Inventory management and ordering is a hot topic currently because doing it well will increase customer satisfaction and reduce wastage costs, both of which are great for the bottom line and keeping the investors happy. Before we look at some basics of inventory management, let us consider what inventory-related problems can cost the company dearly.
When inventory is mismanaged
Managing inventory effectively means that the balance of inventory being receipted is closely matched to the stock being sold, so that storage amounts and times are kept to a minimum. When this balance is out of kilter, two adverse situations can occur.
The first is that excess inventory remains in the warehouse being stored and not being sold. The problem here is that money has been used to pay for this inventory and has not been recouped yet through sales. Therefore, the company misses out on revenue, but also they miss out on the ability to invest the money they should have recouped elsewhere. This is termed ‘lost opportunity cost’. Storing inventory also incurs extra costs such as electricity, insurance of the goods and leasing of the warehouse. This situation can significantly affect a company’s financial status and can be a cause for liquidation when the company no longer has any cash flow.
The second situation is when the company does not keep enough inventory on-site to fulfill customer orders. On the one hand, the company is no longer exposed to the risk of storing too much and losing revenue that way, however on the other hand, it is exposed to significant risk of a damaged reputation and higher ordering and shipping costs. If there is not enough product to fulfill a customer order, more product may be ordered urgently resulting in expedited shipping costs. However, if this is not possible, then the customer is informed their desired product is out-of-stock and will result in delays. The customer experience is then compromised, and if this becomes a habit, can certainly result in a tainted reputation that will also significantly affect future sales and revenue.
As can be appreciated, a key component to effectively managing inventory is to have ordering down to a fine art so that it is as closely matched as possible to the sales, despite the ordering occurring prior to the sale. Here are some ordering models to consider:
Inventory Ordering Models
- Just-in-Time: This model of ordering is where the stock is ordered very shortly before it is required. The silver lining to this model is that storage costs are reduced which is a significant cost saving to the company. However, it is imperative to have reliable suppliers who can deliver the exact amount of product when they say they will, as any alteration to this could result in delays that are passed on to your customer.
- Drop-shipping: This is where the product is shipped directly from your supplier or a third-party storage company to your customer. The bonus of this method is also reduced storage costs. Something to be aware of though, is that you no longer have complete control of the process yet you are the face and name to the operation. So if there are any delays or problems from your supplier, you must ensure you know about them and take ownership of them to your customer. This method can be quite risky as your reputation really is on the line and largely out of your control.
- Bulk ordering: This method involves ordering product in bulk with the purpose of being eligible for bulk discounts and therefore saving money. This is well suited to companies who sell product with a high inventory turnover and therefore the time product is stored in the warehouse is minimal. However, this can be risky if there is a drop in sales or product does not move quickly because then storage costs increase, which may outweigh the savings, received from the bulk purchase.
- Back ordering: Customers need to be informed if this is the ordering method of choice as it will inherently result in delays to their product being delivered. Basically, you only place an order with your supplier when your customer has placed the order with you and therefore guaranteed the sale. This method has a clear bonus of you only ever paying for product when you have been paid and therefore never really losing revenue due to the mismanagement of inventory. Likewise, storage costs are drastically reduced which also saves a great deal. However, customer satisfaction can be compromised if they are not pre-warned about possible delays due to back-orders.
- Accurate Response: As the name suggests, this method implies ordering is done accurately based on good statistical and market analyses of sales trends. Although the company orders and pays for stock prior to a sale and also has to store it, the inventory should move out the door fairly quickly. Because a sensible order level has been calculated, the risk of overstocking (and incurring unnecessary storage costs) or understocking (and short-ordering the customer) should be minimized.
To achieve a good method of ordering and delivery to the customer where inventory is well managed and in balance, a good inventory management system such as Unleashed is invaluable. This is especially true for the final method of ordering where accuracy and market predictions are so important.
Article by Melanie Chan in collaboration with our team of Unleashed Software inventory and business specialists. Melanie has been writing about inventory management for the past three years. When not writing about inventory management, you can find her eating her way through Auckland.