10 Inventory Management Techniques That Will Cut Your Costs

21st March 2017

Imagine a set of business decisions that could slash your costs and boost return on investment, profits and return on sales. Though the jury is still out on a perfect correlation, at least fifteen studies in the past twenty years have suggested a positive link between tighter inventory management and business performance.

Even more directly, evidence suggests that performance is related to ‘the number of techniques employed and the depth of their implementation’. And, according to the same study, that the adoption of improved inventory management techniques has a positive knock-on effect, encouraging management excellence in other business areas.

In short, taking greater care of your inventory pays. But all that begs the question: which techniques can you adopt to ensure your inventory is working for you? In this blog, we’ll share 10 ideas to get you started:

1. Choose Your Metrics

In our experience, metrics become a problem when your goals are vague and targets shift constantly. We therefore advise picking just one or two metrics and setting rigid targets from the word go. If you’re concerned about flexibility, shorten your target period rather than muddying the water with new targets.

Which inventory metrics should you choose? Here’s our advice: don’t start by looking at metrics – start by brainstorming your biggest inventory problems. Are you struggling to maintain supplier relationships? Is storage too expensive? Are you running out of room? Do you have a warehouse full of surplus items?

Once you know the problem, avoid scouring the internet for the right metric, simply measure the problem: What’s your supplier turnover? What’s the average cost of storage per item? What’s your current space utilisation? What’s the ratio of surplus to sold items?

You can bet that there are impressive names for all these metrics, but you don’t need to know those, you just need to hit your targets.

2. Identify Risks

There’s almost nothing that can hurt your business like a supply chain catastrophe, and your risk is higher now than ever. Identifying your greatest inventory risks is therefore one of the most effective ways to cut long-term costs.

For a quick but effective start, spend an afternoon with other experts in your business jotting down a long list of inventory disasters that could affect your business: price volatility, rising transport costs, environmental disasters, shrinkage issues, etc.

It can be useful to consider these problems alongside a VED analysis of your inventory. Otherwise, try categorising potential risks by supply chain phase – buying, moving, storing, etc – to make things more manageable. Finally, you can use Excel’s What-If Analysis tools to see the damage to your figures.

Once you’re out of ideas, find an action you can take to mitigate each risk before it happens, and one thing you could do if the worst occurs anyway. The result might look something like this (but with more risks!):

A risk analysis table of inventory management

3. Review Reordering Levels and Quantities… Regularly

Many businesses struggle to translate reordering theory – which includes everything from common sense to the sort of eye-watering maths that would leave good Will Hunting trembling – into actionable policy. If you find yourself in that camp, with little to no reordering system in place, we advise following these two steps:

  1. Firstly, set reorder points for each SKU. For a detailed guide on how to do this, check out inFlow’s superb guide, or use Trade Gecko’s reorder point calculator .
  2. Next, remember that effective reordering revolves around two basic choices. You need to decide whether you’ll check stock levels periodically or use software to ding you the moment it happens. You also need to choose whether to order a fixed quantity each time or order up to a certain stock level.
The reorder point formula

How does this help? The rewards are in setting baselines and then tinkering with the numbers to optimise results. Did you run out of item A this month? Try shortening your review period. Or raising order quantity. Or raising the reorder point. In other words, reviewing your figures is the basis of success, so do it regularly!

4. Upgrade Inventory Systems

The most obvious advice, but also the most effective: use the right software. Decent inventory management software will help you deliver on almost every other tip on this list, and that will save you money.

However, before racing off to buy the latest and greatest enterprise-level software, note that the right software for your business is not always the package that can do everything. Lost in a world of feature comparison charts, it’s all too easy to get sucked in and buy features you don’t need.

We advise reading a little about possible features online before looking at the options, writing down those that’ll save you time and improve business operations. That way you’ll dodge bloated software.

In short, when it comes to making the leap, opt for simplicity over vast feature sets, unless you really need them. Software that’s too complex will only result in spiralling training and maintenance costs, all while discouraging employees from actually using it.

5. Eliminate Surplus/Obsolete Stock

Many businesses hold on to stock too long without fully realising the hurt it’s causing them. In accounting, we’re all taught that our inventory is one of our greatest assets. The trouble is, in the realm of supply chain management, you can also think of inventory as a liability . That’s because:

  1. Inventory uses up liquidity.
  2. Inventory eats up both labour and physical resources.
  3. Inventory is often perishable and loses value while sitting in storage.

Inventory costs you money. It’s this single fact that has led to the meteoric rise of lean business principles. Of course, it’s also true that inventory makes you money, and it’s precisely this balance that determines just how much of an asset or liability your inventory is.

Now think about that balance for surplus and obsolete stock. Obsolete items eat your cash flow, they still need to be managed and stored and they’ve perished by definition, all of which drains your resources. If you’ve already accounted for safety stock in your reordering model, surplus items should never be used, which renders them effectively obsolete. Time for a clear out!

6. Consider First-In, First-Out (FIFO)

If dealing in perishable goods is your bread and butter, you should also consider FIFO. It’s important to note that most goods are ‘perishable’, from bananas to laptops (see this horror story from HP), it’s just a question of time frame. So how do you know whether FIFO is for you?

FIFO keeps stock moving, with the first to arrive being the first to leave

The best way is to take a look at how long inventory items are spending in storage. For a given SKU, how long does it spend in storage on average? And what’s the maximum time reached for any single unit? If you find that your highest storage times are regularly exceeding the lifespan of your products, it’s time to adopt FIFO.

Note that using FIFO for inventory valuation may increase tax liability, so the decision can be a bit more complicated. Our advice is to check how much surplus, spoiled and obsolete stock is costing each year; if that’s higher than the possible tax hike, FIFO still makes sense. Otherwise, stick to weighted averages for valuation.

7. Check Inventory Accuracy

Just how accurate are your inventory records, digital or physical? It’s a question that few smaller businesses ask seriously or continuously. The yearly annual physical inventory is enough to satisfy the accountant, so it’s enough for many managers.

However, as supply chains get more complicated – especially in the omnichannel retail space – inventory accuracy becomes increasingly important. Without it, companies sway between the opposing risks of holding more inventory than necessary and failing to satisfy customer demand .

But surely this is a minor issue – just how inaccurate can inventory records get? At one leading retailer, a study revealed that 65% of 375,000 SKUs were inaccurate. If industry leaders can get it that wrong so can you, which would spell disaster for your business.

To remedy this issue, it’s best to implement some variant of cycle counting, usually based on ABC analysis. But please note that cycle counting is not a total solution; you will still face inaccuracies between counts, so inaccuracies must trigger process improvements.

8. Use Inventory Classification

We’ve mentioned inventory classification twice already in this article, which goes to show just how useful it can be. Whether it’s ABC, VED, FSN or SOS, all these techniques will help prioritise the right segments of your inventory.

Once you’ve found the best items to focus on, it’s a simple matter of dedicating extra time and attention to the inventory that makes your business tick. That means cutting the time and resources spent on less important items, and slashing costs in the process.

If you’d like to find out more, we’ve written a complete guide to inventory classification and its benefits:

Part one of our inventory classification guide: ABC analysis

9. Boost Forecasting Accuracy

When forecasting models break down, it’s not just inflated holding costs that hurt but even more painful sales losses and service level penalties. Forecasting challenges affect most businesses, and it’s unlikely you’ll eliminate them entirely, but there are steps you can take to minimise risk.

Unless you have a horde of mathematicians on retainer, it’s likely that software packages and other tech are the best route to accurate forecasting. If you use a POS system, like Shopify or Lightspeed, take advantage of inventory management add-ons; otherwise, integrate a third-party solution like Trade Gecko or inFlow.

And remember that you’re not alone – your biggest customers are just as determined to make sure you deliver on time, so don’t be afraid to speak to them about demand in advance. A PwC survey found that collaboration with key customers on planning is one of the top differentiating factors of global supply chain leaders.

10. Avoid Inventory Altogether

How does eliminating your holding costs altogether sound? If your products are not your own, it’s well worth considering dropshipping. Though it’s not for everyone, dropshipped goods will help minimise inventory risk and allow for rapid expansion of your product range.

Of course, there are downsides: it’s a real challenge to keep customer service levels high, and your margins will be squeezed, but for many, the benefits outweigh the costs.

If that sounds frightening, you could investigate dropshipping some of your less important products. Do you have any items with high holding costs that aren’t generating much profit? Or do you rely on the long tail, selling many smaller items in low bulk? Once again, this is a prime opportunity to bring out some ABC analysis for those actionable inventory insights.

If you run an e-commerce business, one of the greatest advantages and hidden cost savings of dropshipping is the amount of time you’ll save. There are a number of cloud-based dropshipping automation platforms that’ll handle the whole order process for you, so you can get back to building other areas of your business.

What are we missing? If you know some great inventory management techniques we’ve glossed over, please let us know in the comments section or on Twitter @ActionStorage.