Not optimizing your inventory is costly. Luckily, this simple 5-step inventory optimization guide can help keep your expenses down and profits up.
Ultimately, your inventory optimization (especially a lack thereof) impacts your ecommerce brand's bottom line.
That's because inventory optimization directly affects your vital front and back-end operations, including demand forecasting, inventory management, and the customer experience – all of which drive growth and profit. Here's how.
What is inventory optimization?
Inventory optimization strikes a balance between having optimal inventory quantities available and keeping logistical costs low, so you can meet demand without paying more than necessary to make it happen.
Striking this balance often relies on aligning marketing goals with inventory management KPIs. That way, your front-end marketing team can focus on generating demand, knowing your operations team will be able to fulfill that demand.
Some benefits of optimizing your inventory include:
- More capital because you’ll only tie up cash in inventory that will sell at a profit
- Lower operational costs and higher margins when you’re not spending more than necessary ordering and storing inventory
- Easier inventory management with fewer units to babysit, making it easier to order enough and avoid a stockout
- Improving the overall customer experience by always having what people want in stock and ready to ship
How inventory optimization boosts profitability
Inventory optimization boosts your brand's profitability by ensuring it can fulfill any demand generated – without racking up unnecessary holding costs that wreck margins.
For instance, brands can keep lots of safety stock lying around, and technically, you'd be able to fulfill any demand. (After all, lots of safety stock means no stockouts, right?)
But the longer you have to store and protect this excess inventory, the more expensive it becomes.
So, by the time you sell the item, you're not actually making much off the sale (if anything).
Sure, you can run a marketing event to generate demand and eliminate some of this slow-moving stock. But say this inventory has already been sitting around for a while. Will the sold product still generate a profit after the marketing spend and holding costs?
That's where a more proactive strategy like inventory optimization becomes so cost-effective – especially compared to the reactive “promote what's not selling” approach.
How to ensure profitability by optimizing your inventory
Profitability relies on proactivity. So, here are 5 steps you can use to get ahead of inventory optimization and improve your bottom line.
Step 1: Track the right inventory management KPIs
Before optimizing your inventory, you need to know what you're optimizing for. So, you'll want to set some inventory key performance indicators (KPIs). Or, in other words, track metrics that focus on inventory management and supply chain management.
For instance, here are a few inventory KPIs you should track and how to track them:
|Inventory KPIs||What this tracks||How to track|
|Total sales per product||How many units you’ve sold of each SKU||Using an inventory management system IMS, how many total units of sales in each product’s lifetime|
|Bestselling SKUs||Which SKUs you sell the most of when they’re in stock||Using an inventory management system IMS, the SKUs that you’re selling the highest quantity of in the past 30 days or so|
|Dead stock||Which SKUs aren’t selling despite being in-stock||Using an inventory management system IMS, any SKU that are not really selling in the past 30 days or so|
|Inventory turnover rate||If a brand has too much inventory for the demand||Inventory Turnover Rate = Cost Of Goods Sold / Average Inventory Value = Number Of Units Sold / Average Number Of Units On Hand|
|Holding costs||How much it costs to store and protect unsold inventory||Inventory Holding Cost = (Storage Costs + Employee Salaries + Opportunity Costs + Depreciation Costs) / Total Value of Annual Inventory|
|Lead time||How long it takes to receive orders from your manufacturer||Lead Time = PO Processing Time + Production Time + PO Fulfillment Time + Supply Chain Delays|
|Safety stock||How much excess product brands should keep on hand in case of supply chain issues||Safety Stock Needed= (Maximum Daily Usage x Maximum Lead Time) – (Average Daily Usage x Average Lead Time)|
|Inventory days on hand||How quickly a business uses up its inventory levels on average||Inventory Days On Hand = (Average Inventory For The Year / Cost Of Goods Sold) x 365|
|Cost per unit||How much one unit of inventory costs to manufacture or supply||Cost Per Unit = (Fixed Costs + Variable Costs) / Units Produced|
|Stock to sales ratio||How healthy your inventory levels are||Stock To Sale Ratio = Average Inventory Value / Average Sales Value|
|Net profit margin||How profitable is each SKU sold||Net Profit Margin = (Revenue - Cost) / Revenue|
🤿 Want to dive deeper? Cogsy goes into more detail on how to track each of these inventory KPIs on the ShipBob blog. And they published a follow-up post that breaks down how to improve each of these KPIs.
Step 2: Improve your demand forecasts
There is no denying that accurate demand forecasting is vital for your inventory management and optimization. Without it, you'll likely fall into the trap of ordering too much inventory or too little. And you'll end up with dead stock or stockouts, respectively.
But with accurate demand forecasts, you'll only invest in inventory that's guaranteed to sell and sell quickly. And as a result, you'll decrease inventory costs and, consequently, boost profitability by:
- Reducing dead stock by only investing in inventory that will sell
- Increasing your inventory turnover rate by not carrying more than you need
- Ensuring better product availability which in turn boosts sales
- Lowering costs of goods sold by accumulating less holding costs and creating better margins
There are a few ways you can go about increasing forecast accuracy. If you're going about it manually, use a bottom-up forecasting approach. With this approach, you'll determine your baseline inventory needs. Then, cautiously layers key growth assumptions (like seasonality or a marketing promotion) onto that solid foundation.
However, keep in mind that manual forecasting is prone to human errors and relies on outdated data. So, inherently it is less accurate than using a real-time demand forecasting tool like Cogsy.
This brings us to the other primary way you can increase forecasting accuracy. Tools like Cogsy track your historical sales, real-time inventory levels, and current demand trends. Then, it uses that information to instantly project future demand and map out how you can optimize your inventory. Plus, each time new information is introduced, the demand plan is updated to reflect that information, making the end result wildly more accurate.
Step 3: Assess your product storage methods
Optimizing your inventory does no good if you don't also optimize how you store that stock. Otherwise, you run the risk of inventory shrinkage, damaged items, or not having a safe place to keep it all. These factors make it harder to manage your inventory (let alone optimize it) and satisfy customers.
So, if you're optimizing your inventory, you'll need to audit and likely tweak your storage solution. For instance, in your warehouse, you might want to:
- Build robust standard operating procedures for how you process, store, and fulfill orders
- Increase inventory visibility with a new, more organized storage system, so you always know what's SKUs are stored where
- Create an optimized warehouse layout so employees can quickly and safely complete their tasks
- Automate processes or use a 3rd-party storage partner to help streamline productivity
Likewise, if you're an omnichannel brand, you'll also need to assess your in-store merchandising and storage. This might include:
- Opting for new storage racks and shelves that better showcase your products
- Rethinking your store layout (including aisle widths) to create a more intuitive experience
- Taking stock of what's at each brick-and-mortar
- Running a promotion to reduce the amount of inventory you have on hand
Step 4: Rethink your replenishment process
Achieving inventory optimization is one thing. Your replenishment process is how you maintain it.
That's because what you put on your purchase orders (POs) directly decides whether you have too much or too little inventory at any given time. Plus, how much capital you have tied up.
Order too much, and you'll find yourself paying a lot more in holding costs which take away from your take-home profits. Too little, and you risk selling out and likely sending customers to your closest competitors. Both of these challenges can be avoided in the replenishment process.
That's because a perfected replenishment process ensures you order the right amount of the right SKUs at the right time.
But you can always improve your replenishment process. Let’s walk through a few.
Buffering your brand from stockouts with safety stock
After auditing inventory levels and optimizing merchandising strategies, retailers should revise and update their buffer inventory needs. To calculate how much buffer stock you need for a specific SKU, use this formula:
safety stock = (max. daily usage * max. lead time)- (avg. daily usage * avg. lead time)
Redo your brand's Always Better Control (ABC) analysis
An ABC analysis determines the value of stock items based on their importance to your business by ranking risk, demand, and cost data. This way, you can prioritize your best-performing products. DTC brands should review this once a quarter.
Review your supply chain KPIs
Establishing and reviewing your supply chain KPIs is important (especially in 2022 with the current supply chain uncertainties). This way, you can take control of your order lead times, fulfillment rates, and more.
Embrace inventory planning automation
Quality inventory automation, such as Cogsy, gives important real-time forecasting, inventory planning, purchase orders, and backorder data. Plus, Cogsy even sends replenish alerts when it's the ideal time to restock and automatically builds your POs. This saves you time while ensuring your inventory planning is more accurate.
Step 5: Rethink your online merchandising strategies
Finally, your merchandising strategy is how you turn inventory optimization into peak profit performance. With a stellar strategy, you ensure you're moving the right stock to maintain optimal levels, boost conversions, and hit your revenue goals.
A solid online merchandising strategy should consider your:
- Best reviewed products
- Bestselling products
- Margins on each SKU (after discounts)
- Average order lead times
- Current inventory levels vs. optimal stock levels
- Product page performance
- Customer tracking parameters, like segment tags
Ideally, you want to use this information to personalize the merchandising experience for the customer.
Using a merchandising solution like Kimonix, you can automate how you sort, recommend, price, and promote products in your online store. And you get tons of data on what SKUs fuel conversions and keep customers coming back.
You can then use this information to take control of your inventory by building segmented collections. With these collections, you can personalize the experience and set parameters to boost sales and move inventory smarter.
For instance, by building promotions to speed up slow-moving SKUs (so you're not racking up storage costs). Or slowing down certain SKUs when a purchase order is on its way, and you're at risk of a stockout.
Plus, Kimonix's holistic, AI-powered merchandising solution for the ultimate inventory optimization when used alongside Cogsy. With the 2 tools, you can:
- Leverage real-time inventory trends and past sales data for more accurate demand forecasts
- Set up highly optimized purchase orders with automatic replenish alerts
- Hit your most aggressive revenue goals based on bottom-up sustainable operational plans
- Create ROI-driven customer journeys with multiple segments
- Use real-time inventory trends and past sales data to inform your merchandising strategy
- Hit your most aggressive revenue goals with sustainable operational planning
To learn more about how Kimonix and Cogsy can help you optimize your brand’s inventory, get in touch with the Cogsy team today.
About the author
Nicole Blanckenberg is a DTC business coach and inbound marketing manager for Kimonix. When she's not researching the next ecommerce trend, creating informative content, managing business blogs, or spending an unhealthy amount of time online shopping, she's an avid beach-goer and coffee shop junkie that's hanging out on LinkedIn.
Find out more at kimonix.com