16 Cost Reduction Strategies in Inventory Management

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So your company is looking to reduce costs, and you’ve been asked to contribute by reducing your inventory cost. That makes sense – inventory is one of the most capital intensive areas for any product business.

Here we explain how you can do this with 16 cost reduction strategies in inventory management that are each proven to reduce a company’s costs. 

1. Consider Vendor Managed Inventory

One way to save costs in inventory is to shift the responsibility of its management to your suppliers using a VMI system.

Under a VMI system the supplier, usually a manufacturer, is responsible for optimising the level of inventory held by the distributor. To achieve this the customer shares information on sales and product needs with the supplier, who is then able to ensure the correct amount of inventory is supplied.

VMI creates efficiencies in the supply chain as it ensures data from sales is a key part of the inventory management system. It also improves communication and cooperation between those involved in different steps of the supply chain.

A man at a desk with computer and packages

There are several methods for reducing inventory costs – getting your suppliers to manage stock levels for you (VMI) is one of them

2. Improve your supplier relationship management

VMI is a one way you can improve cooperation between those involved in the delivery chain – but it’s not the only way, and there are other means of improving these relationships and saving costs.

Another technique you can use is to audit existing relationships with suppliers to ensure transactions are running as smoothly as possible – a method used by business and government organisations alike.

This type of audit considers communication lines and product deliveries. It may also be useful to use KPIs for your most important suppliers – for example KPIs for goods and services are delivered, whether they are on time, and whether they meet quality expectations. Targets can also be developed around communication and relationship management, ensuring issues and concerns are dealt with effectively, appropriately and within certain time frames.

Using this strategy improves efficiencies in product delivery, frees up capital and reduces warehousing costs. It can also reduce downtime resulting from late stock delivery.

3. Conduct an FSN analysis

FSN analysis is used to categorise products as fast-moving, slow-moving or non-moving. ‘Fast-moving’ products are the inventory stock that has rapid turnover, while ‘slow-moving’ items are slow to be shifted. Finally, ‘non-moving’ items are those that are not used over the analysis timeframe.

Splitting stock into these three categories makes it easier to identify issues and concerns around consumption, usage and quantity held in storage. It can also be used to configure warehousing to ensure the most effective storage of the three types of goods. For example, fast-moving items should be held in the most easily accessible part of the warehouse while the non-moving stock may be shifted out altogether.

A person analysing graphs at a desk

Analysis of how your stock is moving – using FSN, for example – gives you insights into what stock is moving and how fast, so you can design your supply chain accordingly

4. Look to dropship some of your products

Dropshipping is where a business accepts orders but doesn’t hold the stock to satisfy those sales. Instead, it sends the order directly to a manufacturer or another type of supplier, who then transports the order directly to the customer.

Dropshipping some or all of a business’ products can mean significant savings in inventory management. Using this process for even some of your products saves on labour costs, fulfilment demands, warehousing space and administrative work.

At the same time the benefits remain, since the vendor still collects a profit from the product being sold through their online systems. Effectively, it’s like acting as a sales agent for a business that doesn’t engage in sales and marketing of its own.

5. Set reorder points for your most frequently purchased items

As your business grows, it can be difficult to keep track of the right time and stock level at which to reorder more products. Setting reorder points for the most frequently purchased items can help significantly improve inventory efficiencies and save costs. It also avoids the need to dip into safety stock.

However the way the reorder points are set can make all the difference as to whether your strategy is successful or further issues. A common calculation to find the reorder point uses figures for average daily usage and average lead time:

  • Reorder point = Average daily usage x Average lead time in days + Safety stock

There is some leeway provided by safety stock, which has its own formula:

  • Safety stock = (Maximum daily usage x Maximum lead time in days) – (Average daily usage x Average lead time in days)

Once the correct reorder point is found it can be set in your system to make the ongoing reordering process smoother.

Two women examine data on a piece of paper

Calculations for key figures like reorder points, safety stock and EOQ are handy tools for reducing your inventory costs

6. Work out an Economic Order Quantity (EOQ) for your most frequently purchased items

Another smart calculation you can make is Economic Order Quantity (EOQ) for your most frequently purchased items.

In essence, this tells you the most cost-efficient amount to order so your holding and transport costs are in balance. It’s important to note that using an EOQ assumes demand continues at a steady pace over time.

If this sounds useful the way to calculate EOQ for a product is to get figures for the demand in units, order cost and holding cost. You can then calculate the EOQ using this formula:

  • Economic Order Quantity = √(2DS/H)

Here D is demand in units per year, S is order cost per purchase order, and H is the holding cost per unit of the product per year.

Using this calculation on an ongoing basis to order stock will ensure you can meet demand while also minimising holding costs.

7. Apply the principles of Just in Time (JIT) manufacturing

This one’s for manufacturers: when you’re looking to save costs in inventory management, you can apply the ‘Just in Time’ (JIT) strategy. Toyota has used this method effectively since the 1970s to streamline its car production line.

This management system brings orders and production schedules together. It works by ensuring goods are delivered in a timeframe that aligns with production capacity. That way there is little to no wastage in time and labour after materials and components have been delivered.

8. Find additional suppliers for the same items

Exploring new suppliers is often forgotten as a way to save money for your business. It’s easy to select a supplier for key goods, then set and forget as long as the product keeps getting delivered.

However there can be huge value in stepping back and reassessing suppliers in the market. Often new entrants, a changed economic environment, or a streamlined system can deliver lower prices and easy savings. Furthermore there may be an option to negotiate volume-based discounts. A little bit of desktop research can deliver an easy boost to the business’ bottom line.

A person scans the barcode on a package

The simple strategy of finding new suppliers for the same goods is often forgotten – but it can be key to saving inventory costs

9. Bundle slow-moving items with more popular lines

Bundling is one way you can get creative to shift slow-moving stock. This technique involves packaging slow-moving items with those which are selling faster to shift them more quickly.

You can use FSN analysis, discussed above, to identify which products can be classed as slow- or non-moving stock, and then take action to shift the products on.

For example, it may be worthwhile to run a promotion that parcels slow-moving stock in with fast-moving stock. A classic way to achieve this is to offer the ‘pick 6’ beer pack that includes one or two less popular flavours.

10. Centralise purchasing to avoid the bullwhip effect

A common phenomenon in supply is the ‘bullwhip effect’ where a small change in demand at the retail end can have a progressively bigger effect on the rest of the distribution chain – much like the motion of a whip. In this scenario increases in demand are passed down the supply chain, and the biggest impact is felt by those at the farthest end – suppliers of raw materials.

The impact of the bullwhip effect is that buyers down the supply chain purchase excess stock to deal with variations in demand at the retail end. This effect can be exacerbated by individual purchasing staff making forecasts, rounding their orders up or down, or purchasing extra stock because of bulk discounts. The overall effect is excess stock levels – which are costly to purchase and store – and may even spoil.

To avoid this effect it’s best that purchasing is centralised – meaning purchasing staff have visibility over your entire operation so they can keep careful track of inventory levels and maintain supply without stocking out or overstocking. Using purpose-built inventory software will assist with this, by giving visibility over real-time stock levels and data to make more accurate forecasts.

A man and woman working with packages at a desk

Centralising your purchasing helps to avoid the bullwhip effect – the name for a phenomenon that causes excess inventory to be purchased down the supply chain

11. Use a 3PL

Working with a 3PL (Third Party Logistics) partner can be an excellent investment, particularly if the business is small with limited labour and warehousing capacity. A third-party logistics partner can manage all warehousing and logistics needs, vastly reducing the strain on the in-house labour force.

Under a 3PL model, the external party receives inventory and receives orders as they are made at the main points of sale. This can be done manually or through an automated notification system. Staff at the 3PL then do the picking and packing of products and arrange for them to be delivered.

Working with a third-party provider will have an upfront cost, and it will be important to analyse the return on this investment beforehand. If your business is beginning to run out of space or is finding itself overwhelmed with orders, there could be value in taking this step.

12. Consider the value of consignment inventory

Consignment inventory is the process of holding and selling inventory on behalf of another company. For example a business may choose to place its products in a retail store before charging the retailer, and hope the increased visibility of the products will lead to sales. If the products are sold, payment is then made to the original supplier.

The benefit of broader exposure is a key reason this strategy is used. Under this model, a supplier can enter new markets or areas without the need to invest in local manufacturing. But it does come with some risk given the product has been delivered to a retail store without payment having been received in advance. It relies on a good relationship between the supplier and the end seller, which can become strained if the product doesn’t sell as expected.

When considering this model, it’s important to clarify details around how the product will be housed and showcased at different sites, when and how it should be returned, and who is responsible if the product is damaged.

Two men working in a warehouse

Consignment inventory means you can retail goods before purchasing them from a supplier – which has several benefits

13. Set inventory Key Performance Indicators

As a general rule, setting KPIs across all aspects of your business helps maintain momentum and ensure accountability of performance and delivery. As such, it makes sense to set KPIs for inventory management.

KPIs can consider factors like turnover, costs, relationships with suppliers, and other metrics. By setting realistic targets and tracking how the business performs, you can see what may need improvement.

For example you might set a goal for the turnover of items held in stock. If some are lagging, it will be important to understand why and what can be done about it. This is when other methods can come into play, such as bundling slow-moving goods with fast-moving ones, a strategy we discussed above.

14. Consider partnering up for joint procurement

Procurement, the process of finding and purchasing goods and services needed to run a business, can be a time-consuming part of running a business. There can be advantages to considering joint procurement, or banding together with a similar business to streamline the process and potentially benefit from the bulk purchases.

An example of joint procurement can be found in the EU’s Joint Procurement Agreement (JPA), set up in 2014 to procure medications to deal with pandemics. The aim behind the JPA was to ensure that medical treatments could be supplied to members in a cost-effective and equitable way.

Of course the success of joint procurement will always depend on the details of the agreement and the transparency of operations, including factors like finance and the flexibility to deal with unforeseen circumstances.

People sitting around a desk analysing data on paper and devices

Setting KPIs is an important way to measure the performance of your inventory system and work out which processes you can improve

15. Investigate cross docking services

Cross docking is the system of transferring goods from inbound transport to outbound transport with little to no time in storage. It’s particularly useful for businesses that have a fast turnover or time-sensitive goods to deliver – industries like eCommerce, food & beverage and pharmaceuticals.

The ability to rapidly transfer goods from one form of transportation to another through a specially designed transport hub speeds up delivery times and saves on warehousing and storage costs.

16. Invest in cloud inventory management software

One way to help save on long-term costs is employing cloud inventory management software. Not only does this help you track your inventory easily, but will help with almost all of the cost-reduction strategies we’ve outlined above.

The benefits of using cloud-based inventory software are numerous for SMEs. Unlike traditional software, it requires little upfront investment since you pay subscription to the service.

It’s also scalable as your business grows and contracts, meaning you don’t have to worry about making changes as your business develops. SaaS inventory software is also cheaper than full ERP software packages – and SMEs often find ERP offers more functions than they need anyway.

One last cost-saving tip: Often cloud software providers, including Unleashed, will offer a discount if you pay for a year at a time – just another way to reduce your overall costs.

More about the author:

Alecia Bland - Unleashed Software
Alecia Bland

Article by Alecia Bland in collaboration with our team of inventory management and business specialists. Alecia's background is in ancient languages. When she's not reading a book with her cat for company, you can usually find her cooking, eating or trying to make her garden productive.

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