So, the title of this post is a little jarring. How can reducing your inventory actually help you make more money? Surely that statement is incorrect. Despite reservations, that statement is in fact not only correct, but could also be the solution to your inventory cost problems. Inventory reduction provides a number of advantages and solutions to a business (like making you a lot more money).
What Does Inventory Reduction Mean?
Let’s first remind ourselves of the objective of inventory management: to keep enough inventory to meet customer demand while also remaining cost effective.
Inventory exists to meet customer demand. With the ever changing business environment, controlling cost has not always been on the top of the list of priorities. In the past, companies maintained a steady level of inventory because competition was low. Now, more competitors and a growing market with rapid changing products and features cause inventory prices to rise.
Inventory levels are reduced to save on costs, decrease on lost profit, and free up money for other operations in your business.
Think of it this way, if you’re trying to make big money you would never invest everything into one source. You need to diversify your portfolio to succeed. The same principle is applied to inventory reduction. If you want to make profits, don’t put all of your cash flow into inventory. Inventory reduction is performed for a number of reasons, all of which we will discuss in this article. Here’s a few signs of high inventory levels that you may be experiencing.
- Inventory is so oversaturated that a bulk of it becomes obsolete before it’s sold.
- When customer demand is forecasted incorrectly, unsold inventory is accumulating. As a result, more expense is needed to expedite in products in short supply.
How to Reduce Inventory
Inventory reduction is performed to reduce costs in several areas, like:
In order to reduce inventory, companies must formulate an inventory strategy first. Without a strategy in place, your company could see themselves with a surplus or shortage of inventory.
[This Post is an extension of the Smart Inventory Management Page.]
Benefits of Reduced Inventory
Reduce Material Maintenance and Cost
Excess inventory inflates extra storage space costs. When you hold more inventory than what is needed, you’re paying for the space and resources to hold that inventory. You’re also paying for labor and transportation fees to move the stock around.
That’s a lot of rental, storage, and labor fees going towards unused stock and lost profit.
If you can reduce inventory, you’ll have more space for inventory that’s more likely to sell faster. Reduced inventory also means less money allocated towards workers to handle excess inventory. You can focus your efforts elsewhere and in a warehouse that is appropriately sized.
In an age of constant technological advancement, it’s irresponsible to order vast inventory quantities.
You have to be flexible in the amount of inventory you order because product lifecycles become shorter and shorter each year. If you order too much of a product that will become obsolete in six months, you’re left with unused inventory taking up space in your warehouse. Reduced inventory per product lifecycle is the key to success.
Additionally, the way people shop continuously changes.
For example, as brick-and-mortar stores become obsolete in favor of strictly online sales, you want to have enough free cash flow to accommodate a change in infrastructure. That means having enough money to do things like build a website and purchase online advertising without having all your money tied up in inventory. With reduced inventory ordered on an as-needed basis, your company can be ready for industry changes at a moment’s notice.
Unused inventory is waste. When you order too much inventory and it just sits in your warehouse, not only do you lose profits, but you are forced to find ways to get rid of it. If you mark down the items in a fit of desperation, your customers will become accustomed to that price reduction and expect it in the future. This can be hard to overcome.
If you’re working with perishable goods, they will literally go to waste if not used quickly. And not to mention the negative effect throwing away mounds of unused inventory takes on the environment. Reduce your inventory to reduce waste and overall inventory costs. Spend the freed up money on goods to replace the unused waste.
Why Inventory Buffers Are Important
Part of that inventory strategy is implementing inventory buffers. Inventory buffers are an important preemptive measure to take when controlling inventory quantities.
Buffers should be set between production stages to prevent problems along the supply chain, like excess inventory orders. When you set buffers, you will reduce the risk of not only over ordering inventory, but also overselling and underselling items across marketplace channels.
Buffers are an important feature of inventory management, as well. Buffers are supplies or products kept on hand in case demand or supply chain fluctuations ensue in the future.
The following paragraphs are examples of ways to reduce inventory so that buffers can be kept as a safety measure.
Improve Supply Chain Management
The phrase ‘better safe, than sorry’ aptly applies to reducing inventory in supply chain management. Because inventory costs are high, if companies can catch and reduce inventory costs at various stages along the supply chain, the end result is rid of uncertainty.
Some of these uncertainties can be created by a company or supplier’s poor quality, or in the form of late delivery times, unstable production schedules, or fluctuations and poor forecasts in customer demand. By streamlining the supply chain as a whole, not only can a company reduce inventory, they also speed the time to market, shorten cycle times, decrease costs, and free tied up cash.
Avoid Excess Safety Stock
Determining demand is hard to estimate, so suppliers, distributors, and manufacturers include an additional amount of inventory called safety stock on hand to meet demand.
Safety stock is extra stock purchased to eliminate the risk of stockouts as a result of poorly planned demand and supply.
Additional stock can be built up to meet seasonal or cyclical demand. However, if you’re not in a business of seasonal demand, reduce your inventory throughout the year to avoid excess safety stock.
Consolidate Your Supplier Base
To combat excess inventory, many manufacturers are consolidating their supplier base and using fewer vendors to do business with. However, this more focused approach gives room for a closer relationship with the vendors they do choose to do business with. The manufacturer and supplier base build a relationship to improve products to reduce material costs. Customer service facets like improved delivery time is also a benefit.
Although it is hard to predict demand, it can be done. One way to improve forecasting is by increasing communication with suppliers. Again, establishing a good relationship with suppliers benefits the quality and quantity of products coming in and going out of your inventory.
Negotiate reduced minimum order quantities with suppliers in order to deter long-term risks of holding too much inventory and racking up debt. As a result, smaller and more frequent orders enable your company to have flexibility when variations in demand occur. If demand patterns change, you’ll be okay because smaller inventory quantities can accommodate change, rather than huge piles hoarding valuable space in your warehouse.
Shorten The Product Lifecycle
Have you ever found yourself returning to stores that change their window displays more than stores that don’t? It’s not just your imagination. There’s a reason behind constant inventory changes. By reducing your inventory you can rotate new products frequently. This means people are more likely to keep coming back to see what’s new, while also feeling a sense of urgency to purchase before a product is gone. With inventory management, you can stay ahead of the curve in product lifecycles and always have fresh inventory cycling through. It’s kind of magic, really.
The ABC System
The ABC classification system is a method used to classify inventory based on several factors, but for this article we’re going to focus on its dollar value of inventory. That means how much of a high dollar value amount an item needs to register as close inventory control status.
- Class A: 5-15% of all inventory items account for 70-80% of the total dollar value of inventory
- Class B: 30% of total inventory units, 15% of total inventory dollar value
- Class C: 50-60% of inventory units, 5-10% of total dollar value
ABC analysis is important for the subject of how to reduce inventory because each class of inventory requires a different level of inventory monitoring and control.
The higher the value of the inventory, the tighter the control. With this concept in mind, Class A, which holds the highest total dollar value of inventory percentage, would need the tightest control on reduced inventory levels. Since Class B and C make up a significantly less portion of the total dollar value of inventory percentage, they require less strict inventory control.
Obviously the percentage levels of each class will vary based on the size of your total inventory, but these are good concepts to keep in mind. You want to keep an eye on your items holding the biggest total value. If you order too much and it never gets sold, that’s a whole lot of cash flow that could have been used somewhere else. Keep a tight control over this class of inventory and allow a little more wiggle room for the smaller classes.
If centralizing multiple warehouses for your company is possible, it could help greatly in inventory reduction. Sometimes that’s just not at all possible. But if you can narrow it down to one warehouse, your order quantities can be greatly reduced while order frequency can be increased.
Safety stock is a key component to the push of increased inventory. The more facilities you have the bigger the amount of safety stock you need to have on hand. Safety stock increases by the square root of the facility increase. So, if you can centralize your warehouses into one warehouse, you’ll need less safety stock which could potentially turn into wasted excess inventory.
Don't Neglect Customer Service
It’s typical of customers to expect retailers of any size to always have plenty of whatever item they want at all times. The term ‘sold out’ is not acceptable.
It should most definitely be a company’s objective to provide a high level of customer service, however, that concept often comes with the assumption that a company should maintain large quantities of inventory at all times.
As you have learned by now, carrying large quantities adds up in storage costs and carrying costs. Obviously this is not ideal. Businesses can still practice inventory reduction without sacrificing a level of customer service. It’s imperative to understand your customer’s needs. If they’re okay with receiving products in half shipments, go for it.
Overall, if you can provide excellent free shipping and returns, prompt customer service, and quality products, for example, customers won’t place so much emphasis on a neverending supply of inventory.
Okay, you’ve made it to the end. Hopefully you’re scrambling to rethink your inventory management situation if any of these scenarios sparked concern. If not, it’s still not a bad idea to think ahead and get smart. After all, smart inventory management is all about running an efficient and automated business with less inventory to better plan for the future. Be nimble in business and only purchase what you absolutely need.
As a final piece of advice, remember these parting words of importance:
- Reduced inventory allows you to adapt and adjust to rapid market and industry changes, like short product lifecycles.
- Reduced inventory saves your business carrying costs, storage costs, and transportation costs between warehouse facilities.
- Inventory reduction eliminates obsolete stock, which if not sold under dire circumstances, will go to complete waste and cash flow down the drain.
- If you want to succeed, don’t put all your eggs in one basket. Diversify cash flow across your business instead of investing it all in inventory.