By Abby Heugel
There was a time when inventory management could be done by writing down your numbers in a spreadsheet or even a notebook. But given how retailers have expanded their businesses to multiple channels, sell an even more diverse line-up of products, and offer various fulfillment options, that system will no longer cut it.
As time and technology — and the retail industry — have evolved, a more sophisticated approach to inventory management isn’t just a good idea — it’s become a necessity. While there is no one-size-fits-all approach to inventory management, there are certain approaches that have proven to be successful that you can apply to your business to decrease your stress and increase your bottom line.
What Is Inventory Management and Why Is It Important?
Inventory management is a way of keeping track of your business’s stocked goods and monitoring their weight, dimensions, amounts, and location. The aim is to minimize the cost of holding inventory by letting you know when it’s time to replenish products, or buy more materials to manufacture them.
Inventory management is one of the most important things you can do as a merchant, as it ensures you have enough stock on hand to meet customer demand. When not handled properly, you can lose money on potential sales that can’t be filled and/or waste money by stocking too much inventory.
But when done right, inventory management can save you money in a variety of ways. If you sell something with an expiration date, inventory management helps you avoid unnecessary spoilage. This also helps you avoid dead stock — those items that might not expire, but that can go out of season or style.
Finally, inventory management saves you on warehousing costs. Storage costs increase when you have too much product to store at once or if you’re stuck with a product that’s difficult to sell, so avoiding this saves you money.
Essential Inventory Control Methods
Inventory is product that you’ve already paid for, but when it’s sitting on your shelves or in a warehouse, it’s not making you any money. That’s why effective inventory management can lead to better cash flow, and increase your bottom line. And while there are many different inventory management methods to use, the more common inventory management techniques are listed below.
Establish Par Levels
The first thing you should do is establish par levels of your products, which are the minimum amount of product that must be on hand at all times.
You know it’s time to order more when your stock dips below that predetermined level, which will vary by product. These levels are based on how quickly the item sells and how long it takes to get back in stock, and in a perfect world, you will order the minimum quantity that will get you back above par — eliminating excess stock while preventing a lack of in-demand product.
While establishing par levels can take a little bit of research and up-front work, having them set will systemize the process of ordering and help you make quicker decisions. Remember that things can change over time, so check your par levels throughout the year and make any necessary adjustments.
First-In, First Out (FIFO)
First-in, first-out (FIFO) is one of the more straightforward approaches to stock control and is when a retailer fulfills an order with the item that has been sitting on the shelf the longest. Basically, your oldest stock gets sold first — not your newest stock.
While this is absolutely critical for perishable items to avoid spoilage, it’s also good practice for non-perishable items. Things like packaging design and features often change over time, and the last thing you want is to end up with something obsolete that you can’t sell.
FIFO often results in a lower cost of goods sold number because older items generally carry a lower cost than items purchased more recently, due to potential price increases. With a lower cost of good sold number, you can have higher profits.
Last-In, First Out (LIFO)
On the other end of the spectrum, we have last-in, first out (LIFO) which is the opposite of FIFO. This inventory management method assumes the most recently acquired product is also the first to be sold, and the most recent pricing is used to determine the value of the merchandise that has been sold.
While most retailers opt to use the FIFO method, some choose LIFO based on the assumption that prices are steadily rising. This means the most recently-purchased inventory will also be the highest cost, which will yield lower profits, and, subsequently, lower taxable income.
Manage Supplier Relationships
There’s more to having a good relationship with your suppliers than simply making friendly conversation. It requires clear, proactive communication because being adaptable is part of successful inventory management. Things can quickly change, and having the ability to return a slow selling item to make room for a new product, quickly restock a fast seller, troubleshoot manufacturing issues, or temporarily expand your storage space depends on how willing your suppliers are to work with you on solving any potential issues.
Keeping the lines of communication open means they can let you know if a product is running behind schedule or informing them when you’re expecting an increase in sales so they can adjust production. If you have a strong relationship with your suppliers, this can lead to stronger sales.
Use ABC Analysis
This inventory management technique helps you to prioritize products, categorizing each item under one of the following:
- A (high-value products, low sales frequency): They will require the most attention because these items have a greater financial impact on your business. However, they’re harder to forecast because they’re not in high demand.
- B (middle-value products, average sales frequency): In terms of priority, these products fall somewhere in the middle.
- C (low-value products, high sales frequency): These products move off the shelves more quickly and easily, making them easier to predict. Because they generate sales that are less impactful to your bottom line, they require the least amount of attention and maintenance.
This method helps you understand which products are sitting on the shelves for too long. “A” products are the most valuable and should be closely monitored to make sure you don’t run the risk of over- or understocking. With “C” products, which are more self-sustainable, make sure they’re making you money and that it’s worth it to keep selling them. Finally with “B” items, simply monitor them to see if there’s the potential for them to turn into “A” or “C” products.
Utilize Open-To-Buy (OTB) Inventory Planning
Open-to-buy (OTB) inventory planning, also known as merchandise management, helps retailers stock the right amount of the right products at the right time by showing the difference between how much inventory is available and how much is needed. Because it breaks it down by category, this can help you get more product-specific insights.
The OTB formula shows you how much inventory you can afford to purchase and is:
Planned sales + sales and markdowns + planned end-of-month inventory – beginning-of-month inventory
This is typically a monthly calculation, and can help you move more product quickly because it requires less commitment and investment. This is an especially effective technique for retailers who frequently bring in products at the start of the season and put them on sale at the end of the season, as well as those who simply want to keep inventory fresh and exciting for their customers.
Prepare a Contingency Plan
With retail, it’s simply a matter of time before you’re faced with a challenging issue. Whether it’s having sales spike unexpectedly and you oversell your stock, a product is unexpectedly discontinued, or the manufacturer runs out of your product and you have orders to fill — you have to expect that you’ll have some sort of problem to deal with.
You can mitigate the damage by identifying possible risks and preparing a contingency plan. Figure out what issues may arise and decide how you’ll react, what steps can be taken to solve the problem, and if/how other parts of your business might be impacted.
Accurately Predict Demand
A critical part of inventory management is being able to forecast demand — which is no easy task. There are countless factors and you can never be completely sure what’s coming, but that doesn’t mean you can’t try and get as close as possible. When trying to project future sales, here are a few things that you can consider:
- Market trends
- Last year’s sales at the same time
- Growth rate of the current year
- The overall state of the economy
- Guaranteed sales from contracts
- Planned promotions and ad spend
Enjoyed this post? For more tips, check out Vend’s Complete Guide to Retail Inventory Management. This handy resource offers advice and action steps to help you:
- Set up your products and inventory system correctly
- Get the right people and processes in place so you can stay on top of stock
- Figure out which of issues are causing shrink in your business so you can prevent them
The Bottom Line
With a proper inventory management system in place, you can do everything from reducing your overall costs and predicting future sales to preparing your business for the unexpected and keeping your business profitable.
There’s no “one best” technique, but by trying some of the ones we discussed here, you can more easily find out what works best for you.
About Francesca Nicasio
Francesca Nicasio is Vend's Retail Expert and Content Strategist. She writes about trends, tips, and other cool things that enable retailers to increase sales, serve customers better, and be more awesome overall. She's also the author of Retail Survival of the Fittest, a free eBook to help retailers future-proof their stores. Connect with her on LinkedIn, Twitter, or Google+.