What is Inventory Optimization?
Inventory optimization is a set of best practices for organizations wanting to use less capital while maintaining a saleable inventory. This is a vital part of inventory management that factors in the volatility of supply and demand. It is a method of balancing investment constraints against business objectives and fulfillment targets across a large variety of inventory stock-keeping units.
Inventory optimization keeps warehouses and supply chains in business and helps maintain business liquidity. It helps businesses know exactly what amount to buy for stock-keeping units, enables them to have it readily available for timely order fulfillment, and reduces excess inventory that becomes obsolete in the long term.
The Key Ingredients of an Inventory Optimization Formula That Works
There are a few key parts to a successful inventory optimization process:
- Forecasting demand by going digital
- Standardizing inventory policies
- Managing product life cycles for all SKUs
- Accounting for uncertainties in supply and demand
- Overseeing supplier lead times, delivery patterns, or schedules
- Tracking changes in buyer behavior
- Factoring in seasonality and promotional campaigns
Forecasting Demand
Accurately forecasting inventory amounts to stock for the next sale cycle is a crucial element of inventory optimization. To reach ideal figures, companies should factor in account sales data, inputs from a sales force or on-the-ground personnel, and the previous year’s supply and demand data.
To best optimize, companies should be on the alert for any shifts in trends or technological advances that could render a product obsolete. Avoid being stuck with unsaleable inventory and capital losses. Machine learning can assist in many ways--from fast assessments of previous year’s data to predictions about current sales volume.
Establishing a Well-Thought-Out Inventory Policy
An inventory policy ensures employees identify and accurately label the most important stock-keeping units that bring in cash flow. Essentially, an inventory policy is an optimization tool that keeps tabs on the inventory items that are indispensable to business or production.
To best optimize, it is necessary to follow standard practices like ABC or XYZ analysis:
ABC analysis helps classify inventory items based on their “consumption value.” It is the total value of the item consumed over a specified period and is usually calculated on an annual basis.
The “A” parts have the highest consumption value, followed by B (intermediate), and C, which sees the lowest consumption.
Furthermore, the 80/20 rule, also known as the Pareto Principle, applies here. It proposes that 80% of the consequences come from 20% of the causes. This means that A parts, as they are the highest percentage of parts consumed, form the lowest percentage of inventory stock and C parts make up the highest percentage of inventory stock.
XYZ analysis comes in handy while classifying inventory items per the variability of their demand and how reliably their future needs can be forecasted.
The X parts, which show the least variation in their demand, can be the most reliably forecast. The Pareto Principle is in play here as well. The X parts account for the largest percentage of inventory value, but the lowest percentage of inventory stock. Conversely, the Z parts are those that comprise the highest percentage of inventory stock, and therefore the lowest range of inventory value.
Following the Product Life Cycle
Whenever a new product hits the market, it creates future demand based on the impact it generates and the popularity it garners. The novelty factor confers a first-mover advantage to the seller, with demand for the item growing exponentially till it plateaus into a stable, bankable stock-keeping unit. The time limit here could be finite, except for certain evergreen products that are constantly in demand. For others, the sales may become sporadic before veering into a negative demand trend and finally dying out.
Every seller must be able to have a read on the correct stage of the product life cycle for every stock-keeping unit. Knowing where your products are right now will help you figure out where they are logically headed, and which ones to keep in stock and which ones to drop. This confers an incredible advantage in inventory optimization.
Accounting for Uncertainties in Product Supply and Demand
Suppliers or sellers can no longer request for customers to wait for an unavailable item. With aggregator websites and eCommerce marketplaces, businesses are put on equal footing and a company’s inability to supply turns into another’s competitive advantage.
Small-to-medium businesses are especially at risk for customer churn if they are unable to stock or restock at the rate of larger enterprises with more extensive supply chains. Therefore, having a network of reliable vendors is highly important, as is maintaining backup methods to procure stock-keeping units. Staying on top of supplier lead times, delivery patterns, and schedules goes a long way in managing item availability for customers.
Going Digital- Automating Inventory Management is Inevitable
Adopting automated inventory management (over outdated modes like Excel) is one of the smartest moves small-to-medium businesses can make to level the playing field against larger competitors. Manual inventory management can cause errors, ranging from minor to colossal. Fallout can range from delays or poor service ratings, to a large amount of un-saleable inventory and freezed capital. Traditional retailers, e-tailers, and eCommerce practitioners can all benefit from automating and upgrading their operations.
The Internet of Things (IoT) is transforming the way retailers traditionally operate. In the inventory management and inventory optimization sectors, innovative technology such as smart shelves make better business outcomes. For example, these technologies provide real-time notifications on sales figures and alerts when any stock-keeping units begin to fall below the reorder level. Manual errors are eradicated, and smart technology prevents overstocking and shortages. Inventory optimization keeps cash flow ongoing, avoids excess inventory, and slashes storage or maintenance costs.
Following Buyer Behavior and Tracking Trends
Haven’t sellers often wished that they could get a glimpse into the minds of their customers? Automated inventory management, at the touch of a button, can provide data and detailed reports. Data and analytics are an irreplaceable tool in the arsenal of modern-day sellers to peek into the minds of their consumer base. Data and behavioral analytics can help retailers predict what items from their inventory will sell and what items should be phased out.
Tracking purchase trends also offers insight into what items can be unloaded through promotions, sales, and campaigns to generate steady or quick cash. This new capital can be invested in acquiring trending items that maximize sales.
Factoring in Seasonality and Promotional Campaigns
Seasonality can be tricky to navigate for retailers. A tartan coat may have been all the rage one season, but fades quickly from the fashion scene (and public memory) by the time the next winter rolls around. Though fashions are cyclic, putting unsold merchandise in storage can drive up maintenance costs and hold capital. This is one area where forecasting is complex and can hinder inventory optimization.
One way to unload excess inventory is through “end-of-season” promotional campaigns, which is another important tool for inventory management and optimization in retail.
Advantages of Inventory Optimization
While inventory optimization is vastly helpful in the best of times, unpredictable economic ebb and flow shines a spotlight on how companies should invest in inventory optimization.
The greatest advantage of inventory optimization is an unblocked cash flow.
Inventory optimization greatly reduces costs associated with owning, storing, and managing an organization’s inventory, particularly in the context of warehouse and overhead expenses. With rising fuel costs, shipping costs are also on the rise. Taxes and rents can reduce a significant portion of business revenue.
Inventory optimization helps establish an amount of inventory that is “just right.” While expected demands are securely met, costs go down and the retailer has a better degree of control over what new inventory to purchase and when. Forecasting and planning inventory purchases ahead of time provides a significant buffer against the challenges of shipping and sourcing.
Inventory optimization generates a high-performing inventory that has the maximum potential for great financial turnover, providing a steady stream of cash for businesses.
The endgame for any retail enterprise is generating an ever-growing base of happy and returning customers that forms the lifeblood of the business. With an optimized inventory management system, it is possible to streamline other aspects of the business and gear them towards timely order fulfillment, which, in turn, fuels customer delight.
In unpredictable times, the disruption of long-established supply chains can destabilize foundational brands. Inventory optimization is a safety net in unpredictable economic climates.
In manufacturing and technology, optimizing raw material, supplies, and technology infrastructure can lean out functioning until a steadier demand is established. The uncertainty of customer demand is challenging established manufacturing or distribution forecasting models. Leaning inventory during unpredictable times (by unloading excess stock or putting new purchases on hold) is a prerequisite for better operational performance and financial returns when the situation improves.
Challenges in Inventory Optimization
Recent trends in inventory and supply chains have created challenges for new and established businesses.
Inventory Optimization to Prevent or Offset Supply Chain Disruption
A major challenge to retailers and manufacturers is supply chain disruption due to factors like global lockdowns and natural disasters. Inventory optimization processes will have to contribute to making supply chains as robust and unbreakable as possible to prevent stock outages and to ensure that consumers continue to get whatever they need when they need it.
Catering to Volatile Consumer Demand
Another challenge is keeping up with changing customer preferences. What retailer has not experienced a time when a product became an overnight sensation? In such situations, those who have it in stock already have struck gold. Those who do not have the product find themselves facing higher costs of acquisition. When the trend dies out quickly, retailers can be left with dead stock. Though it seems like a daunting proposition, businesses should accurately optimize inventory through forecasting tools and techniques to avoid inventory issues.
Maintaining an Order Fulfillment Momentum
Operational challenges and supply chain disruptions effectively upset the workings of inventory management. As a result, inventory personnel are caught between the challenges of maintaining sales, replenishing stock, and moving stalled inventory--all while keeping customers satisfied. Businesses that lack automated processes for inventory optimization will be saddled with an increasingly frazzled workforce, resulting in more human errors and unhappy customers. Automation gives businesses a competitive edge in inventory optimization and a shield to protect against whatever crisis is brewing next.