5 Ways to Reduce Your Inventory the Right Way
As every wholesaler, distributor and trader can tell you, holding a physical stock is a major bugbear of their business model. Unlike Software as a Service providers such as EMERGE App, traditional businesses need to purchase and store stock before they can sell them, hopefully, for a profit. But sometimes it doesn’t always work out this way.
It is this time between purchasing stock and re-selling them that is critical for these businesses. Hold more stock than you need and you’ll start to see tangible and intangible costs eat into your profits. Conversely, hold too little stock and your customers will see long lead times on their purchases. Frustrated customers will swing their orders to your competitors.
Here, we’ll start by covering what reducing your inventory means. Then we’ll summarise some inventory holding costs that you might not know about. Finally, we’ll cover 5 ways that you can take to sensibly reduce your inventory now.
What Does Reducing Your Inventory Mean?
Reducing your inventory means just that. It’s about reducing the quantity of stock held for each product variant in your inventory. Unfortunately, it doesn’t mean reducing or shrinking the physical size of your products! It means trimming your holdings of stock so that it doesn’t have an impact on your sales, and reduces your holding costs at the same time.
Think of it as spring cleaning for your warehouses. Over time you’re going to have lots of data that tells you about your best sellers. And you’re going to have a couple of duds and flops, too. Hopefully not too many of these. So, reducing your inventory here involves going through each and every product and looking at their sales performance.
What Are Inventory Holding Costs?
We wrote a comprehensive blog post about inventory carrying costs. They are the total cost of holding inventory by your business. These include expenses to store the inventory such as rent, utilities and warehouse salaries. Less obvious ones are economic costs such as opportunity cost. Finally, there are inventory costs such as shrinkage, expiry, and insurance.
So, why should you be worried about carrying costs when there are already marketing, sales and logistical challenges in selling the stock? Simply put, inventory carrying cost measures how long inventory can be held before you make a loss. Typically, carrying costs make up one-quarter to one-third of the inventory’s value. This is a sizeable sum that cannot be ignored.
How Can I Reduce My Inventory?
1. Embrace Good Habits
Secretly, we like to call this Inventory Management Hygiene. Huh, inventory management what? It’s about adopting good, clean habits from the very beginning so that bad habits don’t come back to haunt you. It’s very hard to undo bad habits when employees and workflows are set and ingrained. Nip the problem in the bud by starting on a good foot.
A. Apply FIFO Principle
FIFO means First-In, First-Out. That is, the first goods that you purchase are the first ones to be sold. The beauty of FIFO is that it makes perfect business common sense. As a business owner you would want to sell your oldest goods first to beat expiry dates, obsolescence or the changing winds of technology and fashion.
The goods news is that modern order, purchase and inventory management systems such as EMERGE App are ingrained with the FIFO principle. In fact, we want to make sure that all businesses, new and old, are adopting the right inventory management principles from the start. Hence FIFO is well and truly built into EMERGE App.
B. Use Perpetual System Inventory
The perpetual inventory system is something that is rarely spoken of with the same intensity as say NFL or EPL football. But surprisingly it makes its presence felt in every modern inventory management system such as EMERGE App. You’re already using it and it’s taken for granted when you’re using sophisticated inventory management software.
What this means is that your inventory records are updated and recorded in real-time. Isn’t this something that we expect of software anyway? But I’m sure you’d be surprised to hear of other alternatives! Yes, it’s called the physical inventory system in contrast. This involves stopping your business and counting your inventory one-by-one in order to know the actual quantity on hand.
2. Tweak Your Business Model
Tweaking, pivoting or changing your business model isn’t going to work for everyone. This is a fundamental change in the way your business works and operates. They might read better on screen but work out horribly for your business. So, use your common sense and don’t apply a new business model for the sake of doing so or because everyone else is doing it.
A. Sell on Consignment
We’ve also written at length about consignment sales. This is where a retailer agrees to sell a product and store it in their warehouse. However, the supplier still owns the product until it is sold. Once sold, the retailer will then “purchase” the product. Also, until the products are sold, retailers can return products back to the supplier.
Take a good look at your products first before you think of consignment sales. Are your products suitable for the rough-and-tumble world of retail consignment sales? Will your brands be affected or diluted by consignment inventory? Will the retailer really store the goods properly and display them at an attractive eye level for consumers?
B. Adopt Drop Shipping
We’ve covered drop shipping in the past. It experienced exponential growth, only to taper off recently. Today, we can all agree that drop shipping still has a part to play in the fulfilment of certain goods. However, it’s not for everyone and customers may be put off guard by their purchases being shipped from abroad along with lengthy shipping times.
We’d like to say that drop shipping truly is in its element for fast moving consumer goods that are not too valuable. Just think of mobile phone screen protectors and cases. This market changes monthly with every new iterative release of a phone. And past models become rapidly obsolete with every new season. Are you still shopping for a phone case from 2017?
C. Try Just in Time
We saved the best for last as it won’t fit every business. Just-in-Time or JIT is a Japanese manufacturing methodology that minimizes the inventory of raw materials and semi-finished parts. As such it was best suited to heavy manufacturing such as cars and equipment. Every player in the supply chain must be able to supply inventory when called upon.
Unfortunately, this may not be the case in countries outside of Japan. The Japanese manufacturing industry has historically been dominated by very large manufacturers with an equally large number of sub-contractors and family-run suppliers supporting it. It requires that everyone works with clockwork precision and supply chain harmony.
3. Change Your Purchasing Patterns
One thing that you can change for the better is your purchasing pattern and habits. After all, this is where to start to identify what and how much of each product that you’re going to buy. Making informed decisions is critical to manage the ebbs and flows of your cash flow. The more business intelligence you have about purchasing patterns, the better.
A. Use ABC Analysis
ABC Analysis is a simple inventory categorization technique. It divides your inventory into three categories:
- A items with very tight control and accurate records,
- B items with less controlled and dependable records, and
- C items with simple controls and minimal records.
Why should business owners apply ABC Analysis in their free time? In effect it’s a way of identifying stocks that have a significant impact on your overall inventory cost. Each category of stock will require different management and controls in the business. This way you spend the right amount of inventory control and expenses on the right stock.
B. Calculate Economic Order Quantity
Economic order quantity or EOQ is the order quantity that minimizes the total costs of your inventory in a business. As mentioned earlier, these costs of inventory include holding costs, order costs and shortage costs. However, EOQ has its roots in economics and the formulaic approach may not work for your business.
EOQ assumes that the demand for a product is constant over a year, and that each new order is delivered in full when inventory reaches zero. However, this is unrealistic when your stock faces seasonal and holiday fluctuations. Also, in EOQ there are no inventory shortages or related costs as there is instantaneous replenishment of stock. But, what about slow-moving, high-value luxury items?
C. Increase Purchasing Frequency
Your historical sales data can tell you the least amount of stock you can hold to meet your sales. This is your safety stock level. But, holding a minimum level of inventory also means increasing your purchasing frequency. You’re buying a lower quantity each time but much more frequently. However, the MOQ from your supplier may not allow this.
D. Set Inventory Reorder Points
Setting up inventory reorder points means calculating how low your inventory can go before you issue purchase orders to replenish them. This is a little dicey as you’re minimizing how much stock you need to purchase each time at the expense of experiencing stock outs. You also need to factor in the lead time for orders from your supplier.
4. Reduce Physical Levels of Stock
Here, it’s about good old fashioned trimming of the fat in your business. The excess here is, of course, your stock inventory level. How do we know which ones to cut and which ones to keep? Whim and fancy won’t work here. You’ll want at least a year or two of sales data to make any meaningful decision. And you’ll be going through your inventory with a fine-toothed comb.
A. Trim Dead Stock
We’ve written extensively on dead stock and how to deal with them. Of all the stock that you’re holding dead stock is the most toxic. These are products that haven’t sold in the past 12 months for various reasons. Some reasons could be obsolescence, damage or faulty design. They’re taking up valuable warehousing space that you’re paying for.
The best way to deal with dead stock is to dispose of them and move on. There’s very little you can do when you’re dealing with dead stock factors beyond your control. You cannot turn back trends to fight obsolescence, for example. So, swallow bitter medicine and take measures to dump your dead stock now. Write them off and move on.
B. Practice SKU Rationalization
Without knowing it, you might be suffering from SKU overload. This means getting products in every possible variant and creating an impressive multi-matrix product table in the process. But do you really need to stock products in every possible size, colour and configuration? It’s likely that you’re carrying more products that you actually need.
Ideally, you should be doing SKU rationalization every 6 months as part of your Product Life Cycle Management. This means revisiting your marketing strategy, fine-tuning your product catalog, understanding your customers better, and forecasting product switching and cannibalization. Ultimately you want to balance incremental sales with inventory carrying costs.
C. Improve Forecast Accuracy
Also, an inventory management app produces historical data. Lots of it. It is said that to forecast the future, you need to understand the past. The same could be said of making sales forecasts and thus your purchasing strategy. From historical sales data, and allowing for seasonality, you can attempt to extrapolate sales and forecast the future.
5. Talk (Nicely) To Your Suppliers
Now that we’ve covered the buying side of your business (you), how about the supply side (your suppliers)? You might be able to change your buying habits but can you change how long and how much your supplier insists on selling to you? Yes, you can with a smile and at least a decent history of purchases from them!
A. Negotiate Minimum Order Quantity
As we’ve mentioned elsewhere, suppliers have the upper hand when they set down their MOQ. It’s there way of telling you politely that this is the least amount of business expected from you. No MOQ, no talk. You can go elsewhere if you can’t fulfil their MOQ. However, this means that you effectively need to purchase more than what you really need in inventory quantity.
Let’s get this straight first. You’re not going anywhere with reducing MOQ if this is your first order from a supplier. They will gladly take orders from your competitors if you can’t meet their MOQ. So you need to build a credible business relationship at first. Go along with their MOQ for at least a couple of orders and get the gist of things. Build relationships then you can ask nicely.
B. Reduce Supplier Lead Time
Supplier lead time is the time taken to fulfil your purchase order. This is calculated from the time they receive your order to the time you actually receive in your warehouse. This period of time can wreck havoc with your reorder points if you’re depending on them to reduce your inventory. Your supplier needs to consistently deliver on time, every time. On the other hand, you can increase your order frequency to order less stock as well.
With these 5 ways of reducing inventory in hand, you’re ready to tackle your inventory holding costs in a sensible manner. Remember, take a good look at your business first before applying any change. And don’t do it for change’s sake. Will it work for your business? Will it backfire? How else could you approach your excess inventory issue? Grapple your inventory levels with open eyes and you’re on the way to reducing your inventory the right way.