just one SKU reduced safety stock by 13%.
Another method of optimizing inventory is to prioritize certain well-performing SKUs.For example, Lululemon attributes its massive growth to four inventory strategies:
- Offering limited quantities to make products seem more valuable.
- Dropping limited edition pieces that evoke FOMO.
- Refreshing core styles regularly so they don't cannibalize their own product offerings.
- Maintaining a smaller line of product categories than many competitors.
By focusing on inventory turnover (how often a business sells and replaces inventory during a given period), Lululemon reports consistently higher gross margins than its competitors.
Free up working capital for growth
In a 2021 study, over one-third of small businesses said they failed due to "a lack of capital." As DTC brands reduce costs related to excess inventory and increase revenue by selling on backorder, they naturally free up working capital. This provides a significant advantage because these brands can now invest in other growth channels and initiatives.
In 2021, the DTC market is expected to grow 15% year-over-year, reaching nearly $20B sales worldwide. This trend will continue into 2022 and beyond.
But just as the growth in the DTC market has skyrocketed, so have customer acquisition costs (CAC). This makes it more challenging to scale a brand.
But by resolving inventory problems and freeing up working capital, brands can invest it in:
- Marketing spend can target new customers or retarget current customers to increase their AOV.
- Investing in launching new projects can help a brand expand its portfolio and diversify. Exploring new initiatives like developing new products or releasing limited edition products could help boost growth.
- Adding a team member who can improve operations in an area that needs additional help. At the right time, the right new hires can be pivotal to move the needle for brands' bottom lines.
Whatever a brand chooses to invest in should align with its values and overall strategy for the future. No matter their choice, their working capital is better used invested in growth than tied up in extra unsold inventory.
The path to operation excellence is through inventory optimization
Forward-thinking brands optimize their inventory to boost their margins and profitability. In doing so, they set themselves up to grow.
But not all growth is created equally. The brands that focus on operational excellence unlock long-term sustainable growth. Meanwhile, others eventually hit a growth ceiling that they can't breakthrough.
When considering the effects inventory optimization could have on your business, bear in mind:
- The adverse effects of inventory issues flow throughout the rest of the company, affecting the bottom line.
- By optimizing inventory, costs related to stockouts are reduced or eliminated.
- Retailers that stay in stock don't leave revenue on the table.
- Brands thrive by focusing on the best-performing SKUs and reducing overstock.
- Freeing up working capital opens the door to new avenues for growth.
These single-digit improvements will reverberate throughout the rest of your business, helping you scale and grow faster, better.
Inventory optimization FAQs
Why is inventory optimization important?
Inventory optimization is a key part of the inventory management process for any brand that is serious about growing and scaling their business. By optimizing different workflows within the inventory management process, brands can increase their revenue and save costs by running an efficient supply chain.
How do you optimize inventory?
There are many steps involved in inventory optimization: setting supply chain KPIs, running ABC analysis, managing dead stock, improving warehouse management, automating processes with inventory management software… to name a few. Each business is unique and it is key to first have a solid understanding of the supply chain before identifying main bottlenecks to optimize for.
What is inventory optimization in retail?
In the most basic sense, inventory optimization in retail is the process of assessing supply and demand for a product in order to stock the perfect amount of inventory. The goal of inventory optimization in retail is to minimize carrying and maintenance costs, without impacting customer service and prompt shipping speed.