Every retail brand should be doing inventory planning, but is your forecasting method supporting your business as well as you think it is?
The direct-to-consumer (DTC) retail space is growing exponentially--even throughout the COVID-19 pandemic. And during the pandemic, the ecommerce space saw five years' worth of growth into 4.5 months.
Most of these retail brands are growing rapidly by "bootstrapping" or building a business without external funding. But a subset of DTC retail brands are growing in an unprecedented way. To scale, business owners are expected to streamline their inventory optimization and planning processes to elevate their service levels and customer satisfaction.de
How do they do it? First off, they seek additional funding that will help them manage newly set inventory control processes.
DTC brands are experiencing an increase in funding
More and more DTC retail brands are accessing external funding via venture capital. Five years ago, venture capital funding for retail brands would have been virtually unheard of. But today, they're raising money on similar terms that tech and SaaS companies were raising three to five years ago.
Between 2015 and 2019, $3.3B was invested in consumer packaged goods with a direct-to-consumer component, accounting for nearly 60% of all money invested during that period.
As a result, the investors putting money down for the retail brands expect massive returns. They want to see the businesses become rocket ships with exponential growth curves—as all venture capital investors do.
Once retail brands raise this funding, the question becomes: how do they create the type of exponential growth and meet investors’ profitability expectations?
On the other side of the coin, retail brands growing by bootstrapping also face a similar question. Specifically, how do they create the type of growth that will sustain their business in the long term?
Growth is a complicated topic for both types of retail brands—bootstrapped and venture capital-funded. One that is not always as simple or positive as it may seem.
Growth is never linear, and your inventory planning shouldn’t be either
As retail brands grow, their leadership teams have the challenging task of figuring out the best way to:
- Create more demand for their products, and
- Fulfill that demand through their inventory.
Founders and their operations teams are sitting in meetings that sound something like this: "Our business did $1M in revenue last year, and we want to 3x that by next year."
On the operations side, particularly for those in charge of inventory planning, a question arises: "If we needed X amount of units to support $1M, how many units do we need to support $3M?"
For simplicity's sake, let's say this retailer sold 100 designer purses to reach the first million in revenue. Then, they need to sell 300 handbags to reach their goal of $3 million in revenue...right?
That top-down approach to forecasting growth and demand is not the most effective way to spend working capital. That's because it doesn't consider the nuance and granularity of what needs to happen during the year they plan to 3x revenue.
To understand why, let's take a step back to cover the fundamentals of inventory planning.
What is inventory planning?
Inventory planning is the set of activities that surround the process of buying, stocking, and reordering inventory. Inventory planning aids in lowering the costs of keeping items in stock while ensuring a sufficient safety stock. It considers inventory plans, sales channels, customer demand, inventory turnover, etc. to forecast how much inventory a business will need.
However, inventory planning involves more than just plugging numbers into an inventory management system. It's also supply chain management, preparing for possible shortages, and warehouse management.
Get it wrong, and you're stuck paying holding costs on dead stock. Or, worse, with lots of unhappy customers when your best sellers go out of stock.
That's why most DTC retail brands have a dedicated inventory planner. And they typically look for candidates with years of experience in inventory planning—because inventory management is such a critical component of running a retail-based small business.
Inventory planning and management take into consideration:
- Current inventory levels and require constant monitoring of this to determine the right reorder point
- Suppliers' production schedules and order lead times (how long it takes to source each product).
- Forecasted demand (track relevant metrics to predict how much each product will sell in the coming months or years).
- Predictions of possible changes in the supply chain or how global trends may affect that production schedule.
As you probably could tell, the two most important aspects of successfully managing inventory are real-time data and forecasting. And the real-time inventory data feeds into the forecast to make them more accurate.
More accurate forecasts help create more opportunities for a successful operation. And they keep all internal teams aligned and focused on carrying out a synergized strategy.
As a result, 40% of retail supply chain teams are looking to invest in real-time supply chain visibility in 2021.
As much as possible, businesses want to avoid both stockouts and being overstocked. But that means striking that delicate balance between demand forecasting and vendor lead time. That way, the company has just the right amount of inventory—just in time with no extra units.
Inventory forecasting isn’t as simple as it seems
But, you may be wondering, why are forecasts so important? Can't you just use historical data?
While it's true that the past helps predict the future, forecasts aren't foolproof. After all, nobody can truly predict the future. The goal is to get as close as possible with the correct inputs.
And studying your historical data can help you charter a course for next year's sales forecast. But the errors are usually tied to a few assumptions about growth.
Let's set the record straight.
1. Your inventory does not grow linearly alongside revenue
Let's return to the example of the purse business and their assumption of linear growth.
If they sell 100 designer purses to reach $1M in revenue, they need to sell 300 handbags to reach their goal of $3M in revenue. So, they should source 300 purses for this year.
But the amount of inventory the business needs to meet that revenue will never be linear.
Retail businesses need to consider the timing factor. From an operational and logistical standpoint, it may be difficult or impossible to source 300 purses this year at the cadence the business needs to sell them. Supply chain disruptions happen, and a company can only sell the inventory items on hand.
On top of that, inventory planning needs to consider the business's best-performing SKU mix (the portfolio of products driving that revenue). The product mix may stay the same from one year to the next or change drastically.
What if the SKUs driving revenue stop selling well, and your brand is stuck with that excess inventory? Consumer trends can change faster than inventory levels, and then what?
When placing purchase orders for each SKU, how will the inventory planner make assumptions about which ones will be best-sellers in a few months or a year? After all, you don't want to find yourself overstocking--or worse, understocking.
Better inputs create better forecasts.
2. Inventory costs go up with your stock levels
Businesses must consider storage and warehousing costs, the inevitable write-offs of dead inventory, spoilage, obsolescence, and more.
Generally speaking, 20-30% of inventory will be written off as obsolete. Due to the actual cost of capital, insurance, handling, administration costs, and more, the cost of that can end up being as much as 30% more than the original unit cost.
The bottom line is simple: the larger your stock levels, the higher the ongoing cost.
The retail brand that reduces its inventory and the related costs through operational excellence will always win.
For all these reasons, if a retail brand invests in 3x the inventory, they will not necessarily get a 3x return on that working capital. Following a top-down approach to inventory planning of matching revenue growth to inventory, purchasing is not the most effective way to grow.
All growth is not equal
Another critical point for retail brands is that not all growth is created equally.
Both bootstrapped and externally funded retail brands think marketing is their golden ticket. It's not.
Societally, businesses are still focused more on growth than the underlying unit economics that unlock growth. So when a team wants their company to perform better, their first instinct is to push growth initiatives like marketing instead of finding efficiencies in inventory planning, management, and other operations.
For example, many funded brands will use either customer acquisition cost (CAC) or their return on advertising spending (ROAS) to justify their need for venture capital funding.
On the other hand, Bootstrapped brands may try to increase their marketing budget for the same reasons.
They may sit in their meetings discussing the following: "If we have additional capital to grow, we will reinvest it into our growth. And our unit economics (our CAC or ROAS) will stay the same."
But that isn't guaranteed.
When using arguments like this, teams infer that they know what their business' actual inventory needs look like. As discussed earlier, that is almost impossible to achieve because inventory needs are not linear and difficult to forecast.
A top-down approach to inventory planning doesn't work because growth is not created equally, and unit economics can't be optimized without better forecasting methods.
Instead of from the top-down, the better way to manage inventory is from the bottom-up.
Manage inventory levels from the bottom up for more accurate inventory planning—and cash flow
A bottom-up approach to inventory planning creates much more accurate forecasts. These can then be used by retail brands to achieve operational efficiency and excellence. This applies to both products on hand and the best use of working capital.
Let’s walk through a few examples of how to do that.
To manage inventory from the bottom up, retail brands should start with their inventory needs and their supplier’s production schedule as the baseline. Then cautiously layer on a few key growth assumptions.
These assumptions could be based on new project initiatives, new distribution channels, new partners, or key shopping dates.
For example, a modern footwear brand may take the following approach to inventory planning:
- The company’s current inventory management software (like Cogsy) forecasts 503 units they'll need in November. The team confirms that the supplier can deliver the required units.
- The team has recently been experiencing a month-over-month growth rate of 8.78%. So, they adjust the forecast accordingly, from 503 units to 518 units.
- On top of that, the team recognizes that November is a massive month thanks to Black Friday and Cyber Monday. They layer in a multiplier of 3 and adjust the forecasted units from 518 to 606 total units to account for that.
With a bottom-up approach, the end inventory forecast will be much more accurate than a top-down approach.
Cogsy aims to take a bottom-up approach to inventory planning by analyzing and presenting an accurate forecast of inventory needs for retail brands. Most importantly, the inventory optimization tool urges teams to take action, empowering them to create purchase orders in one click based on automated replenishment recommendations. And thereby removing pesky spreadsheets from your operations.
Pro tip: As Cogsy continues to build toward that bottom-up approach to inventory planning and optimization, sign up for the newsletter to be the first to know when new features are ready. 😉
As the DTC space continues to grow rapidly and growth continues to be a hot topic among retail brand’s operations teams, we propose a bottom-up approach instead of top-down.
Bottom-up inventory planning is the best way to grow a retail brand
It doesn't matter if your retail brand chooses to sell to a wholesale partner, via Amazon or your own e-commerce site. Keeping a close eye on the supply chain, inventory levels, and demand planning is the key to setting yourself up to grow effectively and efficiently.
The timing and cadence of your product replenishment are essential to using your working capital in the best way to help your brand grow better, faster.
When choosing between top-down and bottom-up inventory planning, remember:
- More often than not, growth is not linear.
- The types of inventory driving your growth may change over time.
- Your working capital should be allocated in your best growth channels, not tied up in inventory.
Are you ready to try a bottom-up approach to inventory planning? Cogsy is here to help.
Inventory planning FAQs
What are the three types of inventory?
The three main types of inventory are:
1. Raw materials
2. WIP (Work-in-Progress)
3. Finished products
How to calculate inventory levels?
For accurate inventory planning and management, retail businesses often resort to one of the four calculation methods: basic stock , percentage variation , week's supply , or stock-to-sales method . However, most businesses choose to use the basic inventory planning formula: beginning inventory + net purchases – COGS
What are some of the main inventory planning methods?
There are several inventory planning methods to use for accurate inventory management:
- Economic order quantity (EOQ) model
- Minimum order quantity (MOQ) model
- FIFO & LIFO models
- Safety stock inventory
- ABC analysis
- Reorder point formula
- Batch tracking