What is Inventory Management? (And 6 Inventory Management Techniques)
The following article is part of our Inventory Management Blog Series which covers all aspects of developing an effective inventory management strategy so you can optimize your sales and profit.
Inventory management is the foundation of a well-functioning retail business, and is a fundamental building block to a company’s success and longevity. When inventory is organized and accessible, the entire supply chain will function with ease. But without inventory management software, companies risk making any number of mistakes due to human error, and unfortunately, are more likely to disappoint their customers in the process (with inventory management costs increasing as well).
In this article, we’ll take a look at the importance of keeping a close eye on your inventory, and review a few ways to incorporate this practice at your own place of business.
What is Inventory Management?
Inventory management encompasses the ordering, storing, and using of inventory. It allows companies to know where their inventory is and how much they have on hand at any given time. With inventory management techniques, businesses can oversee both raw materials and finished products, and can regulate the warehousing and processing of these items, as well.
Why is Inventory Management Important?
Implementing a good inventory management system is critical to the success of companies of all sizes, yet too many small businesses use outdated practices or neglect tracking their inventory levels altogether. Inventory management isn’t solely about your finished goods; it’s about accounting for your company’s cash flow, labor, and overall assets.
With a viable system for inventory management in place, your company can maximize its operations and experience exponential growth across all departments.
Ensuring product availability goes hand-in-hand with optimizing your fulfillment potential, and thankfully, ecommerce inventory management supports both of these objectives. With proper oversight, your team will know exactly how the inventory is moving, meaning you won’t miss crucial sales or ruin a customer’s experience because you’re unable to complete their order.
Inventory management systems allow you to account for buffer stock, which you can use for order fulfillment while you wait on additional shipments. This will prevent you from running out of stock (though that's not always the worst thing, see our article on out of stock vs. back to stock) What’s more, inventory management helps guarantee orders are fulfilled on time, which keeps your customers happy as well as benefiting your company’s sales performance as a whole.
Your products are the core of what you do, but if you’re not tracking your inventory counts, you run the risk of incurring excess inventory and unnecessary costs that can negatively affect your bottom line. One benefit of inventory management not to be overlooked is how it reduces costs by offering a detailed look at your stock levels, thus helping to avoid excess, mispicks, and various shipping mistakes.
Human error can easily cost you money, but when you have these figures at your fingertips, you’ll be much more prepared when making inventory-related decisions. Every company should be looking for practical, attainable ways to lower their operating costs, and incorporating an inventory management system is one of the best ways to do exactly that.
Prevent aging stock
For the last few years, days inventory outstanding (DIO) -- that is, the average number of days a company holds onto its physical inventory before turning it into sales -- has been on a steady upswing. Common sense tells us if you continue to invest in your inventory when you have a surplus of unmoved products, you stand to lose money in both the short and long-term.
Fortunately, tracking inventory in real-time keeps surplus and waste as low as possible, while also ensuring the production and storage of said inventory is handled efficiently. By preventing aging stock, you can avoid gratuitous losses and gain more control of your finished goods.
Provide better customer service
Excellent customer service is a hallmark of any great company, yet it’s difficult to provide quality service if you don’t have a good grasp on the products you sell. But with an understanding of your inventory levels and an accurate way to track how products are moving, you can provide better, more consistent service to your entire customer base.
Inventory management techniques equip your company to serve customers with confidence, since you’ll have the knowledge and numbers needed to take care of their concerns. And this way, you can prevent customer frustration, or worse -- the total loss of a customer due to poor service or unreliable information.
6 Inventory Management Techniques
The beauty of inventory management is it keeps you from constantly counting stock, and it ensures you never unexpectedly run out of a product or accidentally order in excess. It also allows you to track critical inventory KPIs and meet your goals. While there are plenty of management techniques to choose from, look for those which best suit your business’s needs and will be most effective within your warehouse.
1. Economic order quantity (EOQ)
Economic order quantity (EOQ) is a term for the ideal quantity a company should purchase to minimize its inventory costs, like shortage or carrying costs. The overall goal of economic order quantity is to decrease spending; its formula is used to identify the greatest number of units needed (per order) to reduce buying.
One of the primary gains of the EOQ model is customized recommendations for your particular company. At times, EOQ may suggest investing in a larger order to take advantage of discount bulk buying and to cut down on total costs associated with multiple shipments.
2. ABC analysis
ABC analysis is a technique that splits products into three categories based on consumption values and their impact on annual inventory cost.
For example, Category A includes the most valuable products with the largest contribution to overall profit. Category B are ‘interclass’ items, landing somewhere between the most valuable and least valuable products. And lastly, Category C products account for the small transactions that are vital to collective profits, but don’t matter much to the company on an individual level.
With ABC analysis, companies can have better control over their high-value inventory items, experience improvements in availability, and see a reduction in costs or losses.
3. Just-in-time (JIT)
Just-in-time (JIT) inventory management allows companies to order raw materials from suppliers in conjunction with production schedules. Utilizing the JIT technique is a great way to reduce costs, since companies receive new products on an as-needed basis, rather than ordering too much of something and winding up with dead stock.
Inventory that doesn’t sell is certainly a drain on money and resources, but business owners who employ the JIT strategy will see an increase in efficiency and a decrease in waste. By only only receiving goods as needed for the production process, you’ll cut down on inventory costs and enjoy a more productive warehouse and distribution flow.
4. Safety stock
Safety stock is a technique wherein extra inventory is ordered beyond expected demand, in hopes of preventing stockouts caused by inaccurate forecasting or unforeseen changes. Safety stock can be looked at as an insurance plan, protecting companies against uncertainties in supply, demand, or manufacturing yield.
By using a safety stock approach, businesses can maintain an adequate amount of inventory at all times, and daily operations can proceed according to plan. Buffer stock is an invaluable asset whenever sales are greater than anticipated, or when the supplier is unable to deliver product by the agreed upon date.
5. Reorder point
The reorder point (ROP) in inventory management is the minimum unit quantity a company should have in stock before they need to place another order. This idea is based on a brand’s unique purchase and sales cycles, which likely varies per product. Typically, a reorder point is higher than a safety stock number, as it has to factor in lead time.
Placing orders at the reorder point ensures replacement products arrive in good time (so no stockouts occur). Additionally, ROP helps avoid holding costs from placing orders too early, which can also cause an inventory pile up at the warehouse.
6. FIFO and LIFO
FIFO (First-in, First-out) and LIFO (Last-in, First-out) are methods to help determine the cost of goods sold. While FIFO encourages the oldest inventory to be sold first, LIFO assumes the last unit to arrive (in other words, newer inventory) has priority. FIFO is an excellent way to keep inventory fresh, whereas LIFO can prevent products from going bad.
Although there are benefits to each approach, LIFO is not always practical for some companies, since they’d rather not leave their older inventory sitting idly in stock. This is why FIFO is used more often, as it assures the oldest products get out the door before anything else.
4 Common Obstacles to Inventory Management
From saving you time and money, to mitigating mistakes and keeping customers happy, there are plenty of reasons why inventory management is so heavily praised.
And while most companies easily leverage inventory control and management to their advantage, it’s important to note a few of the common obstacles you may encounter. This way, you can be proactive in addressing these issues before further problems can occur.
1. Deciding who takes control
Deciding who takes control and who’s responsible for making inventory decisions needs to happen before anything else can fall into place or be put into motion. Will decisions be made by an individual, or will things be decided on by a team of people? Outlining the structure and authority for who controls inventory can boost accountability and prevent confusion later on.
2. Managing spaces and people
Warehouse management is an essential ingredient to running a smooth operation. If the staff and the space itself are not properly managed, it can present an obstacle to your company’s success. Since the warehouse team is directly handling your inventory, they should be given clarity around all operating procedures so everyone is working from the same page.
3. Keeping up with demand
Making more sales than you have products available is not only damaging to your bottom line, but it hurts the customer experience, as well. Once you’ve committed oversell, it’s difficult to reconcile those oversold items and maintain customer satisfaction. If this happens, you’ll need to quickly order more inventory (which can be costly), and alert your customers to any delays.
4. Running out of stock
Although stockouts aren’t as harmful as overselling, they still have similar consequences. If a particular product is out of stock for too long, your customers might purchase from a competitor, which then makes it possible they’ll never return to your brand. Running out of stock is certainly less than ideal, but it should be remedied right away if and when it does occur.
4 Examples of Successful Inventory Management
While inventory management is now widely practiced around the world, there are a few companies who really stand out for how they’ve utilized these systems. The following brands have all employed various inventory management software to achieve exponential growth and to excel in their respective industries.
In 1970, Toyota became the first company to effectively implement the just-in-time technique, and is still using JIT systems today. Their strategy ensures raw materials are not brought to the production floor until a customer order is received and the product is ready to be built.
As production is underway, no parts are included in the next station unless they are required to; this keeps the amount of inventory to a minimum, thus lowering costs and allowing Toyota to quickly adapt to customer demands.
Apple is another company who has successfully incorporated JIT principles within their manufacturing process. Unlike Toyota, Apple’s approach is actually to leverage their suppliers to achieve their just-in-time goals. Apple has just one central warehouse in the U.S., but about 150 key suppliers worldwide.
The strong relationships Apple has with these suppliers allows them to outsource production, resulting in reduced costs and less product overstock. In fact, with only one domestic warehouse, most of Apple’s inventory is kept within their own retail stores.
IKEA is a global retail business that relies on a replenishment process with maximum and minimum settings for their reorder points. For each of IKEA’s products, the company has determined the minimum amount of items available before reordering, and the maximum amount of an item to order at one time.
And thanks to IKEA’s inventory management software, managers can easily access point of sale data on each product. With these advanced methods for streamlining the supply chain and overseeing their inventory, IKEA has remained incredibly competitive in a very saturated market.
Glossier is a direct-to-consumer beauty brand who released its first four products in late 2014. Their initial launch was met with such incredible demand, Glossier actually sold a years’ worth of product in just three months (with a waiting list in the 10,000s).
To prevent these massive stockouts from happening again, the company hired experts in supply chain management to oversee their inventory levels and assist with forecasting. Today, Glossier continues to prioritize inventory management, working closely with vendors to secure a good margin for growth and shorten their lead-times.
Skubana + Inventory Management
Skubana exists to empower companies of all sizes by integrating their products, fulfillment centers, and sales channels into one seamless platform. With Skubana, companies can introduce clarity across multiple channels, manage inventory counts in real-time, and speed up their fulfillment process with ease.
Request a demo today, and see for yourself how Skubana can enhance your plan for inventory management and help you exceed expectations for growth!
The inventory management process is rooted in quality control, by tracking the lifecycle of products as they continually come and go from your supply chain. To put it lightly, an effective inventory management strategy is vital to any company looking to optimize their sales and increase their profits. Without an established approach to managing existing and future inventory, you’re in danger of frustrating customers, losing vital sales, or wasting money on products that don't sell.
Inventory Management FAQs
How does inventory management work?
Unlike Enterprise Resource Planning (ERP), inventory management focuses on one supply chain process. It optimizes the entire spectrum of said supply chain, from order placement with the vendor to order delivery to the customer, mapping the complete journey of a product. Plus, inventory management programs often integrate with other software, like point of sale or channel management, so you can customize the system to meet your specific needs.
What are the methods of inventory management?
There are a wide variety of inventory management methods on the market, mostly used as single entities but sometimes used in collaboration with one another. Among all of these options, the most popular techniques are economic order quantity, ABC analysis, just-in-time, safety stock, reorder point, and First-In, First-Out/Last-in, First-Out.
How do you measure to see if you are successfully managing inventory?
When it comes to measuring your company’s inventory management success, there are a few key components that’ll help determine if you’re on the right track. These components typically include inventory turnover, average days to sell inventory, return on investment, and relevant carrying costs. By looking closely at each of these metrics, you can make better decisions about how and when to scale your business, and identify important areas for improvement.
Chad Rubin is the co-founder and chief executive officer of Skubana, a multichannel e-commerce software the enables brands to unlock growth by unifying their back-office operations.