It might be tempting for companies that sell non-perishable items to order and have extra stock on hand in order to meet customer demand and order fulfillment objectives.
Carrying extra inventory is a sometimes beneficial thing since it keeps customers satisfied and helps prevent expensive backorders.
However, retaining too much can result in a variety of drawbacks, including high carrying costs, excessive stock investment, and inadequate cash flow. Therefore, it makes sense to seek for strategies to lower inventory and maintain levels.
In this article, we explain inventory reduction, discuss how it may help you optimize the return on your investment in inventory, and provide 8 effective inventory reduction strategies you can use to cut inventory expenses in your retail business.
- 1 What are inventory reductions?
- 2 Inventory reduction formula
- 3 8 effective strategies for inventory reduction
- 4 FAQs
- 5 Summary
What are inventory reductions?
Inventory reduction can be defined as the process of bringing down stock levels until they are sufficient to fulfill demand from customers.
Manual or SKU-based inventory reduction is required to get rid of extra items, free up storage space, reduce cost, and boost profitability. One of the best methods for cutting costs in inventory management is SKU rationalization.
However, too many businesses struggle with too much inventory. Insufficient warehouse organization, inaccurate demand projections, subpar inventory control, and other factors may contribute to it. The key to avoiding this problem is to keep track of inventory levels and determine the ideal reorder point.
Inventory reduction formula
There are a few computations that can help you figure out what inventory level you should maintain, even if there isn’t simply one straightforward formula for inventory decrease.
Utilizing the inventory turnover method, you should first determine your inventory turnover ratio. This represents the number of times during a specific time frame that you have sold through inventory. It’s a useful measure that may show you which items are in the most demand and where you should focus your efforts and resources.
The formula for figuring out your inventory turnover is as follows:
Inventory Turnover Ratio = Cost of Goods sold (COGS) / Average Inventory
The economic order quantity (EOQ) for your items is another thing you should determine. That is, how much of a product you should have on hand at all times so that you can fulfill demand without having to hold any extra stock?
The formula to determine your EOQ is as follows:
EOQ = 2 Demand Order CostHolding cost
8 effective strategies for inventory reduction
Forecast your demand accuracy
Retailers typically maintain too much inventory since they underestimate the genuine demand for their goods from customers.
Because of this, their forecasting procedures either forecast too much or too little product.
For instance, you would not know the true level of demand if you had sold all 2,000 of your Laptops last year. If you had kept them in stock, you could have been capable of selling thousands more. Simply by making selections based on last year’s sales figures, your purchase this year will likely repeat last year’s blunders without understanding the genuine demand.
Alternatively, perhaps you run a clothing store that sold 8,000 white t-shirts last Summer and you only had to price down 5% of the stock before the Fall season. That outcome would appear to be acceptable. However, if you don’t account for the shift in consumer preferences from white to green in your prediction for the upcoming summer, you’ll end up purchasing much too much of the incorrect thing.
Analyzing previous sales results only takes you so far.
What and when people buy is influenced by seasonal buying trends, changes in the competitive environment, assortment adjustments, and other variables. For each SKU at each location, hundreds of factors must be examined in order to forecast genuine demand.
Numerous innovative methods for reducing your inventory expenses can be made possible by a precise demand prediction.
Using Pareto’s law
Planning your merchandise range shapes how your clients view your brand. The product categories you assort are determined by it. Additionally, it determines how much you must spend on inventories.
Unfortunately, preparing your goods assortment might also increase your inventory expenditures.
Planners and purchasers would want to believe that all of their goods are superior. In actuality, 80% of your earnings will come from just 20% of your SKUs. Many SKUs in a lineup are basically just present to provide consumers with a wide variety of options in any given category.
Therefore, you ought to treat your best players differently than your supporting cast.
Utilize planning analytics to develop assortment plans that pinpoint which of your items are star performers and which are supporting cast members. Finally, balance the breadth and diversity of your assortment in the best possible way.
The bottom takeaway is that lowering your supporting player inventories allows you to spend more inventory money on your top performers.
Leverage data to choose your purchasing
Inventory success is largely dependent on time as well as quantity.
Your purchase orders must always be submitted on time. However, making an early purchase can also be costly as your cash flow will dry up and your merchandise will lie on the shelf.
Other impacts of timing can be seen farther up the supply chain.
In this category as well, a strong demand projection would be beneficial.
To entice you to place bigger purchases or try new items, vendors frequently offer bulk discounts. These offers, however alluring, may wind up costing you more in markdowns. If the deal and the timing make sense, a precise demand estimate will let you know.
The demand projection will provide you leverage in vendor negotiations even if you’ve never sold the goods. Instead of purchasing everything at once, you might persuade your vendor to agree to a test project with the possibility of purchasing additional supplies should there be a need.
Optimize warehouse, and logistics
Incorporate your vendors into the supply chain operations wherever it is practical.
By doing this, you may be sure that you get the proper goods at the right time. You will reduce the expenses related to erratic vendor lead times while gaining more visibility into how your product travels through the supply chain.
To reduce safety stockpiles, advanced retail analytics may integrate information from your vendors and your demand prediction.
Most merchants overestimate their buffers for inventory.
Particularly true for the 80% of SKUs that account for 20% of profitability. Advanced analytics offers more suitable safety stocks and incorporates them into your purchase orders by evaluating genuine sales rates at each retailer.
Automate replenishment process
Automating your replenishment procedure is related to our earlier discussion on vendor integrations.
This is due to the fact that sophisticated analytics may automatically recommend reordering amounts, timing, and more, automating and optimizing your replenishment all at once. Your staff may concentrate on tasks that provide more value by reducing the need for human interaction in the routine activity of replenishing.
The mismatch of promotional and inventory planning frequently results in bare shelves and dissatisfied customers.
Your outlets won’t be prepared for the increase in sales brought on by the campaign if your inventory analysts plan for standard replenishment levels. The products you sell at a lower price will be identical to those you would have sold at full price.
Rush orders placed at the last minute can “save” the promotion. However, the cost of such small-quantity purchases is higher, as is the cost of shipping them. By integrating promotional and inventory planning, you may enhance the effectiveness of the campaign while carrying out both plans.
Your demand projections and actual per-SKU-per-store sales-through rates will guide the automated orders that advanced analytics makes possible, bringing you one step closer to the ideal just-in-time inventory.
Reduce obsolete stock
Inventory products that no longer have any demand from customers are considered obsolete. This often happens when a product is replaced by a new model, when tastes and trends change, or when the decline in demand isn’t well controlled.
It’s crucial to know where each of your inventory products stands in the product life cycle in order to prevent an accumulation of outdated stock (such as growth, maturity or entering decline).
You can implement stock reduction tactics to handle slow-moving products as they approach the conclusion of their product life cycle.
These can be introducing sales campaigns to spur interest, discovering new markets where the goods are still well-liked, or simply modifying reordering criteria so you’re purchasing less stock in response to the dwindling demand.
Optimize the price of goods
Demand and price are indissociably connected. You might be able to sell 2,000 units for $5 when you can sell 1,000 units for $7.
This implies that you may develop lifetime pricing plans for your items using the information offered by your demand prediction and sophisticated analytics.
By determining in advance every product’s launch, normal, promotional, and closeout prices, you may influence demand and maximize profitability. This is especially important for low-margin SKUs because you often pay much more for their inventory.
Additionally, lifecycle pricing strategies may be used to determine the greatest combination of demand, sales-through, and profitability when launching a new product.
Retailers frequently start a product’s pricing higher and then progressively drop it until sales and profit are in line with expectations.
By preserving the higher price in most outlets, you may save spending money on costly new product pricing decisions. Before implementing the best pricing throughout the entire organization, use sophisticated analytics to investigate pricing options in test markets.
You’ll be able to make better markdown choices towards the conclusion of the product lifecycle if you adopt a wiser pricing strategy.
Reduce lead time
No one really enjoys having to wait for shipments, especially when meeting demand depends on prompt delivery. Always keep an eye on how long it takes to get the things you’ve bought and keep track of how it affects your clients.
Unsold goods may accumulate in your warehouse if you frequently encounter back-ordered products or lose sales as a result of low inventory. To solve warehouse issues and satisfy demand, talk to your suppliers and determine where the disconnect is.
What makes inventory reduction important?
Reducing inventory is crucial for three reasons: it lowers holding costs, minimizes shrinkage and spoiling, and avoids spoilage. The expenses incurred by maintaining goods for a period longer than is required to sell them are known as inventory holding costs.
Is having more or less inventory preferable?
It is preferable to have a bit more stock than a small amount if you have to pick between the two. This is due to a few factors.
First, it’s a wise habit to keep a little extra inventory on hand than is absolutely necessary so that you have safety stock. In the case of a spike in client demand or high unit sales per customer, safety stock is sold.
Second, you won’t lose out on sales in the meantime even if you have to use your safety stock. Lack of safety stock results in lower profitability since there are no goods to sell while you wait for emergency orders to be filled.
These 8 effective inventory reduction strategies can be used one at a time, but they are all connected.
The most significant decrease in inventory costs will result from a complex, coordinated strategy. By improving your inventory management with little human involvement, a retail AI and data analysis platform will save you time and money in this case.