Inventory Management Best Practices for Online Retailers
There are many areas where catalog and brick-and-mortar retailers can learn from their e-tail counterparts. The increasing costs of paper and postage, coupled with the proliferation of electronic marketing options, have fundamentally changed direct marketing. Smart catalog retailers are actively adopting marketing techniques from e-tailers. But one area where e-tailers should take a lesson from catalog retailers is inventory planning.
Catalogers learned early that sales growth is directly related to matching inventory availability with demand. It's an important issue for them, as the catalog is their store. When a catalog arrives in a consumer’s home, they expect the inventory featured in the book to be on hand to fill their order — in the correct color and size.
When inventory is out of stock, catalogers hear about it from their customers, loudly and often. This feedback, however, enables them to measure the impact of lost (phantom) demand and back orders. At Direct Tech, we often provide this return on investment analysis for companies, who are frequently surprised to learn the financial impact of recovering lost demand. For a $30 million business, capturing the sales associated with 1 percent of lost demand generates incremental sales of $300,000 (with no incremental advertising or overhead costs).
Inventory planning impacts more than just fulfillment; the productivity of inventory flow also directly affects profits. If you're not already doing so, adopt a process to analyze SKU profitability relative to inventory ownership. A common metric for this is gross margin return on investment (GMROI). GMROI is calculated by taking the aggregate gross margin achieved for a SKU and dividing it by its average inventory cost.
Low sales volume SKUs that have too much cash tied up in inventory are reducing profits every day. I frequently hear the comment, “SKUs on the internet are free, so more are better.” That may be true from a marketing perspective, but when considering the cash tied up in inventory and the operational costs to warehouse that inventory, they're certainly not free.
Online retailers haven't grown up with these disciplines, and often don’t appreciate the incremental profit impact of inventory. E-tailers who drop-ship orders from vendors to customers don't have these concerns, but for those who buy and warehouse inventory, both the lost gross margin from stock-outs and the daily incremental cost of owning unproductive inventory harm profits more than is realized. After you've spent all the time and money necessary to source products, recruit customers and build operational capacity, those last few incremental sales are extremely profitable.
To leverage inventory and increase both sales and profits, online retailers should embrace the following strategies:
- forecast weekly SKU demand;
- optimize inventory deliveries by aligning inventory flow with demand;
- identify and liquidate problem inventory as quickly as possible; and
- measure SKU productivity relative to inventory ownership.
Joe is Vice President of Product Solutions at Software Paradigms International (SPI), an award-winning provider of technology solutions, including merchandise planning applications, mobile applications, eCommerce development and hosting and integration services, to retailers for more than 20 years.
Joe is a 34-year veteran of the retail industry with hands-on experience in marketing, merchandising, inventory management and business development at multichannel retail companies including Lands’ End, LifeSketch.com, Nordstrom.com and Duluth Trading Company. At SPI, Joe uses his experience to help customers and prospects understand how to improve sales and profits through applying industry best practices in merchandise planning and inventory management systems and processes.