You’ve probably heard the story of Goldilocks and the three bears. The bears’ preferences range from one extreme to another (too hot to too cold porridge, too hard to too soft beds, etc.) But Goldilocks isn’t happy till everything is “just right.”
A children’s story to most of us, Goldilocks’ tale is the foundation of an actual economic principle. The Goldilocks principle dictates that the ideal should fall within certain extremes – basically, getting everything “just right.”
The principle applies to inventory management, too. You want to have the right amount of product, at the right price, at the right time, and in the right place.
1. The right amount
When it comes to stocking the right amount, you’re walking a thin line between understocking and overstocking.
If you’re ordering too little, you’ll find customers turning elsewhere when you’re out-of-stock of popular items. Customers that may never return to you.
On the other hand, stocking too much will leave you with tons of dead stock that you’ll be forced to sell at a loss to clear and prevent obsolescence.
Dead stock is basically product that just won’t sell – it hasn’t sold a single unit over the past month, and it’s sitting in your inventory collecting dust and taking up space that could be put to better use. Instead of helping you cover your costs by contributing to your revenue, you’re spending money on storing it.
When it comes to dead stock, there’s only one thing to remember: Even in the unlikely event of a sale, the product’s not going to turn suddenly desirable again, deserving a fresh shipment.
If you already have an inventory management software, the reporting function is going to be of great help when it comes to deciding how much to order. You won’t just know what your bestsellers are – you’ll know exactly how many pieces you sold every month last year.
On one hand, you can base your ordering decision off last year’s demand, or you can apply this information to the Economic Order Quantity (EOQ) formula to find the optimal order quantity after taking costs into account.
2. The right price
The EOQ aims to minimize inventory costs, but it cannot take into account things like price quantity breaks – where your supplier offers discounts for orders above a certain amount.
Is ordering more than your EOQ to enjoy these discounts worth it? It’s easy to justify this by thinking, “If I’m going to have to reorder at some point, I might as well enjoy some better prices.”
But you’ve also got to consider things like carrying costs. Paying for the item is only the start. After that, you’ve got to bring it home, keep it safe and looking good – and the costs of these can even eclipse the cost of the item.
As a business owner, your goal is to reduce these costs as much as possible. To do this, you’ll face a whole range of carrying costs that include:
1. Capital costs: The opportunity cost of investing in your inventory instead of into your business – could you have earned more if you had invested this elsewhere?
2. Storage costs: How much are you spending on renting and maintaining your storage facility?
3. Inventory service costs: Do you have any other inventory-related costs like insurance, wages, or software applications like inventory management software?
4. Inventory risks costs: Sometimes, shrinkage and obsolescence can happen – stocks get damaged, get stolen, or go out-of-date.
While ordering less stock sounds like a surefire way to reduce your carrying costs, there’s also costs attached to ordering too little. If you decide to order less in a bid to cut down on your carrying costs, you may discover that you now need to expedite shipping from your suppliers to match customer demand – pushing your costs even higher!
3. The right time
When you’re placing an order, you want your shipment to arrive at the right time. Ideally, that would be around the same time you finish selling items from the last batch.
If they arrive too early, you’ll find yourself looking for space to store these items… but even that’s preferable to the other extreme.
That means your new shipment arrives too late, and you’re forced to announce that you’re out of stock.
When it comes to determining your reorder point, here’s a simple formula to help you out:
Once your stock levels hit this amount, it’s time to place a new order to top up. But all your products aren’t likely to hit the reorder point at the same time, so you’re likely to be constantly writing new purchase orders, which can be time consuming to say the least.
But here’s a tip for those of you who are already using inventory management software: you can automate your reorder point by setting the amount in the system, and the software will prompt you to place a new purchase order once stock levels hit the reorder point.
If you’re wondering what safety stock is and why it’s included in the reorder point formula, it’s emergency stock, meant to tide you over when unexpected circumstances strike!
This stock shouldn’t be touched at all – it’s like an emergency button you should only push when stuff hits the fan.
I know it’s tempting to squirrel away enough stock to withstand the apocalypse… but always remember, carrying more stocks equals higher costs.
4. The right place
Do you sell on multiple channels? If you do, you want to ensure you’ve got sufficient stock spread across your different sales channels to meet customer demand.
With the growing popularity of eCommerce, the “right place” isn’t literal, since you’re probably shipping all your products from the same warehouse. To eliminate the risk of overselling, you’ll want inventory management software that offers real-time updates on stock levels across different sales channels.
But you still want to have enough for all your customers whether you’re selling from a brick-and-mortar store, an independent online store, a store on a marketplace like Amazon, selling business-to-business, or any combination of the above.
To accomplish this, you want to know exactly how much you’re selling on all your different channels. And here’s where intelligence reports will be a great help: You’ll know exactly how much you’re selling on every channel, which will help you determine the right quantity to meet your customer demand.
For those of you with a physical shop – you’ll know how much stock you’ll need to hold on hand to keep your walk-in customers satisfied.
Optimizing your inventory with metrics
So how do you know you’ve done a good job in getting everything ‘just right’?
To help you quantify your success, I’m introducing a few of the metrics featured in our eBook so you can get started on putting a number to your achievements.
1. Inventory turnover
You can’t talk about inventory management metrics without going into inventory turnover. Your inventory turnover is the number of times you’ve sold and replaced your entire inventory over a certain time period.
Generally, a high number means you’re doing a great job getting everything just right with your inventory, while a number that looks too low means you should consider revising your business strategy.
Of course, there are business-specific exceptions to this: a bike rental business that sells accessories may have low inventory turnover rates – but that’s because the bulk of their revenue comes from renting bikes.
2. Return on investment
Was investing in inventory of a certain product worth it? You’ll find out when you calculate the return on investment.
When it comes to calculating your cost of investment, remember that it’s more than just the cost of goods sold. You’ve also got to add all other costs to your business (inventory related or otherwise) – like the costs of procuring stock and wages.
Knowing your return on investment is particularly useful when you’re trying to decide if a new venture is paying off.
3. Service levels
The service level is the probability of not hitting a stock-out during the replenishment cycle (a.k.a. the lead time for new stock to arrive).
Offering customers a 100% service level is simply not viable due to hefty carrying costs, since the chances of you selling out every last item in your inventory is highly unlikely.
When deciding on your optimum service level, you need to calculate the tradeoff between the cost of inventory and the cost of lost sales when it comes to holding stock, up to the point diminishing returns set in.
Most retailers aim for high service levels of around 95%, as it builds customer loyalty since there’s only a 5% chance of going out of stock.
Ultimately, maintaining an optimal service level also means you’ve managed to get your inventory just right to match customer demand.
In the highly competitive world of eCommerce, if you can’t beat the lowest price and the fastest delivery, your customers will start looking elsewhere. And as customer expectations increase and profits grow leaner, getting your inventory just right will let you stay ahead of the curve. By getting everything just right in accordance with the Goldilocks principle, you’ll be able to trim away excess costs, streamline your business efficiency, and enjoy a higher turnover rate.
And the first step to getting things ‘just right’ is to consider investing in inventory management software.
Header by Rachel Wille
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