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DEEPER DIVES: The Cost of Poor Inventory Management

DEEPER DIVES: The Cost of Poor Inventory Management

How better inventory control leads to lower costs and happier customers

John McClymont
September 15, 2024

Good Morning,

First, as always, thank you for joining.

Welcome to all of the new subscribers. Last week’s newsletter blew up and there are A LOT more of you getting insights that I don’t share anywhere else.

We’re already half way through September, and you can feel the tension around peak season. Tons of misguided information seems to be going around, as everyone is needs to bolster their activity base (especially with the HUGE 321 announcement from the White House).

Newsletter topics can vary a lot week to week. Don’t forget to check out the archive of past issues if you’re looking for information on a different topic.

And, as always, if you have something specific you’d like to see me write about, you can let me know here.

Here’s what this issue brings:

Inventory 101

This issue is all about how to think about your inventory and costs. Everyone is trying to sell something these days, but don’t get fooled.

If what you are buying (or what you are selling) can’t handle most of these different needs, it isn’t worth it.

Don’t believe anyone trying to sell you the easy button, real success is in the details.

Improving Your Fulfillment with Strategic Inventory Control

Inventory management isn’t talked about enough these days.

Most of the time, retailers and D2C brands are bombarded with non-stop chatter about diversification.

While I support risk mitigation by leveraging different fulfillment strategies, the truth is that there is no one-size fits all solution when it comes to executing (for your business) at excellence.

And while most people manage inventory behind the scenes, it’s one of the biggest factors when it comes to your customer experience and controlling costs.

Having a solid grip on inventory helps you avoid the mess of stock-outs or excess stock.

Here’s an inventory 101 to help you execute more effectively each day.

Why Inventory Matters

Your inventory will be one of your biggest assets.

For most companies in the retail or consumer packaged goods (CPG) space, your materials and finished goods will usually be 20% to 40% of your costs.

How you manage it directly impacts your profitability. When you get it right, you free up capital, improve your cash flow and dramatically reduce your carrying costs.

And since customers can only buy what’s in stock, it’s the number one driver when it comes to maximizing your sales and improving customer satisfaction.

When it’s done wrong however, you end up fighting fires on two fronts. First you have stock-outs that result in lost sales, frustrated customers and slower fulfillment speeds. On the other hand you end up with excess inventory that leaves your money tied up in finished goods, increasing risks of the market shifting leaving you stuck with outdated and less valuable inventory to sell.

The Purpose of Carrying Inventory

Here are the four main buckets that your inventory should be in:

Regular (or cycle) Stock

This is your core order and the baseline for your planning. A business’ regular inventory is what helps lower costs by taking advantage of bulk orders and long production runs. But just because ordering more can lower your per-unit costs, overstocking will tie up unnecessary capital if you don’t sell it fast enough to meet your next planning cycle.

Safety Stock

This acts as a buffer against demand fluctuations or supply chain disruptions. The absolute BIGGEST mistake that people make is lumping these inventory levels into their regular stock calculations.

Always calculate and monitor safety stock levels as their own entity.

The right level of safety stock is unique for your business and depends on variables like lead time, demand, and your desired service levels.

Seasonal Stock

When you know demand will spike during certain seasons, like holidays, having the right amount of seasonal stock on hand avoids having to react quickly and make last-minute adjustments.

Another important point is that “seasonality” for your business doesn’t have to just be related to the weather.

Seasonality in your sales patterns should be considered as any peaks and valleys that happen regularly over time for your business or industry. The better your data recording, and the more you have, the better you will be able to forecast the seasonality of your business.

Transit Stock

This one is simple. These are goods in transit.

Managing this stock efficiently will make sure your supply chain keeps moving smoothly without unnecessary delays.

Breaking Down Inventory Costs

In the same way that you track your physical inventory in specific buckets, you should be doing the same with your costs.

While some are easier to capture than others, the better you can track these different stages, the better understanding you will have and the higher your profitability will be.

Carrying Costs

These can run anywhere from 20–30% of your inventory value annually.

They include capital costs (the opportunity cost of having cash tied up in stock), storage costs (like warehousing and handling), risk costs (damage or obsolescence), and service costs (like IT systems).

Regularly optimizing your warehouse operations, reviewing your (or your provider’s) performance, investing in technology or rationalizing your SKU count can all help reduce these expenses.

Ordering Costs

Every time you place an order, it costs money.

And it’s not just the cash that goes out the door for the PO. It also includes things like admin expenses, setup costs for production, and the receiving and inspection processes for your products.

This is why there is often so much effort put on streamlining and consolidating orders. Since a lot of these costs are more fixed than variable, consolidating activity often cuts these costs.

Stock-out Costs

Trying to track your stock-out costs is one of the hardest things to track.

These are things like lost sales, potentially lost customers, expediting costs, and downtime in production.

Since most systems struggle to capture failed orders (or will track them completely independently of re-orders or delayed shipments), data accuracy is a huge issue.

While solid demand forecasting and real-time inventory tracking will help, this is definitely an area where talent and deep business understanding give you an edge.

In-Transit Carrying Costs

Goods in transit still cost you.

By optimizing transportation routes and choosing the best modes, you can reduce these costs and keep your supply chain running efficiently.

Key Considerations for Direct-to-Customer Fulfillment

eCommerce is soaring.

It has given so many businesses the opportunity to be discovered and compete.

But managing inventory in direct-to-customer fulfillment comes with some unique challenges.

Inventory Placement

Should you centralize your inventory in one warehouse or spread it across multiple locations?

That’s probably the biggest question on every D2C company’s mind these days.

Centralized inventory is more cost-effective but can slow down delivery.

Using multiple warehouses will reduce shipping times (and cost), improve customer satisfaction, and potentially drive more sales but comes with higher capital investment and adds a lot more complexity to managing inventory multiple at locations.

The majority of D2C brands should probably use a one-warehouse fulfillment strategy.

There are definitely considerations that could influence this when your sales are under $10M however.

What I often recommend is a much more targeted strategy where you use secondary facilities in key markets to sell your best stuff (or items that have a high regional penetration).

Replicating your full inventory line (unless you only carry a handful of SKUs), usually becomes a huge burden to bear.

Safety Stock Management

Keeping safety stock levels balanced is essential.

You want enough inventory to avoid stock-outs, but too much can tie up capital.

Regularly updating your safety stock based on real-time data is key.

Focus on high-impact items and collaborate with suppliers to improve lead times, which can reduce the need for extra stock.

Inventory Visibility and Integration

These days, the biggest gift you can give to your business is real-time inventory visibility.

It prevents both overstocking and stock-outs.

You need systems that integrate across the warehouses and your sales channels, and unfortunately, this isn’t always cheap.

The bright side is that the more strategically you invest in strong inventory management systems, the better off you will be as your business continues to scale.

Demand Forecasting and Seasonal Planning

Align your inventory with actual customer demand to avoid the twin problems of stock-outs and excess inventory.

This sounds so simple, but it’s crazy how often this DOESN’T happen. Too many times people get locked into their shiny software or elaborate process and refuse to acknowledge the customer behaviour happening in front of them.

Use historical sales data, market trends, and advanced analytics for better forecasting.

Create open and collaborative processes with your sales, marketing, and supply chain teams to stay aligned, and continuously compare your forecasts to actual sales.

The real key to success here is brutal honesty.

Cost Management

To maintain profitability while meeting customer expectations, you need to manage costs carefully.

No matter what anyone tells you, operations can go from black to red in a heartbeat if you aren’t paying attention.

Distributing inventory across multiple locations can raise costs, so use tools like the Economic Order Quantity (explained below) model to find the most cost-effective order size.

Also, consider other types of supply models like Just-in-Time (JIT) if your product allows for it.

Vendor-Managed Inventory (VMI) arrangements can also provide advantages that stem from your product expertise and ability to accurately forecast for your market.

Returns Management and Reverse Logistics

This is probably the hottest topic in retail these days.

While there are a ton of new options on the market for how you handle your returns, there is one rule above them all that will keep your business as healthy as possible.

Do whatever you can to stop returns at the source. There is no level of efficiency of handling or systems processing that will allow you to outrun bad sales.

But, no matter how well you qualify a sale, returns happen.

So….

Focus on efficiently processing returns.

Whether you do this through a centralized returns center or use automated systems, reducing complexity is paramount.

Make sure you can track why products are being returned, from who, in what condition, how soon after delivery, etc.

Use the information and insights you collect to continuously tweak and make adjustments to reduce return rates in the future.

Your return rate goal should be the same as your workplace accident goal.

0%.

You’ll never hit it, but it should always be what you are working towards.

Outsourcing to 3PL Providers

While outsourcing to third-party logistics providers offers scalability and access to advanced systems (and expertise), it also reduces your direct control over inventory.

Be sure to work with 3PL partners that have experience in your industry and have a strong reputation for QUALITY.

Make sure to set clear service-level agreements, and integrate their systems with yours for real-time data sharing.

Don’t go cheap with integrations. It takes longer and might be more expensive, but do it right the first time to get maximum benefits.

Enhancing Customer Experience with Inventory Management

Great inventory management leads to a better customer experience.

There isn’t one customer anywhere that has praised a brand for the item they wanted being out of stock.

Having the right products available when customers need (or want) them increases loyalty and helps build a solid reputation.

With the majority eCommerce sales these days, you only get one shot to stand out when that customer places their first order.

Offer accurate delivery times, flexible fulfillment options, and personalized product recommendations whenever possible.

Never offer a product to a customer that is out of stock.

(Personal note, to this day, every time I use the Wayfair site I shake my head at the fact that “show in stock items” isn’t checked by default. Never get a customer’s hopes up and have them excited about finally finding the right product to then show them on the next screen it’s out of stock / unavailable!)

Effective Inventory Strategies

The following strategies help optimize inventory levels and cut costs. Choosing the right one is dependent on your business, product, customer base and market.

Economic Order Quantity (EOQ)

This helps you figure out the most cost-effective order size by balancing ordering and holding costs.

Make sure to update your EOQ calculations regularly to account for changes in demand, costs, or lead times.

Here’s a detailed breakdown on this process from ShipBob.

Just-in-Time (JIT)

Despite the bad press this got during COVID, it remains one of the most effective ways to manage and control inventory.

Reduce holding costs by receiving inventory only when it’s needed. This approach keeps your inventory lean but requires close coordination with suppliers to avoid stock-outs.

A 3 minute video overview of the concepts of JIT.

Materials Requirements Planning (MRP)

MRP helps plan your inventory and production schedules by calculating the components needed for finished goods.

Now, while you may not think that this is something you need to manage too heavily (since pretty much everyone outsources manufacturing), making sure that you are controlling the flow of goods dramatically increases your results.