The concept of inventory optimization helps many businesses improve their inventory turnover – without damaging stock availability. This post will explain how, but first, let’s deal with a few simple definitions.
Many stock-holding businesses have a significant amount of working capital invested in inventory sitting in their warehouse. The quicker they can convert this investment back into accessible cash (by selling the items or using them in manufacturing processes) the better. The inventory turnover ratio calculation helps a business measure its inventory management efficiency, as it shows the number of times it buys and replaces (or turns) its inventory over a certain period of time (usually a year).
Here are six inventory optimization strategies to improve inventory turnover without damaging stock availability:
Let’s look at each one in turn:
As items move through their product life cycle, their demand will change. Most items in the growth stage will experience an upward demand trend. At maturity, demand often levels off and becomes quite steady, and during decline it can become more erratic and then fall off. This means that in your product portfolio you’ll have 1000’s of SKUs with different demand patterns/types.
Demand types are important when you’re aiming to improve inventory turnover (read points 2 and 3). But when focused on the product life cycle, it makes sense to concentrate on items that are entering their decline stage. This is so you can monitor their demand more closely and come up with strategies to reduce stock levels before the items become obsolete and have no demand.
Possible strategies include reducing your reorder quantities and levels of safety stock or using marketing campaigns or pricing tactics to increase demand and move the stock faster before your customers lose interest altogether.
When looking to improve inventory turnover, it’s important that inventory planners and purchasers only order items that have a demand in the marketplace. Accurate demand forecasting is therefore critical.
Until now you may have only used simple moving averages to calculate demand based on a certain number of stock days. However, these calculations are just too simplistic to deal with the demand and supply fluctuations of today’s markets. As a result, they can be a cause of over-forecasting, leading to a low inventory turnover.
To improve your inventory turnover, you need to go beyond these basic calculations and move to statistical demand forecasting principles. Firstly, you need to factor an item’s demand type into your forecasts, based on its position in the product life cycle, and adjust your forecasting algorithms accordingly.
Secondly, you should identify items with seasonal demand patterns and market trends and again fine-tune the forecast.
Thirdly, you should refine your forecasting parameters to reflect demand volatility in the market e.g. set longer forecasting periods for slow-selling markets and much shorter ones if market demand is volatile.
And finally, allow for qualitative demand insights, such as adjusting forecasts for promotions or competitor activity.
We’ve already discussed how every item in your product portfolio will have a different demand type. But, at the same time, every item will also differ in terms of their:
It therefore makes no sense to have one generic stocking policy where you manage every item in your portfolio in the same way. The aim of inventory optimization is to prioritize which products you stock, based on their characteristics. By doing so you can optimize your inventory levels and thereby improve your inventory turnover. For this reason, it’s critical that you classify every item of inventory into groups, to allow you to manage items with similar characteristics in the same way.
A basic form of inventory categorization is ABC analysis. With ABC analysis, you group products based on one dimension: value. A items are the most valuable to the business, B items less valuable and so on.
But for more sophisticated inventory classification, you need to consider more variables that affect turnover rates, such as an item’s pick frequency, cost or demand. You can then produce multi-dimensional inventory stocking policies that show what items to stock and in what quantities.
By optimizing inventory levels, you’ll quickly see an improvement in your inventory turnover, without risking stockouts of your most important lines.
While it may be tempting to place bulk orders to get supplier discounts, it’s wise to understand the impact this will have on your inventory turnover. Don’t forget that inventory costs money to carry and ties up working capital. And, if the items you’re buying in bulk aren’t best sellers, they could end up as excess or even obsolete stock at a significant cost to the business.
Ideally you want to place small order quantities on a regular basis, to keep stock turning and investment minimized.
However, sometimes this isn’t always possible due to inefficient processes, shipping costs or suppliers’ ordering restrictions. In these situations you have to think smartly and weigh the costs against each other for replenishment. For example, EazyStock has an order fill-up feature that allows you to work to minimum order quantity, value or weight restrictions. So, when you need to top up an order, the system simulates the order process going forward (based on forecasted demand, stock levels, and orders due to be delivered) and recommends the most suitable items to add. This simulation also factors in sales trends and seasonal behavior, to ensure the stock you fill up with is the right stock.
If you have multiple warehouses you may notice that inventory turnover varies between each location. While some sites may have excess stock of certain products, others maybe short of the same SKU.
A further principle of inventory optimization is to optimize stock levels across each location, through redistribution. This process eliminates the need to procure more inventory from the supplier and helps keep item counts low and lean.
Without stating the obvious, you need a good inventory management system to track your stock levels and provide an accurate base to calculate and improve inventory turnover. A warehouse management system (WMS) or an inventory module of an enterprise resource planning (ERP) system can do this for you. A good system will be able to calculate and monitor inventory turnover ratios down to SKU level, allowing you to identify which products are not providing an adequate ROI.
However, when it comes to optimizing inventory levels and carrying out the sophisticated demand forecasting, inventory planning, classification and replenishment activity described above, we (obviously) recommend inventory optimization software.
Inventory optimization apps like EazyStock can easily be integrated with your inventory management system to provide the extra level of intelligence needed to increase inventory turnover without harming stock availability.