This is a post by Alexandra Sheehan.
One time, inventory management could be as simple as handwritten tracking in a notebook. As time and technology have evolved, retailers are expanding their businesses to other channels, selling more types of products, and offering more fulfillment options. With these changes to the retail industry, a more sophisticated approach to inventory management isn’t just crucial, it’s practically mandatory.
There are tons of different inventory management methods to learn about. When it comes to retailers, certain approaches may be more effective than others. Below, we’ve taken a look at the more common inventory management techniques and rounded up some stock control tips to help you get started.
Inventory management methods for retailers
1. First-in, first-out (FIFO)
The FIFO stock control method is when a retailer fulfills an order with the item that has been sitting on the shelf the longest. Basically, the products that were acquired first will also be the first products that you sell.
Generally, FIFO leads to higher profits. The value of inventory at the point at which it was acquired may be less than when it is sold. That’s because over time, inventory-related expenses generally increase. Older inventory is typically purchased at a lower price point.
Let’s say you sell women’s sweaters in your retail store, and you’re using the FIFO inventory management method. Earlier in the year, you purchased sweaters for $10 a piece. Six months later, the price has increased to $12. When you’re tracking inventory, the FIFO method states that those $10 sweaters were sold first. So, your income is based on that. If you had allocated those first sales to the $12 sweaters, your profits would be less.
FIFO is one of the more straightforward approaches to stock control, and it’s one of the easier ones to understand and implement in your business. You don’t need to manipulate any stock or income numbers, and as long as you’re purchasing what you need, it should also accommodate the normal flow of products in and out of your biz.
Healthy snack brand Think Products uses the FIFO method in their online retail business. This helps them ensure that their products don’t expire before they’re sold. According to Unleashed, using “best before” dates helps Think Products to properly execute the FIFO methodology. Doing so also “allows them to communicate clearly with their warehouse about which products need to be used first.”
- Retailers who sell perishable products (food, drink, skincare, cosmetics, etc.)
- Businesses that sell seasonal products, such as apparel, furniture and home goods
2. Last-in, first-out (LIFO)
LIFO inventory management is the opposite of FIFO: It is the inventory management method that assumes the most recently acquired product is also the first to be sold. This means that the most recent pricing is used to determine the value of the stock that has been sold.
Let’s look at our sweater example again. If you sell them for $20 each, you’re making $10/sweater according to the FIFO method. But since the $12 sweaters were acquired after the $10 sweaters, LIFO says that those are the ones you sold first, and you’re only making $8 on each sweater until you’ve sold all of the ones you bought for $12. Therefore, you net less on paper, which also means you have less taxable income.
This is an inventory management technique that is commonly used in the U.S. Because of possible discrepancies between the recorded and actual cost of goods sold (COGS), it isn’t used in most other countries. It’s less straightforward and requires more manipulation of the books. This is one reason why FIFO is more commonly used in retail businesses.
- Non-perishables and heavy raw materials, such as gas, metal or chemicals
- U.S.-based businesses
3. Just-in-time (JIT)
The JIT inventory management method takes more of an as-needed approach to stock control. Inventory is ordered according to sales. The benefits of this method include reducing risk, expenses and waste. On the other hand, this can also adversely affect fulfillment times and product availability.
Toyota was the first global retail brand to introduce this inventory management technique. They’ve used this nimble approach to manufacturing and production to maximize profits and increase efficiencies.
- Retailers who have mastered accurate forecasting
- Larger retailers, as small businesses may end up paying premiums and reducing profits for low stock levels
- Retailers that want to reduce holding costs
4. Economic order quantity (EOQ)
The EOQ inventory management method uses customer demand, ordering cost, and holding cost to determine what the sweet spot is for inventory levels. Also referred to as the optimum lot size, EOQ is calculated as follows:
A represents the total customer demand over the course of the year, Cp is your ordering cost, and Ch is the carrying cost.
Let’s break down what each of these components means…
Customer demand depends on a variety of factors, both external (seasonality, trends) and internal (marketing and promotions, pricing strategies). Ordering costs are typically stable, however, they can decrease as you order inventory in bulk.
And the holding cost, also known as carrying or storage expenses, also vary depending on how much inventory you have. This includes expenses associated with maintaining the space, interest on money borrowed to purchase stock, or shrinkage. You may also have higher insurance rates if the value of your stock is greater. Therefore, the more product you have, the higher those holding costs may be per product.
- Retailers who have mastered accurate forecasting and want to minimize inventory-related expenses
5. Gross margin return on inventory investment (GMROI)
The GMROI method of inventory management divides sales by the average inventory cost over a period of time and is multiplied by the gross margin percent. This figure shows how much money you’re bringing in for every dollar spent.
Andy Curry owns a True Value Home Center retail store in Colorado. He inherited the GMROI method to inventory management along with the business. At first, he was skeptical, but he’s since seen the value in this approach.
He looks at GMROI numbers both storewide and by department at his hardware store. “What really counts is using GMROI to measure your departments,” he says. “Then you can get to the root of stock issues. When you run a GMROI check by department, the problem will stick out like a sore thumb.”
From there, you can assess the cause of the issue and how to address it.
- Retailers that want to a high-level view at the health of their stock, as well as an opportunity to look at the data broken down by department or product line
- If you suspect you have stock issues and want to identify the source
Want to calculate your GMROI?
Vend’s Excel inventory and sales template helps you stay on top of your inventory and sales by putting vital retail data at your fingertips.
We compiled some of the most important metrics that you should track in your retail business, and put them into easy-to-use spreadsheets that automatically calculate metrics such as GMROI, conversion rate, stock turn, margins, and more.Learn More
6. ABC analysis
The ABC analysis approach to inventory management helps you prioritize products. Essentially, you’d categorize each product under one of the following:
- A (high-value products, low sales frequency): These products have a greater financial impact on your business, but they’re more difficult to forecast because they’re not in high demand. They will require the most attention in your business.
- B (middle-value products, average sales frequency): Predictably, products categorized as the letter B fall somewhere in the middle in terms of priorities.
- C (low-value products, high sales frequency): Because these products move off the shelves more quickly and easily, they’re easier to predict. They also generate sales that are less impactful to your bottom line, so they require the least amount of attention and maintenance.
Any products categorized A are your most valuable and important products, while C falls at the bottom of your priority list. First, focus on your As. Why aren’t they moving fast enough? Is your pricing off? Do your customers know about the product? Are you marketing them to the wrong customer segments? Closely monitor your A products, as forecasting is essential to making sure you don’t lose money to overstocking. And you definitely don’t want to run out of a product that you have fewer chances to sell.
Next, look at your C products. C products are typically more self-sustainable, but it’s important to monitor your profits here. Are these products making you money? And is it worth it to keep selling them?
Finally, B products fall somewhere in the middle. When you’re tracking B products, there’s a potential they’ll turn into A or C products, at which point you’ll need to pay more attention.
- Retailers who want to understand which products are sitting on the shelves for too long
7. Fast, slow and non-moving (FSN) analysis
The FSN inventory management system is another classification of what you have in stock. Similar to the ABC analysis, you’ll go through your list of products and identify them in one of three ways:
- F (fast-moving stock): These products have sold the most and spent the least amount of time on your shelves during a certain period of time. You may be able to increase the price point for these products.
- S (slow-moving stock): Products that have sold more slowly and spent more time on the shelves during that same period of time. You may want to reconsider the marketing and pricing strategies behind these products.
- N (non-moving stock): Stock that hasn’t sold at all and is still sitting on the shelves during that period of time. You may want to consider discontinuing these items.
- Retailers that want to better understand the shelf life of their products
8. Open-to-buy (OTB) inventory planning
OTB inventory planning, also known as merchandise management, helps you understand how much stock you can purchase in the near future without major risk. OTB accounts for inventory planning considerations such as sales and promotions, normal customer demand, and current and planned stock levels.
The formula to find out how much inventory you can afford to purchase is:
Planned sales + sales and markdowns + planned end-of-month inventory – beginning-of-month inventory
OTB is typically calculated monthly, and retailers who use this method are often more nimble. Because it requires less commitment and investment, you can move product more quickly. And if your customers don’t like a product, you don’t need to restock it. This also helps you stay on top of stock levels more closely.
“Consider maintaining an OTB plan for your business as a whole, but also plan for each category of merchandise you stock,” recommends The Balance. As OTB tells you more about how much to buy and less about which products to buy, breaking it down by category can help you get more of those product-specific insights.
- Retailers who sell seasonal products (apparel, cosmetics, home goods, etc.) and frequently bring in products at the start of the season and put them on sale at the end of the season
- Stores that want to keep inventory fresh, new and exciting for customers
If you need more advice on counting and reconciling your inventory, 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
Inventory management tips for retailers
Choosing an inventory management method(s) to implement in your retail business is only half the battle. You’ll want the proper tools and processes to ensure your inventory data is accurate, updated and accessible.
Equip your business with the right inventory management tools
From choosing the right inventory management software to finding a POS solution that fits your biz, it’s essential to implement tools. The right ones will integrate together to streamline and automate processes, making inventory management more accurate and efficient.
Stay on top of inventory counts
Regular audits and cycle counting will help you keep an eye on your inventory and maintaining accuracy. Be sure to conduct physical inventory counts and compare the data to what you have in your software and tracking systems. Any discrepancies will reveal potential issues for you to look further into.
(Tip: Avoid using a pen and paper when counting your items, as they can easily lead to human error. Instead, use a tool like Scanner to digitize your counting process.)
Set par levels
“PAR” actually stands for “periodic automatic replenishment” — and it is when you set minimum stock levels for specific products or product categories which you’d like to maintain. These stock numbers should be based on customer demand and inventory turnover. Many inventory management software options can automate reorders when products have hit your established par levels.
Nail your forecasting
Again, implementing the right tools and ensuring your data is accurate will help you forecast more accurately. This is absolutely essential to maintaining inventory levels that meet customer demand and help you turn a profit. Consistency is key here: If you forecast via a different means or use different data each time, you’re likely to encounter some discrepancies.
As you can see, there’s no one best technique for staying on top of your inventory. The right method for your business will depend on your products and processes, among other things. If you’re not using an inventory management technique in your retail business, consider trying some of the ones we discussed here and see what works for you.