10 Inventory Management Techniques for Better Profit Margins
If you’ve ever gone to purchase something online and gotten an “out of stock” message, you know the pains of poor inventory management. It can frustrate customers and cause them to go elsewhere to purchase a similar product. But with proper inventory management techniques, you can prevent running out of stock — as well as overordering — and maximize your company profits.
The Basics of Inventory Management
Inventory management refers to the way you keep track of everything you have in stock. For simple products, you may only be concerned with quantity. But with more complex goods, you may also need to worry about locations, dimensions, expiration dates, seasonality, and more.
In an ideal world, you would have exactly as much stock as you can sell. In reality, you’ll often have too much or too little to satisfy your customers’ needs. Over time, inventory management practices can help you get your stock numbers closer to your actual sales — and improve your profit margins.
What is Effective Inventory Management?
Effective inventory management aims to minimize product loss and maximize sales of all stock. A good inventory strategy will:
- Manage expired stock or stock that cannot be moved due to trends or seasonality.
- Save on warehousing, storage, and climate control.
- Avoid out-of-stock products and missed sales.
- Move old, unwanted, and out-of-style stock.
- Eliminate future over and underordering.
10 Inventory Management Techniques to Explore
The key to effective inventory management is finding techniques that work for your specific company. While no single method fits all companies, consider trying some of these ways to improve inventory management to see what works for you.
1. Forecast-Focused Inventory
One of the easiest ways to avoid excess stock is to forecast your sales properly to avoid overordering in the first place. While forecasting is not a perfect science, consider this basic formula to estimate your sales:
- Start with last year’s sales from the current week (or last year’s predicted sales if in the first year of business).
- Adjust for positive and negative factors, like:
- New marketing initiatives
- Economic and consumer trends
- Company growth
- Guaranteed sales / outstanding accounts receivable
- Consider your calculation as a general range +/-10%.
Good forecasting is one of the most proactive inventory management techniques, and paired with reactive strategies, it can set your business up for success.
Bundling is a great way to move old, unwanted, or out-of-season stock. Simply bundle a highly-sought product with a related product that is less-desirable and lower in price. While you may not be able to sell the bundled product for full price, you will be able to mitigate ordering mistakes and avoid storing a product that no longer sells.
ABC inventory management aims to balance customer demand and cost of keeping different items of stock. To start, categorize your products into three main groups:
- Group A Products: High-cost, low-quantity.
- Group B Products: Mid-cost, mid-quantity.
- Group C Products: Low-cost high-quantity.
It’s important to note that cost refers to the cost of producing, storing, and maintaining the product, not just the sticker price.
This inventory management technique can help you better plan your ordering by keeping cost top-of-mind. By ordering Group A products less frequently, you can avoid long-term storage costs. But by ordering Group C products more frequently, you can prevent shortages with minimal storage fees. It can also be paired with another strategy, like bundling, to keep Group C products moving.
4. Just in Time (JIT)
Just in time inventory management is exactly what it sounds like: procuring goods to sell right before they are needed. This inventory management technique can be highly-effective, but can also be risky due to the low number of products kept in stock. JIT inventory works best with high price points and modular or customized products.
5. FIFO / LIFO
FIFO or first-in, first-out is a common inventory strategy for goods that expire or go out of season. By selling earlier shipments first, companies can reduce expired goods or goods that can no longer be sold.
Less common is the LIFO method, or last-in, first-out. LIFO is often used for heavy, unwieldy goods that are difficult to move. By selling the most recent shipments first, companies avoid having to move heavy goods. LIFO can also be used to avoid excess taxes and balance out accounting records.
Pre-ordering has many of the same benefits of JIT, but with less risk. Pre-ordering has gained in popularity with small companies to build hype and avoid warehousing fees altogether. Companies will post new products available for pre-order for a limited time only, and then will order the exact quantity needed to fulfill the orders placed.
Not only does this avoid overordering, but it builds excitement and turns limited product availability into a selling point. At the same time, it avoids negative customer interactions by removing listings once they are sold out.
7. Reorder Point Formula
As far as inventory management formulas go, the reorder point formula is one of the simplest and easiest to manage. For each product, a reorder point is calculated with the following formula:
Reorder Point = Average Daily Sales (units) x Maximum Lead Time (days) + Predetermined Safety Stock
In layman’s terms, pick a minimum amount of stock you want to have on hand for each product. Then multiply your preferred shipment size times the amount of time it takes to receive. Add these two numbers together to calculate the point when it is time to reorder, and you’ll never fall short on stock again.
Dropshipping is an effective inventory management technique for companies who don’t want to pay upfront for storage and warehousing. With dropshipping, customers place orders, and you relay those orders to your manufacturers who produce, store, and ship the products.
This method is great for startups because it minimizes upfront costs — but keep in mind that you will likely be charged more by your manufacturer for all the services they offer.
9. Emergency Planning
While you can mix and match inventory management techniques to suit your company, one you shouldn’t skip is emergency planning. There are always unplanned events in the economy and in your company that you simply can’t expect. Having contingency plans for emergencies can help you in the following situations:
- Economic upturn or downturn
- Sales spikes or drops
- Miscalculations and errors
- Discontinued products
- Pauses in cash flow
Work with your partners to develop plans for these scenarios. When disaster strikes, you’ll at least have a plan to mitigate and limit your losses.
10. Relationship Management
No matter how much effort or calculation you put into your inventory management strategy, there will be unexpected issues that will arise. One of the best defenses to mitigate these risks is having strong relationships with your partners, suppliers, and providers.
A reliable 3PL partner will help you to navigate inventory management techniques to find the best fits for your company. And, over time, they’ll be willing to go the extra mile to help your business make the most of every situation.