The Perfect Inventory Storm

The sharp increase in November and December sales makes inventory planning and scheduling an extreme challenge for cross-channel retailers. The combination of increased sales, long vendor lead times, inherent forecasting challenges and limited cash availability create a “perfect storm” of inventory management opportunities. Understanding the factors that create this perfect storm will give you a head start on putting solutions in place to optimize your inventory ownership and improve sales and profits.

The chart to the right displays the extreme and short-lived sales peak. Due to the annual flurry of holiday shopping and increased marketing through that period, typical direct retailers see November and December sales average roughly 50 percent higher than all other months of the year. Many direct retailers see significantly higher peak sales. The abrupt increase in November and even more abrupt decrease following Christmas creates a challenging six-week peak season to manage.

To compound the challenge, most direct retailers purchase a significant percentage of their inventory offshore, with lead times of 12 weeks or more. As a result, they must purchase the majority of their anticipated demand long before the sales peak begins. Nearly all the planned inventory to cover this period's sales should be on hand by November 1.

Average product-level forecast error in the direct retail industry is 30 percent to 40 percent. In other words, if a direct retailer has $10 million of inventory on hand on November 1, between $3 million and $4 million may be unwanted excess inventory — and a similar amount of unfilled demand may exist. Within a six-week period, inventory managers are asked to purchase inventory to fulfill the potential lost sales and put plans in place to address the excess inventory.

The combination of these challenges means a typical direct retailer has more than one-third of its total inventory purchased incorrectly. Furthermore, there's not enough time to correct their ownership through vendor purchase adjustments, in addition to limited funding being available to make purchases for the “runners” in the business. The potential financial impact of lost sales, back orders and gross margin problems stemming from overstocks liquidation is huge.

Let’s also consider the resources businesses have already committed to support peak sales. They've committed the marketing expense, completed all the merchandise planning and product procurement, prepared the web infrastructure, secured warehouse space, and hired and trained temporary staff. Perhaps the most significant factor for success or failure in the last two months of the year is the ability to manage inventory through this storm.

In future weeks, I'll discuss best practices around managing inventory. For now, I'll offer one tip: Apply the 80/20 rule religiously. The majority of your overstock and out-of-stock problems, likely 80 percent or more, will be driven by a small number of products, likely 20 percent or less. Apply your time, energy and money to the 20 percent and you'll derive the best possible inventory, financial and customer service results with the time and resources available.