Inventory management is one of the most crucial processes to get right for any business selling physical products. To make it easier to understand how to optimize the inventory management process, we spoke to warehousing experts who gave us details on how to efficiently run a warehouse so you can focus on growing your business.
What is inventory management?
Inventory management is the organized acquisition, storage, and sale of all inventories, including raw materials, parts, finished products, and things like the boxes and tape you need to ship a package. Inventory management should make it easy for you to track work in process (WIP) goods, MRO (maintenance, repair, overhaul) requirements, and stock (finished products) across all warehouse and inventory locations.
This means that all your stock is counted in inventory, but inventory isn’t comprised solely of stock. The difference is subtle but essential; interchanging the terms could cause you problems, especially when managing large operations or properly tracking elements for duties, taxes, and regulatory adherence.
The benefits & importance of inventory management
Inventory management helps businesses increase supply chain efficiency by streamlining operations, reducing errors, balancing inventory levels, and streamlining logistics. Here’s more on the three most substantial inventory management benefits.
Keep costs down
Given how valuable inventory is, it also invites vulnerabilities that can cost your business. For example, inventory theft, damaged goods, spoilage, and seasonal changes in demand can negatively affect your bottom line.
Businesses can better track and maintain an inventory with an effective inventory management system. You can quickly identify stock discrepancies and strategically organize inventory to minimize damages.
Easier forecasting & planning
Demand shifts are a nightmare and can cost your business at two extremes:
- By underestimating demand, you’re at risk of running out of trending goods. This means fewer sales, and you might lose business to your competition.
- By overestimating demand, you may end up with dead stock or slow-moving inventory, driving your warehousing and management costs up. Additionally, if the items are perishable, you’ll be forced to eat the costs.
Demand forecasting and planning ahead are vital to avoid these pressing challenges. Businesses can accurately balance their inventory levels by accurately predicting demand fluctuations and upcoming trends, avoiding overselling and shortages.
You can achieve the most accurate demand forecasting through analytics technology, usually within robust inventory management software. Management software analyzes historical data and trends to predict future demand changes and lets you set an automatic reorder point to maintain healthy stock levels.
Increase customer satisfaction
You’ll know your supply chain management operations are successful when your customers are happy. An effective inventory system increases operational efficiency and minimizes mistakes, leading to fewer wrong order requests, faster delivery times, and more satisfied customers.
Four different types of inventory
Earlier, we clarified that all stock is inventory, but the reverse doesn’t hold true. This is because there are four different types of inventories that make up your whole inventory, and they are:
Raw material is something you can turn into a finished product. This includes:
- Direct materials that are directly used to make the product. Examples include cotton for making t-shirts or glass for making a mirror.
- Indirect materials are necessary for production but aren’t directly used to make the product. Examples of indirect materials include cleaning supplies or light bulbs to keep your warehouse running.
As the name suggests, Work-in-Process (WIP) inventory includes inventory items currently being worked on, whether they’re indirect or direct materials. An example of WIP is an unfinished car that has yet to be assembled.
Finished goods are your stock; they’re the inventory sold directly to customers. An example of finished goods is fully manufactured mobile devices.
Overhaul (maintenance, repair, and operating supplies)
Overhaul inventory includes materials required to complete and sell your goods, but the inventory is not used in the products. This type of inventory is also known as MRO, short for maintenance, repair, and operating supplies. An example of overhaul inventory is the workwear or safety and lifting equipment used by workers, or the charging stations that scanners and other equipment need.
7 effective inventory management techniques
There is no dedicated ‘best’ inventory management technique; organizations select a technique that best suits their specific business model. Some inventory management methods offer more flexibility than others, and each comes with its own advantages and limitations. Here are some options and discussion on when one may work better than others.
Just-in-time (JIT) inventory
Just-in-time inventory management aims to minimize waste and variability, optimizing supply chain operations and providing businesses with more agility.
In the JIT inventory management solution, businesses maintain as little inventory as possible. They work closely with suppliers to ensure raw materials are delivered ad hoc, hence the name Just-in-Time.
JIT minimizes overhead costs and helps businesses respond to demand fluctuations. Brands don’t need to fear seasonal changes by exclusively storing in-demand inventory. However, supply chain disruptions can severely affect businesses that rely on JIT, as seen by the repercussions of the COVID-19 pandemic.
It’s an inventory approach that can work best when your supply chains are simple and resistant to disruption. You’re minimizing expenditures and the risk of holding product too long but need certainty that you can restock quickly in the event of a spike in interest.
Lean management is similar to JIT in its mutual goals to eliminate waste and maximize value. However, lean management is a broader concept that applies across different departments, including manufacturing, production, inventory, and even marketing, whereas JIT is specific to inventory management.
In practice, this means the lean methodology considers ‘waste’ to be anything, product or otherwise, that does not provide customers with value. This could include overproduction, defects, inventory surplus, and the like.
Lean inventory management typically operates best when you control significant portions of production and sales. The more you bring in-house, the better your control and ability to eliminate both waste and risk. Surprisingly, however, lean management approaches will often benefit from outsourcing fulfillment to a 3PL because this eliminates many opportunities for waste. Flat fees for storage and fulfillment can make it easier to predict costs, cut out fat, and maximize margins.
Minimum order quantity (MOQ)
Minimum order quantity (MOQ) is an inventory management strategy where buyers must purchase a minimum quantity of stock. If buyers can’t meet the MOQ, the supplier won’t approve the sale.
But that sounds more like a sales methodology than inventory management, right?
In practice, yes. But in effect, MOQ directly impacts your inventory management process by keeping stock levels balanced. By imposing an MOQ, you can deplete inventory quicker and keep margins on low-ticket items high.
Implementing an MOQ strategy does come with its share of drawbacks, though. Buyers might be reluctant to purchase larger quantities, which is why wholesalers rather than retailers usually employ MOQ. That said, current supply chain stresses related to the ongoing pandemic have led more businesses to run MOQ strategies in smaller B2B operations and even some B2C markets.
Economic order quantity (EOQ)
Economic order quantity is a more sophisticated system than the MOQ model. A business’s EOQ is the quantity of stock they must purchase to minimize expenses, specifically inventory costs. This includes your ordering, receiving, and inventory holding expenses.
EOQ is calculated using a formula, and the result identifies the most optimal reorder point. You can avoid overstocking and shortages simultaneously by maintaining ideal inventory levels. Since inventory is one of your largest assets, cutting costs can significantly improve your bottom line.
While many large, successful eCommerce retailers leverage EOQ, the strategy is not without fault. The formula assumes demand, ordering, and holding costs as constants, so its predictions don’t account for demand fluctuations. As a result, your calculated EOQ may not always correspond to ideal inventory levels. It’s a solid approach for stable businesses and areas where customers regularly order – like disposable mouthguards or pet foods and supplies. Consider it if your business remained stable in 2020 and 2021.
Perpetual inventory management
A perpetual inventory system leverages automated inventory management systems to track when stock is received or sold. This means perpetual systems monitor real-time changes in inventory levels.
The advantage of a perpetual system is that your business’s inventory data is accurate and up to date. As a result, you can forecast demand more accurately, determine your end-of-year inventory balance, and decrease costs by automating labor-intensive processes.
Perpetual inventory management systems are popular amongst fast-growing eCommerce brands because they offer flexibility, accuracy, and agility. Your inventory data is consistently accurate and centralized, and labor-intensive tasks are automated.
Just about every company should use a perpetual inventory system to monitor inventory levels or supplement large-scale counts. However, fewer brands should use this automation to drive their overall inventory management and holding strategies. Where it performs best tends to be eCommerce brands that follow or surf trends, trying to stay ahead of the curve for what’s next and new. Consistent analysis can help them determine when a fad is starting to fade and immediately begin discounting, kitting, or bundling goods to prevent inventory accumulation.
Six Sigma is another inventory management strategy that aims to tackle waste by minimizing product variations and defects. The strategy consists of two components:
- DMAIC (Define, Measure, Analyze, Improve, Control), used to optimize manufacturing processes
- DMADV (Define, Measure, Analyze, Design, Verify), optimizing processes to deliver better products or services.
Although the Six Sigma management strategy is focused on optimizing manufacturing, the strategy streamlines inventory management naturally by:
- Reliably anticipating inventory replenishment times.
- Streamlining manufacturing processes to meet demand, the benefits of which are reflected in inventory management.
Six Sigma is another data-intensive process and requires a knowledgeable staff. Ongoing training keeps it relevant and appropriate for operations. This tends to restrict its use by enterprises and established leaders at companies whose products face their biggest challenges, risks, and expenses in the manufacturing process. When you compete on quality above all else, Six Sigma approaches lend a helpful hand.
Lean Six Sigma
The Lean Six Sigma strategy combines the lean methodology with the Six Sigma management strategy. The crux of the strategy is to minimize waste by prioritizing key success factors, resulting in optimized business processes and agile workflows. Think of Lean as having a focus on eliminating waste while standard Six Sigma prioritizes the elimination of any variations that deviate from product requirements or target performance.
Like the Six Sigma methodology, the Lean Six Sigma strategy leverages the DMAIC framework to improve various processes. In inventory management, it can be employed as follows:
- The identification phase. At this stage, businesses must identify key problems that arise in inventory management or because of it. For example, are you losing customers due to product shortages? Then your inventory management system may need to forecast demand more accurately.
- The stratification phase. Where your business defines measurable, achievable goals to solve your problem. These goals are usually defined by an LSS leader.
- Streamlining phase. Where your team designs an actionable roadmap to achieve your business goals.
- The execution phase. Where you implement the Lean Six Sigma strategy.
Using Lean to help manage inventory is appropriate when it’s only one part of an overall company effort. Lean is applied across entire operations, where you’re simplifying and streamlining all related processes. In these cases, inventory is one facet placed in a chain of manufacturing, storage, customer service and satisfaction, sales, marketing, and more. Consider it when you’ve got the ear of leadership and can propose a company-wide approach for improvement.
Choose what fits your situation today and tomorrow
The final bit of advice to leave you with is that choosing an inventory management approach should cover both where you are now and how you want to grow into tomorrow or next quarter. Some approaches can be easy to implement and shift to, but could create bottlenecks or inhibit growth. A JIT approach is good when you’re starting and customers are willing to accept backorders, but recent supply chain woes have shown that this generates a perilous lack of inventory when something goes wrong.
Consider each approach and how you can leverage it immediately. Look for flaws and weaknesses that can harm your potential. When the way looks helpful today and clear for what’s next, you’ve likely found a good place to start.
About the author :
Jake Rheude is the Vice President of Marketing for Red Stag Fulfillment, an ecommerce fulfillment warehouse that was born out of ecommerce. He has years of experience in ecommerce and business development. In his free time, Jake enjoys reading about business and sharing his own experience with others.
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