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, retail brands have experienced enormous growth.
In the US, the COVID-19 pandemic catapulted growth for e-commerce—five years worth of growth into 4.5 months, to be exact. The rest of the world has experienced similar trends.
The majority of retail brands are growing at a rapid pace by “bootstrapping”, or building a business without external funding.
But a subset of DTC retail brands are growing in a surprising way.
In an unprecedented move, more and more DTC retail brands are accessing external funding via venture capital, even at the earliest founding stages.
Venture capital funding for retail brands was not often done or very popular even five years ago. What the industry is experiencing now, though, is retail brands raising venture capital on similar terms as to what tech or SaaS companies were raising three to five years ago.
Between 2015 and 2019, $3.3 billion was invested in consumer packaged goods with a direct-to-consumer component, accounting for nearly 60% of all money invested during that period
Caraway (a Cogsy customer) is one such example, raising $5.3 million in seed funding to support the fast-paced growth the brand experienced right from the start.
As a result, the investors putting their money down for the retail brands expect massive returns, wanting to see the businesses become rocket ships with exponential growth curves—as all venture capital investors do.
Once retail brands raise the funding, the question becomes: how do they create the type of exponential growth investors expect?
On the other side of the coin, retail brands growing by bootstrapping also face a similar question: how do they create the type of growth that will sustain their business in the long term?
For both types of retail brands—those bootstrapping or venture capital funded—growth is a complicated topic 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 hard 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 $1 million USD in revenue last year, and we want to 3x that. So, the expectation is to jump from $1 million in revenue to $3 million next year.”
On the operations side, particularly for the inventory planner or buyer, a question arises:
“If we needed X amount of units to support $1 million, how many units do we need to support $3 million?”
If a retail brand sells 100 designer purses to reach $1 million in revenue, then they need to sell 300 purses 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 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?
Managing your stock levels isn’t an easy task. Inventory planning and its subsequent management is a complex endeavor that takes into consideration past inventory plans, sales channels, and all kinds of other metrics and factors particular to your industry and business.
When hiring for inventory planner jobs, most businesses look for candidates with years of experience—because inventory management is such a critical component of running a retail business.
Inventory planning and management takes into consideration:
- constant monitoring of current inventory levels
- a production schedule and lead times, or how long it takes to source each product
- forecasts of how much of each product will sell in the coming months or year
- predictions of possible changes in the supply chain, or how global trends may affect that production schedule
As you can tell, the two most important aspects to successfully managing inventory for retail brands are real-time data and forecasting, with one feeding into the other. Real-time data helps create more accurate forecasts.
More accurate forecasts help create more opportunities for a successful operation, keeping all internal teams aligned and focused on carrying out a synergized strategy.
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, striking that delicate balance between demand forecasting and vendor lead time, so the business has everything it needs—on time and not one unit extra.
Forecasting isn’t as simple as it seems.
But, you may be wondering, why are forecasts so important? Don’t things change all the time?
While it’s true that the past helps predict the future, forecasts aren’t foolproof—because nobody can truly predict the future. The goal is to get as close as possible with the correct inputs.
Studying your historical data can help you charter a course for next year’s sales forecast, but the errors usually are tied to a few assumptions about growth.
The first wrong assumption pertains to the linear nature of inventory needed.
Let’s return to the example of the purse business and their assumption of linear growth.
If they sell 100 designer purses to reach $1 million in revenue, then they need to sell 300 purses to reach their goal of $3 million in revenue. They should source 300 purses for this year.
But the amount of inventory the business needs to meet that revenue is never going to 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 do happen, and a business can only sell stock it has on hand.
On top of that, the business’s strongest SKU mix—the portfolio of products driving that revenue—needs to be considered. From one year to the next, the product mix may stay the same, but it may also change drastically.
What if the SKUs driving revenue stop selling as well, and the brand is stuck with that 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 month’s time—or worse, in a year? Some items may be overstocked, others understocked.
Better inputs create better forecasts.
Secondly, there are significant costs associated with purchasing 3X the inventory in the next year.
Businesses must consider storage costs, the inevitable write-offs of stock that went obsolete, and more. 20-30% of inventory will be written off as obsolete, but—due to the true 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: more inventory, the higher the ongoing cost.
A retail brand that reduces its inventory and its costs through operational excellence will 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 created equally.
Another important point for retails brands to consider is that not all growth is created equally.
Both bootstrapped and externally funded retails brands think of marketing as the golden ticket.
Societally, businesses are still focused more on growth than the underlying unit economics that lead to growth. So when a team wants a business to perform better, their first instinct is to push growth initiatives like marketing, instead of finding efficiencies in the 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 funding through venture capital.
Bootstrapped brands, on the other hand, 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 are inferring that they know what their business’s actual inventory needs look like. As we discussed in previous sections, that is almost impossible to achieve because inventory needs are not linear and difficult to be forecasted.
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 that can then be used by retail brands to achieve operational efficiency and excellence. This applies to both products on hand but also 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 can start by planning out their inventory needs and their supplier’s production schedule as a baseline and 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 plan their inventory demands in the following way:
- The company’s current inventory optimization tool (like Cogsy) forecasts 503 units will be needed in November. The team confirms that the supplier can deliver the required units.
- The team’s internal team decides their strategy will be to set a month-over-month growth rate of 8.78%. The team adjusts the forecast accordingly, from 503 units to 518 units.
- On top of that, the team recognizes that November is a massive month for them due to Black Friday and Cyber Monday. To account for that, they layer in a multiplier of 3 and adjust the forecasted units from 518 to 606 total units.
In a bottom up approach, businesses factor in all operational and logistical aspects.
By layering on growth assumptions cautiously from the bottom up, the end result of the 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, Cogsy urges teams to take action, empowering them to create purchase orders in one click based on automated replenishment recommendations.
(Hot 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 is such a hot topic among retail brand’s operations teams, we propose a bottom-up approach, instead of top-down.
A bottom-up inventory planner is the best way to guide retail business growth.
Whether 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 will be key to setting yourself up to grow effectively and efficiently.
The timing and cadence of your product replenishment is 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 mix product lines that are 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.