This post is by Vera Lim, an Inbound Marketing Manager with TradeGecko.
When people start a new ecommerce business, managing their inventory is often the last thing on their minds. Most will find themselves spending the bulk of their time and attention on getting their brand recognized enough to break through the clutter of the internet. It’s easy to overlook the importance of inventory management: getting the right products at the right place at the right time.
As an online retailer, what you’re gunning for is to ensure that you’re stocking more fast moving goods that are making up the bulk of your sales, and less of stuff that doesn’t seem to sell so well. At the same time you’d want to make sure that you have enough stock to match forecasted customer demand at any time.
You’ll want to get inventory management right, because most companies invest the bulk of their capital in inventory. Just think about it: first you’ll need to purchase products, then you’d have to figure out how much storage you need and how much to spend, followed by devoting time and effort to setting up an inventory management system.
Ultimately, efficient inventory management plays a huge role in your business’ success.
In the early stages of a business, most entrepreneurs begin their inventory management journey with spreadsheets and paper. Yet as your business grows, the inadequacy of spreadsheets soon becomes clear. The more products you have, the harder it becomes to scale spreadsheets to keep up. For older businesses, it’s not surprising to see rows of shelves dedicated to files and files of records.
Because of the time these processes take, businesses tend to adopt a periodic inventory system, which keeps count of inventory changes at specific intervals (e.g. weekly) because it’ll take too much time to do these calculations at the end of every work day! But only tracking inventory changes at specific intervals reduces your visibility and control over your inventory. As a result, by the time you’ve figured out that the numbers don’t tally, it’ll be harder to track the exact point where the error occurred.
If you’ve experienced the above scenario, it’s probably time to switch to an inventory management software solution. With this, you can make the transition to a perpetual inventory system that tracks the movement of inventory in real time, providing accurate reflections of the level of goods on hand at all times. Inventory management software provides better visibility and control, ensuring that you’ll be able to track down the origin of any errors you encounter, and take the appropriate steps to remedy the situation.
Getting started with inventory management
Everything starts with having strong foundations… including your inventory. For a start, you’ll have to devise an alphanumeric Stock Keeping Unit (SKU) system to keep everything in check. SKUs are product codes that allows you to search and identify stock on hand from orders and invoices. They also let you easily track your inventory right down to individual variants of every product (i.e. color, size, etc.).
Having a good SKU system also minimizes opportunity for theft. In a warehouse filled with thousands of products, missing items may go unnoticed. But when products are narrowed down to SKUs that denote a far smaller number of items… it becomes harder for things to disappear.
You want your SKU system to improve the responsiveness and effectiveness of fulfilling orders, and some ideas to take into consideration when creating your SKU system include:
- Making them easily understandable: Your SKU system is a way to record important product information, so use letters where applicable to denote color. size, type, and seasonal variants.
- Arranging characteristics according to importance: Think of how you would describe a product in order of defining characteristics – beginning with the year/season can help you easily restrict the search to the right period, followed by less distinctive attributes like color and size.
- Avoid using letters that look like numbers, along with spaces, accents, and symbols: This is pretty straightforward. Using spaces, accents, and symbol can confuse your inventory system and result in unintended consequences.
With a good SKU system, you’ll be able to determine the popularity of different products and their variants, enabling you to make better business decisions. A good way of putting this into practice is through the ABC analysis: A-items are the top sellers with the highest annual consumption value, followed by B-items of medium consumption, and finally, C-items of low consumption value.
ABC analysis can help you to decide which products are worth investing in, and which aren’t. Inventory management software can provide specific insights into this through sales order reports, as opposed to spreadsheets and paper, which only provides retailers with a rough idea of what’s doing well and what isn’t. This works well in relation to the Pareto principle, which states that 80% of the overall consumption value is based on only 20% of the items. Once you’ve drawn up a graph and taken a close look at what your top performers are, it’ll be easier to organize your inventory to reflect this.
- As your top performers, A-items need more attention through better inventory control and sales forecasts, and ensuring regular reorder points and avoiding stock-outs of A-items should be your priority.
- On the other end of the scale, there are the C-items. Stocking too much of these means you’ll have to bear more carrying costs. Due to the low demand, a recommended policy is to stock only one unit of every C-item on hand, and to place reorders only once a purchase is made.
- B-items straddle the two extremes, and reorder points should be adjusted accordingly. The thing about B-items is, they can easily swing either way: becoming top sellers or bottom sellers, depending on their continued performance.
Do remember that the above only serves as a guideline, and should not be taken as a definite rule. Other factors to consider include the profit margin, as well as the impact of a possible stock-out on your business. For example, a certain item may be slow-moving, but it offers a high margin while being extremely important for its consumers, and without it, you’ll lose the trust of these customers, pushing them into the arms of a competitor. In this case, even if it appears to be a C-item, it may require more attention. So be open and flexible – after all, not all inventory is created equal!
After figuring out what your top-sellers are, it’s time to start optimizing your inventory to minimize costs. The fundamental idea behind this is to order just the right amount of products to arrive at the right time at the right price to minimize carrying costs as much as possible.
Carrying costs are the expenses that come with holding goods in stock. These costs include:
- Storage costs include the fixed cost of renting a storage space, along with variable costs such as manpower and utilities.
- Service costs include insurance payments, taxes, and inventory management systems.
- Shrinkage refers to any inventory loss that occurs after inventory is purchased and before it is sold to your customer. This can happen due to damages in transit, administrative errors, obsolescence, or even inventory theft.
With the right amount of inventory at the right time, you’ll be able to reduce storage costs and shrinkage, giving you more money to spend growing your business instead of leaving your funds to collect dust in the form of bins of C-items that may turn obsolete any time.
Forecasting isn’t magic, it’s a science
In order to have the right amount of inventory arriving at the right time, you’ll need to make an informed prediction before placing an order. Before you start forecasting, certain boundaries have to be set in place to ensure an accurate outcome. For starters, how long is your forecast period? Is there any trend that marks an increase or decrease in demand over a certain period of time? Finally, looking through past sales orders and reports will help you figure out the base demand that serves as the starting point for any forecasts.
You’ll want to be able to get spot-on with your forecasting, because by determining the right order quantities and reorder points, you’ll be able to ensure a high inventory turnover ratio and optimize your inventory to reduce unnecessary spending on carrying costs.
The Economic Order Quantity (EOQ) is an accounting formula that helps to decide the best order quantity that minimizes total inventory costs, while matching customer demand.
You’ll need your annual demand, order cost, and annual carrying cost per unit. Your order cost is decided by the costs of necessary steps taken to procure stock, such as vendor payments and any approval processes. As for carrying costs, focus on the storage and service aspects.
While it’s understandable to want to overestimate your costs, choosing to err too much on the side of caution can give you skewed results that may not reflect the situation accurately, and these highly inflated results leading you to make the wrong decision.
Even after you’ve calculated your ideal order quantity to optimize your inventory, you still need to brace yourself for unexpected circumstances through Safety Stock. Carrying safety stock offers you a way to compensate for unexpected events that can cause inventory stock outs. While it’s probably impossible to plan for unexpected events without veering into paranoia and squirreling away far more than you’ll ever need, safety stock lets you guard yourself against the possibility of going out of stock by catering to potential uncertainties, like a sudden surge in demand or your supplier being swamped by orders and taking a while to ship out your order.
If you’re wondering whether you should carry enough products to guarantee you’ll never go out of stock, just think about how you’d be stuck with the related inventory costs for all of it… which would be substantial, especially when considering it’s for a rainy day! You don’t want to wait until your inventory levels hit the safety stock before placing a replenishment order, so make sure you set your reorder point to include your safety stock.
The EOQ tells you how much to order, but not when to order. When figuring out the Reorder Point (ROP), you’ll need to know the lead time and the estimated demand during that time.
The ROP is a predetermined level of inventory that triggers a reminder for you to replenish your inventory with just the right quantity to optimize your inventory turnover. It’s also known as the min-max system, where the “minimum” of the min-max system is a fixed reorder point, while the “maximum” is the optimum quantity.
Selling Online: Shopping cart solutions, marketplaces
When you begin your career as a retailer, you’re likely to only have one store. This could be either an online store, like Shopify, or a physical brick-and-mortar store. But as your business grows, you’re likely to start looking into branching out into multichannel sales to widen your base of prospective customers. Given the sheer volume of customers worldwide that turn to marketplaces like Amazon and eBay to buy everything imaginable, it makes perfect sense to use these platforms as a means to strengthen your brand while increasing sales.
Most of these come with an elementary inventory management system that provides a way to track products and to alert you when your stocks are running low.
But when you’re moving into multichannel sales, the biggest pain you’ll face is trying to sync your inventory across different platforms.
Using inventory management software can help you manage your inventory from one centralized location. All you need to do is to update your products on it for the information to get pushed to all your ecommerce channels, from online stores to marketplaces. With that, your inventory is synced across all sales channels so you’ll always be able to keep an eye on stock movement everywhere.
Inventory management software also allows you to manage all your orders across all fronts from one centralized location. This way, you won’t need to allot a set amount of stock to each, and risk selling out on one front even though you still have products to sell in your inventory. As stocks are updated in real time as they’re sold, you’ll always know when it’s time to place a purchase order to replenish your supply.
As your sales orders start coming in and you start sending out purchase orders for replenishment stocks, you’ll have to start making sure these are reflected in your inventory management system. An inventory management software solution can automate these processes, making it easy for you. Instead of typing out emails to every supplier detailing the quantities of SKUs desired, inventory management software allows you to automate the drafting of purchase orders at the reorder point. All you have to do is give it the once-over, hit the “confirm” button, and your purchase order is sent to the supplier.
So why would you need an ecommerce platform’s default inventory system?
The draw of merging the inbuilt inventory system on these ecommerce platforms with inventory management software lies in platform-specific perks that allow you better control over the selling. In the case of eBay, it also allows you to classify your products through folders, and to create listing templates that represents the way you want to sell the product. That means you can sell the same product auction-style and fixed-price style, allowing customers to decide how they want to shop.
Similarly, Amazon marketplace allows insights into pricing tactics with the “Match Low Price” feature that helps you to search for and match the current lowest prices (shipping included) on Amazon for the products you offer to maintain your competitive edge.
Inventory management on Amazon marketplace will also allow you to set replenishment alerts (or reorder points) so that once the listing’s quantity hits your threshold, Amazon will send you a Replenishment Alert email. Amazon offers you the choice between setting these alerts according to units or weeks-of-cover (the number of weeks of on-hand fulfillable inventory based on your sales over the last 30 days). With the latter, Amazon does the maths for you. All you need to do is input your lead time and safety stock, leaving Amazon to calculate your reorder point based off current demand.
In order to enjoy Replenishment Alerts, you’ll need to be using Amazon’s Fulfilled By Amazon (FBA) service. Amazon’s FBA means that you’ll ship your inventory to Amazon, who then handles all the packing and shipping details for you from the moment an order is placed. With Amazon FBA, you enjoy the shipping guarantees of having Amazon take care of your products from the time they reach Amazon’s warehouses to the point they’re delivered to the customer’s doorstep. But as an independent seller, cost is definitely a primary concern, and to help you decide whether the FBA costs are worth it, use one of the Amazon FBA fee calculators available.
Amazon has also extended its FBA services to encompass multiple sales channels allowing you to fulfill customer orders from other ecommerce platforms from a single pool of inventory in Amazon fulfillment centers. By opening up FBA services to sellers to who sell on multiple channels, Amazon is muscling its way in for a share of the 3PL (3rd Party Logistics) pie.
3PL allows you to outsource operational logistics ranging from warehousing to delivery and everything in between. If you’re just starting your ecommerce business, using a 3PL provider allows you to focus on developing and selling your products, instead of trying to figure out how shipping and warehousing works. Even a more experienced seller can benefit from using 3PL providers as doing so frees up time to focus on what you do best instead of tying up your time in managing logistics.
So if you’ve already signed up with an inventory management software solution, you want to ensure that your 3PL provider can integrate with it, giving you a one-stop solution. Also, if your aim is to take your business international, 3PLs can help you with matters of international logistics, such as documentation and customs.
When going international, remember that some countries charge import duties and taxes. The United States is one such country, charging sales tax for transactions between states. On the other hand, Australia does not charge Goods and Service Tax (GST) for cross-border transactions under AU$1000. Taxes can be complicated for an ecommerce seller; everything boils down to the question of “Who pays the tax?”
As a seller, you don’t want to end up making losses because you didn’t factor tax into your pricing strategy. Meanwhile if you’re selling to overseas customers who may have to bear import taxes, do ensure you write a disclaimer that overseas customers are liable for any customs and import duty incurred over their purchase… at least you’ve warned them!
Calculate your success
Your products are selling well… but how can you put a number on your success? After all, when it’s time to get your accounts in order, the following metrics can help you calculate your performance for the year and see how you compare to your competitors. The following metrics can also help you to identify areas of improvement, and how to better your business.
Your average inventory is the base from which you can calculate many of the following metrics. Calculating your average inventory is easy. All you have to do is take the median value of your inventory over a certain time period (e.g. a year). By calculating your average inventory, you’ll be able to eliminate fluctuating seasonal trends from your calculations. You may want to stock more in preparation for the holiday sale season, perhaps doubling the amount of orders you usually place, giving you a skewed picture of your inventory for that quarter. Taking the average of your inventory over the course of the year gives you a better idea of your performance over the course of a year.
In this case, the total inventory value would clock in at $10,320.
Perhaps the best way to judge your business success is through calculating your inventory turnover. Basically, inventory turnover is the amount of times your inventory is sold and replaced a period. Let’s say the annual cost of goods sold is $8,600. To calculate the inventory turnover then, you’d take $8,600/$860 = 10. So you’ve sold and replenished your inventory 10 times over a year.
Inventory management software can provide you with the sales reports you need for calculating your inventory turnover rates. The higher the number, the higher your inventory turnover. A high inventory turnover means that you’re selling a lot and that you’ve figured out how to optimize managing your inventory! A low inventory turnover rate means you may need to rethink your business strategy. Again, reports can help you to easily identify areas of excellence and improvement, as these sales history reports can delve into the specifics like products, channels, and location.
Knowing how long it takes you to sell your inventory gives you an idea of your business’s efficiency. The average days needed to sell inventory helps you to put a number to your inventory turnover, so you’ll know how long it takes for you to sell your average inventory.
($860/$8,600) x 365 = 36.5
This gives you an idea of the average of how many days’ worth of sales are held in inventory at any given time, and ideally, you’d want this to reflect your lead time + safety stock, ensuring that your inventory turnover rate is optimal. If it’s too low, it may mean that you’re not carrying enough to match the current demand. On the other hand, if it’s too high, it may mean that you’re stocking too much of slow-moving goods that are taking up space and threatening to turn obsolete.
Also known as profit margins. Simply put, this provides a quick gauge of an investment’s profitability. For your business, you’ll be able to quickly figure out if you’re turning a profit, and if you are, what the percentage is. Do remember that the cost of investment stretches beyond merely the inventory costs and includes the carrying costs attached to your inventory. All these also form part of your investment in your business and should be taken into account.
For convenience’s sake, let’s assume that carrying costs for a year totals about $1000. In this case, the cost of investment would amount to $11,320. Meanwhile, total sales comes up to about $14,150.
($14,150 – $11,320) / $11,320 x 100% = 25%
In this case, the business would have enjoyed a 25% return on investment. Knowing this percentage will help you to know how well your business is doing… which is always useful!
The inventory write-off formally recognizes that an amount of a company’s inventory no longer has value. This includes items that are past their sell-by date and can no longer be used, or items that have gone missing, either due to administrative errors or incidences of theft. These can also include inventory that is lost due to unexpected incidences such as warehouse fires or flooding that renders it unusable. A small amount of inventory write-off every year is to be expected, but if large amounts are written off every year, it may be time for a company to review its inventory management policies due to the large amounts that are either turning obsolete or going missing.
I’ve mentioned the importance of carrying costs earlier, but knowing exactly how much you’re spending on carrying costs is useful.
- Capital costs: The opportunity cost of the money invested in the inventory
- Storage costs: The money spent on building and facility maintenance
- Inventory service costs: These include all costs directly related to inventory (insurance, wages, software applications – like inventory management)
- Inventory risks costs: Shrinkage and obsolescence can happen.
A general rule of thumb is to ensure the total of the above lies around 25% of your inventory value. If your carrying costs are too high, you may want to look towards reducing the size of your inventory. Doing so would mean you need less storage space and you’ll face less inventory risks.
Order fulfillment cycle time
As the name suggests, the order fulfillment cycle time is the amount of time it takes to fulfill a sales order with accurate documentation and no damages during transit. Knowing this can help you to judge the efficiency of your supply chain and the corresponding impact on customer satisfaction. After all, as a retailer, customer satisfaction is key to your business success.
Inventory management software can improve your business efficiency when it comes to the pick, pack, and ship process. Turning sales orders into packing slips lets you know exactly what to pick and pack. Once your items are packed, just print the corresponding shipping label and attach this to your packages… Plus points to you if you take advantage of shipping integrations to make things even easier!
We’re living in an increasingly globalized world where someone in Australia can order products from the US with a few clicks and expect to receive their products within two weeks, while enjoying constant updates on their parcel’s journey halfway across the world.
To succeed in the highly competitive world of ecommerce, getting your inventory in order is a necessary first step to staying ahead of the crowd. By doing so, you’ll be surprised at how much of your expenses you’ll be able to trim away, streamlining your business efficiency to give you more bang for your buck.
My company TradeGecko provides an inventory management solution for ecommerce, but the tips in this article aren’t specific to our software – they’re about the theory and practice of inventory management, and relevant for you to manage your inventory.
This post was by Vera Lim, an Inbound Marketing Manager with TradeGecko, a company that provides cloud-based inventory management software for growing businesses.