The Ultimate Guide to Inventory Optimization: Definition, Techniques & More

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.

As these methods increase customer demand, there’s a massive opportunity for new revenue – but only if you embrace inventory optimization first.

That’s because inventory optimization ensures you have whatever your customers want in stock when they want it (regardless of global supply chain disruptions).

As such, you can easily meet customer demand without accumulating a huge backlog of orders or eye-watering holding costs.

Here’s how retail inventory optimization works. Plus, how to use it to grow your brand.

What is inventory optimization?

Inventory optimization means keeping the ideal amount of inventory available to meet customer demand and issues like dead stock or stockouts while keeping operational costs low.

As a result, retail inventory optimization improves the bottom line and makes reaching their revenue goals easier.

To do this, most retailers rely on an inventory optimization solution like Cogsy to track inventory in real-time, accurately forecast demand, and automate their inventory planning process.

What is multi-echelon inventory optimization?

Multi-echelon inventory optimization is where brands and companies leverage technology to sustain optimal inventory levels across their entire 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.

What is single-echelon inventory optimization?

Single-echelon inventory optimization focuses on stocking the right amount of SKUs for each link throughout the supply chain.

This type of inventory optimization determines and balances stock levels for each independent echelon instead of optimizing levels across the entire network.

Meaning, you will optimize your inventory at the manufacturer, warehouse, or fulfillment center level separately instead of optimizing levels across the whole network like with multi-echelon inventory optimization.

Key elements of the inventory optimization process

Here are the 4 key elements involved in the inventory optimization process.

Inventory levels

Inventory levels refer to the number of products you have in stock at any single moment in time.

Too much inventory requires a lot of working capital upfront and risks SKUs turning into dead stock. Too little inventory means stockouts, which frustrate customers and limit your ability to generate revenue.

Optimal inventory levels mean you only order what you need when needed. Nothing more, nothing less.

Storage

Inventory storage is where you keep inventory. For instance, this might be in self-storage, warehouses, 3rd-party logistic fulfillment centers, or distribution centers.

Where you store your inventory is key to inventory optimization because it informs how quickly you can fulfill demand. It also informs how much you’ll spend on operational costs in the process.

For instance, Shein just opened its first stateside fulfillment center because it ships so many orders to the US. This allows the ecommerce fast fashion giant to fulfill those orders faster because the warehouse is closer than its China counterparts.

However, this storage space is also radically expensive and poses risks that put the brands’ low-cost business model.

Replenishment

Stock replenishment is when you receive more shipments from the manufacturer to return to optimal inventory levels.

The replenishment process considers each SKU’s reorder point, your optimal order quantity, current inventory levels, and your supplier’s purchase order lead time.

With this information, you can determine what, when, and how needs to be reordered at any point in time. That way, you only restock what you need to meet demand.

Demand forecasting

Demand forecasting is when brands use historical data and real-time inventory trends to predict future customer demand.

Admittedly, demand and inventory forecasting software is never 100% accurate.

But demand projections ensure brands are prepared to meet customer demand while radically lowering their stockout and overstock risks (compared to operating blindly).

With this information, brands can make informed inventory replenishment decisions that keep storage and holding costs low.

6 benefits of inventory optimization

As you already know, inventory optimization has lots of benefits for retail brands. Here are the top 6 benefits:

Benefit 1: Balanced inventory levels

Inventory optimization enables brands to keep balanced inventory levels. AKA, only a little stock on hand. That way, you always have enough inventory to meet demand while minimizing costs.

This is critical to optimization because excess stock costs capital (and raises holding costs). Meanwhile, too little inventory leads to stockouts and missed revenue opportunities.

Benefit 2: Optimized shipping

Optimizing inventory lets brands track products in real-time across the entire supply chain. This way, they can move inventory (when needed) to stock warehouse locations closer to areas with high demand.

This ensures that products are available when customers want to buy them. And ultimately, it optimizes shipping by getting merchandise shipped out quickly and delivered on time.

Benefit 3: Lower operational costs

When brands optimize inventory, they inherently reduce storage, warehousing, and dead stock costs.

That’s because inventory optimization eliminates excess inventory, which sucks up cash as it sits in warehouses. And if that stock doesn’t sell quickly (or at all), this inventory throttles your cash flow.

But when you leverage inventory optimization, you only carry the products that actually sell. This not only lowers your operational costs, but increases your profit margins as a result.

Benefit 4: Greater customer satisfaction

Inventory optimization enables brands to have the right products in stock all of the time. This prevents stockouts (as much as possible), ensuring that customers can purchase and receive orders at the exact moment when they want them.

As a result, brands can provide better customer experience, improve customer loyalty, and increase customer lifetime value (LTV).

This is huge, considering even when people love a company or product, 59% will walk away after several bad experiences; 17% after just one bad experience, per PWC.

Benefit 5: Minimized supply chain variability

Having balanced stock levels ensures you always have enough inventory to meet demand. This protects your brand from unexpected supply chain disruptions, like longer lead times and raw material shortages.

Best part? Because inventory optimization requires real-time inventory tracking, you can quickly respond to supply chain issues before it impacts your bottom line.

Benefit 6: Improve your bottom line

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

Take Stitch Fix, for example. The subscription clothing brand has seen a jump in average order value (AOV) since optimizing inventory in 2019.

The popular personal styling solution 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,” without overstocking safety stock to fulfill this demand.

Top 9 inventory optimization techniques

Now that you know what and how proper inventory management affects business, let’s dive into the most common retail inventory optimization techniques.

1. Balance stock levels

Consider these 3 striking statistics from a 2018 study:

1. 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
2. About 10% of items in inventory generate 79% of a brand’s sales volume
3. The slowest-moving 50% generates less than 0.5% of all volume

In other words, brands spend a lot to stock and store inventory that doesn’t sell fast. And when those items to sell, the return doesn’t justify the initial investment.

By optimizing those lower-performing SKUs, brands can reduce operational complexity and inventory costs without negatively impacting sales. How? By not stocking those products at the same levels as your bestsellers.

That way, you are spending less on those SKUs, but you can still fulfill the demand for those products (if there’s enough to justify not sunsetting the product altogether).

2. Account for stockouts

Every brand goes out of stock from time to time. That said, brands that have optimized their inventory have a much lower risk of stockout when things go wrong (like when COVID-19 completely disrupted the global supply chain).

Luckily, when stockouts do happen, brands can mitigate losses by:

• Offering to send a back-in-stock notification when the item, well, comes back in stock.
• Sell products on backorder. In this alternative scenario, customers can purchase items regardless of their delivery status. Once an order is placed, brands set expectations on when the product will be delivered.

3. Reduce overstock

There’s such a thing as too much safety stock. It’s called excess stock (although many retailers continue to refer to it as “safety stock”).

Excess inventory is the surplus stock retailers have on hand. And unlike safety stock, extra inventory isn’t a strategic buffer against stockouts.

Instead, this inventory bloats your warehousing costs, increases write-offs, and makes managing your inventory more demanding. And between time and money, these costs add up quickly.

Because of this, brands that reduce overstock also reduce expenses. In fact, businesses that optimize their entire inventory portfolio reduce safety stock by 13% on average.

But inventory optimization means more than just cutting inventory glut. For example, Lululemon attributes its massive growth to prioritizing certain well-performing SKUs by:

1. Offering limited quantities to make products seem more valuable
2. Dropping limited edition pieces that evoke FOMO
3. Refreshing core styles regularly to avoid product cannibalization
4. Maintaining smaller product lines

The athletic wear brand identified which SKUs to prioritize using inventory turnover (how often a business sells and replaces inventory during a given period). As a result, Lululemon consistently sees higher gross margins than its competitors.

4. Implement demand planning

Without demand planning, it’s impossible to know how much inventory you’ll actually need for the future. And even the best-educated guess puts you at risk of stocking out or overstocking (both of which tie up cash flow and put brands at financial risk).

But when brands leverage tools to forecast inventory needs and prepare to meet that demand, they can confidently purchase enough stock to fulfill upcoming sales while avoiding overstock.

This kind of inventory control enables brands to optimize inventory by:

• Finding the economic order quantity (EOQ)
• Maintaining optimal inventory levels
• Meeting demand and avoiding stockouts
• Avoiding slow-moving SKUs to reduce dead stock
• Understanding the seasonality of products
• Improving customer service levels and loyalty

5. Use reorder point formula

Inventory optimization lets brands stay in stock (with their best SKUs) at all times.

But to do that, you must get your purchase orders in at the ideal time, which starts with calculating your reorder point (ROP).

Your ROP signals when inventory approaches the minimum inventory level and needs to be restocked.

It also deters you from placing an order too soon and tying up capital in unnecessary inventory.

To calculate your reorder point, use the following formula:

For example, your demand during lead time is 2,000 units (or 200 days of lead time x 10 units sold per day), and you have 1,900 units of safety stock.

In this scenario, you should reorder more inventory when you have 3,900 units available:

2,000 units during lead time + 1,900 units safety stock = 3,900 units ROP

If you calculate this number manually, you’ll need to regularly set aside time to rerun this calculation. That’s because every time there’s a shift in your demand, your ROP shifts with it.

Alternatively, a tool like Cogsy can automatically calculate your ROP per the SKU level using your current inventory levels and real-time demand trends.

Then, when any product approaches its reorder point, Cogsy will send you a replenishment alert.

This alert lets you know the perfect time to place your next PO. (Cogsy will automatically draft a purchase order using restock recommendations to streamline your replenishment process.)

6. Free up working capital for growth

In a 2021 study, over 33% 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 was expected to grow 15% year-over-year, reaching nearly $20B in sales worldwide. (This trend has since subsided, and ecommerce growth has returned to its original growth trajectory.)

But just as the growth in the DTC market has skyrocketed, so have customer acquisition costs (CAC). (CAC, however, has stayed high.) 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 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 moving the needle for brands’ bottom lines)

Whatever a brand chooses to invest in should align with its values and overall strategy for the future. This way, their working capital is better used invested in growth than tied up in extra unsold inventory.

7. Conduct regular inventory audits

When tracking inventory manually (via Excel or the likes), there’s a massive risk of human error. That’s why it’s important to conduct regular audits to ensure inventory accuracy.

Inventory audits compare your actual inventory levels to your current financial records.

This way, you can make adjustments to ensure the inventory levels are as accurate as possible. And you can identify inventory shrinkage (like lost or damaged goods) before it becomes a problem.

Sometimes, inventory audits can be performed in-house with a simple count of your existing stock. Other times, these audits may require the help of a 3rd-party auditor.

(This is usually the case if brands have a large volume of inventory or multiple warehouses they’re working from.)

8. Create an inventory policy

When brands create an inventory policy, they establish rules for how and when products should be reordered. This ensures balanced stock levels and a common context for handling inventory.

Typically, ecommerce brands create a periodic review or continuous review policy.

A periodic review policy reorders inventory like clockwork (1,000 units every 90 days).

In contrast, a continuous review policy only replenishes merchandise once levels hit the reorder point. And in an optimized environment, the latter is typically more efficient.

Why? Because a continuous review policy only orders the inventory you need when you actually need it.

This frees up capital (you would have invested in excessive stock) and eliminates waste (avoiding overstock and the associated carrying costs).

9. Use inventory optimization tools

Implementing an inventory optimization tool is the easiest (and most error-proof way) to achieve inventory optimization.

Why? Because these tools sync up all your SKUs to automatically track inventory in real-time and provide on-demand access to inventory management KPIs.

Having inventory accuracy (with an inventory management solution) gives brands more inventory control, making it easier to take insightful action.

That said, the best inventory optimization tools (like Cogsy) offer the following features:

• Inventory visibility (all your data in one dashboard)
• Access to inventory management KPIs
• Demand forecasting and growth planning
• Replenishment alerts
• Omnichannel support
• Automated purchase order system
• Purchase order tracking
• Cross-organizational integration

When combined, these tools help brands optimize inventory. So you can avoid stockouts, cut operational costs, and improve your profit margins (all of which add up to more revenue).

For example, the DTC baby and toddler brand Lalo grew 400% YoY from 2021 to 2022 with the help of Cogsy.

Plus, retailers that use Cogsy generate 40% more revenue (and save 20+ hours a week on manual processes) on average.

How Cogsy inventory optimization software facilitates growth

Cogsy is an ops optimization tool that turns your real-time inventory data into actionable insights. That way, you can proactively get ahead of (and optimize) your inventory needs.

Provides real-time inventory visibility

Cogsy’s operations platform syncs up all your data from other ops platforms to provide real-time inventory visibility. With it, you can clarify what your products are doing around the clock.

Cogsy also helps you make sense of your inventory data. This way, you can pull practical insights from all your numbers. You can then use these insights to make smarter decisions for purchasing, forecasting, and beyond.

Streamlines replenishments and purchase orders

Because Cogsy has eyes on your inventory 24/7, it knows when your stock levels are running below optimal levels — and exactly when you need to replenish.

As you’re nearing your ideal reorder point, Cogsy will automatically email replenish alerts, letting you know it’s time to stock up. With these reliable notifications, you can be sure you order all the products you need exactly when you need them.

But the best part? Cogsy even streamlines your purchase orders. With a single click, Cogsy creates customized POs that keep your inventory levels optimized (zero guesswork involved). All you have to do is check the PO and hit “submit.”

Optimizes inventory management

Cogsy’s one-of-a-kind growth planning feature levels up your forecasting efforts by mapping out operational plans for the next 12 months. It even plays out different scenarios and growth levels, so you know how to respond no matter what happens.

Then, as new information becomes available, it tracks your brand’s actual inventory performance against these plans. This allows the tool to eliminate unlikely scenarios and improve the accuracy of the remaining demand forecasts.

Sells products on backorder

Having your best SKUs in stock (at all times) is ideal. But, as I mentioned before, even an optimized inventory will inevitably experience stockouts.

This is especially true when trying to cut down on holding costs and run leaner operations. But with Cogsy’s backorder tool, you can turn your out-of-stock products into revenue and convert demand while you restock.

For example, DTC cookware brand Caraway uses Cogsy to sell on backorder whenever an item goes out of stock.

This enables them to continue generating revenue even when stockouts occur. And they set clear expectations for customers by automatically displaying the next shipment date across the entire store.

But don’t just take our word for it – try Cogsy free for 14 days.