Retail brands want to grow, but few do the one thing that’s most important: optimizing their operations.

In the DTC industry, common questions among brand teams are:

  • How do I retain my customers?
  • What’s the best tool for improving my SEO?
  • Where should I focus my advertising?

Most retail brands are focused on growing through marketing and improving their sales, but, in doing so, they miss out on a huge opportunity to improve their profitability.

Bettering operations through inventory optimization helps DTC brands lower stock levels, more easily meet customer demand with immediately available inventory, and ultimately make their customers happier. 

Incremental improvements to the operational side of a business leads them down a path of excellence that will serve them as they grow.

Here’s why inventory optimization works.

Inventory problems directly affect the bottom line.

Optimizing inventory levels is an exercise that flows throughout the rest of the business, improving the bottom line at every turn.

Trends show that businesses that optimize their inventory report:

  • Stronger cash on hand positions
  • Positive revenue growth
  • Strong gross profit
  • Consistent profitability

Inventory optimization requires accurate forecasting. When doing demand planning and creating an accurate forecast of what inventory needs to be procured and by what date, brands look at historical data to predict the amount of inventory needed to meet future demand. 

The point of this is to order just enough to fulfill customer orders—not too much, not too little. Brands that forecast effectively can better plan for surprising changes in customer demand, save money on warehousing, and keep their customers' needs fulfilled.

Precise forecasting may be the difference between profit and warehouses full of unsold items. Cash flow is directly affected either way—for better or for worse.

When done well, optimizing stock levels feeds into business goals and strategies, improving margins and profitability.

Stitch Fix, a popular personal styling solution for men and women, has seen a jump in average order value (AOV) since implementing an algorithm to optimize inventory in 2019. The algorithm "pushed up key engagement metrics including client spending and satisfaction." They also reported an increase in the number of items purchased per “fix”.

By staying in stock, brands eliminate lost revenue.

The 80/20 rule applies as much to SKUs as it does to everything else in life.

Consider these two striking statistics from a 2018 study:

  • 89% of items are in the "tail" of inventory as the slowest moving items, but only accounted for 20% of sales.
  • About 10% of items in inventory generate 79% of volume, while the slowest-moving 50% of items generate less than 0.5% of all volume.

As a result, brands could most likely cull its worst performing SKUs without negatively impacting sales. By doing this, brands would cut down complexity and costs.

By prioritizing the best performing SKUs and culling others that aren’t producing enough revenue, teams have less SKUs to optimize for and can better focus on keeping them in stock.

Because brands lose revenue when their products go out of stock.

When a customer tries to buy an item that is out of stock and fails, brands are leaving money on the table, so to speak—money that a customer explicitly wanted to pay them.

Keeping items in stock eliminates lost revenue.

When brands do experience a stockout, a few things could help mitigate the losses:

A brand could put up an email sign-up form for a waitlist. The customer understands that by inputting their email, they will receive a notification when the item they want is dack in stock. Sadly, these rarely work. The conversation rate for these emails is 5-15%.

Or...

A brand could decide to sell out of stock products on backorder. In this scenario, brands allow customers to purchase items regardless of their delivery status, and they communicate the estimated delivery date clearly so as to set expectations from the start. (Below is an example from Uplift Desks.) 

Conversion rates for this method are significantly greater than back in stock notifications. Brands report a negligible drop in sales when their products go on backorder.

A product on backorder sells nearly as well as a product currently on hand.

Optimizing inventory helps brands stay in stock—but when an unfortunate stockout happens, selling on backorder can help bridge that gap without losing revenue.

Reducing overstock brings costs down along with it.

Having too much stock on hand bloats costs in warehousing, stock write-offs, and the time it takes to manage it. When considering the time value of money, the costs of overstock add up.

Brands that reduce overstock reduce costs. A 2018 study found that businesses optimizing for their entire portfolio of inventory, instead of just one SKU, reduced safety stock days by 13%.

Another method of optimizing inventory is to prioritize certain well-performing SKUs.

Lululemon reports massive growth due to very limited quantities (which can make items seem more valuable to consumers), limited edition pieces, refreshing core styles regularly, and maintaining a smaller line of product categories than many competitors.

By focusing on inventory turnover—or how often a business sells and replaces inventory during a given period—Lululemon has consistently had higher gross margin levels than its competitors.

Free up working capital for growth

In a 2021 study, over one-third of small businesses reported "lack of capital" as their reason for failure. As DTC brands reduce costs related to excess inventory and increase revenue by selling on backorder, they free up working capital. This provides them a significant advantage over their competitors.

With the working capital that has been released, brands can invest in other growth channels and initiatives.

The DTC market is expected to grow 15% year-over-year in 2021, reaching sales of nearly $20 billion worldwide. The 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 difficult to scale a brand.

As working capital is freed from inventory issues, brands can invest in a few of the following growth channels:

  • Marketing spending can be targeted toward reaching new customers or increasing the average order value (AOV) of current customers.
  • 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.
  • Growing the team can help improve operations in an area that needs additional help. The right new hires at the right time can be pivotal to move the needle for brands’ bottom lines.

Whatever a brand chooses to invest in should align with their 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 maintain operational excellence as they grow.

Not all growth is created equally. Only the best brands set the foundation for greatness in their fundamentals.

When considering the effects inventory optimization could have on your business, bear in mind:

  • The negative effects of inventory issues flow throughout the rest of the business, affecting the bottom line.
  • By optimizing inventory, costs related to stockouts are reduced or eliminated.
  • Businesses 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.

Marcella Chamorro
Head of Marketing at Cogsy · Writer and podcaster on personal growth, marketing and tech