How to Stay Out of the Inventory Management Money Pit

Inventory management is simple if you are a psychic. All you have to do is gaze into your crystal ball to see which items are hot and which ones are not. If you know how to do this, then move on along. There is nothing for you here. But, if it seems that your profits are continually falling into the inventory money pit, let’s fix it.

Good inventory management programs find the right balance for your company. Too much stock on hand increases carrying costs, shrinkage, and liquidation. Too little increases fulfillment costs, cancellations, and returns. It also reduces customer lifetime value.

The right balance is challenging to find. Many give up and look for a turnkey solution. They want to input transactional data and have the computer magically output the correct inventory level for every item. This scientific approach has merit, but the best system is a combination of art and science. Nothing beats an inventory manager who understands product dynamics and has the right tools to analyze the data.

What do you do if you don’t have that person on your staff? Start with the data and tools. Build historical references so you can predict how new items will perform. Be flexible with great contingency plans. And, keep your eyes open for a top-notch inventory person.

There are five basic steps to forecasting demand:

  1. Start with your sales projections to determine the overall inventory requirements. Ultimately, you will drill down to the item level. The sum of the individual items forecast must equal the total sales projections. If the total campaign is $20,000,000 with a 60% margin, then the total inventory forecast must equal $8,000,000. Each time the marketing plan is revised, update your projections.

  3. Segment the total inventory forecast into product class divisions. This makes the numbers much more manageable. Utilize historical sales information to weight product classes appropriately and define the order curve. The overall curve will follow the sales curve, but individual classes may vary from the norm. Be sure to factor in special promotions when analyzing the data. A special discount offered in the previous campaign skews the historical data. Planned promotions in the new campaign will affect the projected curve.

  5. Continue the segmentation process down to the item level. Use historical sales information and new projections to determine the total units for every carryover item. Begin with the presumption that each item will perform exactly as before. (i.e. an item with 1,000 units sold in the previous campaign, would sell 1,100 units if the forecast were 10% higher.) Utilize historical data for similar items to project sales for new products.

    Once the initial item forecast is complete, adjust the sales by weighting each item. For example, a carryover item that sold exceptionally well last campaign may need to be adjusted down since it has already been presented to the customer base. A new item may need to be adjusted up because it hasn’t been seen before. Work with the marketing team, so there is a clear understanding of the customer/prospect mix. A campaign going mostly to prospects may perform similarly to the previous one because the products will be fresh to the majority of the recipients. When this step is finished, total sales for each item will be forecast.

  6. Calculate all of the costs associated with inventory, backorders, and overstocks to determine the best inventory level for each item. Inventory expenses include carrying costs, product movement, and administrative overhead. These costs will vary significantly as the pendulum swings between backorders and overstocks. Backorder expenses include additional fulfillment processing and shipping costs for multiple shipments, lost opportunity from cancellations and missed sales, increased returns due to late shipments, and reduced lifetime value. Overstock expenses include liquidation costs and restocking fees.

    Using the sales projection curve and demand forecast, break the total units for each item into orders. Be sure to consider lead times, vendor reliability, and processing. There will be three types of orders – the initial order is the one that should cover the inventory until sales data can be analyzed to revise the plan; confirmed orders are firm and will cover the minimum sales forecast; and cancelable orders are pending confirmation or cancellation depending on sales. If these orders are set up correctly, the vendor performs as promised, and the inventory team follows up in a timely manner, inventory levels will provide the maximum coverage at minimal expense.

  7. Communicate, communicate, and communicate. Failure to communicate with the marketing team and vendors derails the best inventory plan. They are your partners in this process. A good relationship with them significantly reduces costs and improves service levels.

A good inventory management program is an investment in future returns. It increases customer satisfaction and reduces costs. Start improving your process today so you can bank the benefits tomorrow.

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