14 E-commerce inventory management tips guaranteed to save you money
If you run an e-commerce business, excellent inventory management should be one of your highest priorities. Unless you have the right strategies and practices in place, there’s a good chance you’ll lose money, compromise customer satisfaction and possibly even put your business at risk.
What is e-commerce inventory management?
Inventory management is a component of supply chain management. Its goal is to ensure you’re always able to fulfil e-commerce customer orders – without overextending yourself. This means purchasing the right quantities of the correct products, at the right time and cost, and then storing them in the best place for easy distribution.
To achieve this, you need to know exactly what’s happening in your supply chain at any given moment:
- Demand: How much stock is likely to be sold in the near future?
- Existing stock: How much stock do you have on hand, and where is it?
- New stock: How much stock is on order from suppliers and due to arrive at your warehouse?
- Outgoing stock: How much stock has been ordered by customers and is due to leave the warehouse?
- Stock in transit: How much stock has been packed and is on its way to customers?
- Returns: How much returned stock has been added back into your system and into your warehouse?
Even if you’re a small business, this takes focused effort. If your business is larger, the process becomes that much more complex. Using a spreadsheet to manage it is simply not viable. Instead, we highly recommend integrating your inventory management system (and your ERP) with your e-commerce platform.
Why is e-commerce inventory management important?
Your inventory is the foundation for many other aspects of your e-commerce business. Without good inventory management, you risk inefficiencies, incorrect pricing, extra costs, unusable stock, theft, orders you can’t fulfil and, ultimately, dissatisfied customers.
On the other hand, when you manage your inventory effectively:
- Your business uses accurate costs to determine profitable product pricing.
- You know exactly when to order more stock and how much to order.
- Warehouse space costs you less as you only stock what you need.
- You seldom (hopefully never) end up with spoiled or dead stock you can’t sell.
- Back-orders are reduced so less admin is required to manage that process.
As a result, you save money, managing your cash flow is easy and you’re always able to fulfil orders and satisfy your customers.
How to improve e-commerce inventory management
Managing your inventory is a continuous balancing act. Finding the right middle ground is crucial, so let’s look at how to do that. Bear in mind that the process is made that much easier with an inventory management system.
1. Aim for accurate forecasts
Demand forecasting helps you identify how much you are likely to sell at different times throughout the year. This allows you to manage your inventory (and your cash flow) accordingly, and to keep your suppliers in the loop so they can also plan ahead.
Start by analysing your historical sales data per week or month for at least the last year. Then consider any likely changes that may affect the volumes sold, and increase or decrease your figures accordingly. For example:
- Date changes for high sales periods like long weekends or Easter;
- Your company’s annual growth;
- Trends in your industry;
- The wider economic situation; and
- Any special promotions you are planning.
2. Calculate the true cost of your products
Getting your pricing right is absolutely essential if you want to make a profit. The cost listed by a supplier for a product is only one part of that equation. You also need to take into account any “hidden costs”.
Start with the amount your supplier quotes you. Then add:
- Ordering costs, which may be:
- Fixed costs, like fees for placing the order, any extra order processing fees and internal admin costs
- Variable costs based on volume, like shipping and unloading into your warehouse
- Carrying costs, including:
- Interest on working capital used to buy the stock
- Cost of warehouse space
- Inventory service costs including technology and staff involved, plus taxes and insurance
- Risk costs, especially for time-sensitive items that may drop in value
- Costs involved with replacing products that are out of stock, for example, a supplier may charge quick delivery fees
3. Know your economic order quantity (EOQ) per product
The EOQ is the ideal number of products to order at once to keep costs as low as possible.
To calculate it, you need to know:
- Demand i.e. the number of units you sell over a period, for example, in a year
- Order cost of each order (see above)
- Carrying cost per unit (see above), assuming the item is in stock for the entire period
For example, imagine you run a South African online shoe store:
- You sell 30 pairs of veldskoen a month i.e. 360 a year
- Every time you order from your supplier, it costs you R250
- Each pair of shoes costs R5 to store for a year
= square root of ((2 x 360) x R250) /R5
= square root of 36,000
So ideally you will order 190 pairs of veldskoen at a time from your supplier. You will order this amount when your stock drops to the re-order point – explained below.
4. Understand suppliers’ minimum order quantities (MOQs)
Suppliers often stipulate the minimum number of items you can purchase from them at any one time. This is usually based on business factors that your supplier needs to take into account in order to make a profit. These may include cost drivers such as availability of the raw material they use, storage of raw material and finished goods, minimum viable machine runs, labour intensity per batch and so on.
Know your own EOQ per product (see above) and compare that to the supplier’s MOQ. If the MOQ is higher, you will need to take any extra ordering and carrying costs into account – or negotiate with them for a lower MOQ if possible.
If your EOQ is 190 but the supplier’s MOQ is 350, you need to calculate the additional cost impact to your business up front. Not only will you be using more of your cash flow to buy the increased batch of products, but:
- It will cost you more to ship and unload the bigger quantity of goods; and
- You will need more warehouse space to store the extra 160 pairs of shoes until you need them.
Once you understand the viability of this purchase for your business, you’re equipped to negotiate with your supplier. Perhaps they can offer you a deal that might make it more worth your while.
5. Take suppliers’ lead times into account
Lead time is how long it takes to receive products you have ordered from your supplier. When you know what this is, you can plan your purchases to allow for it, rather than ordering at the last minute and running out of stock while you wait for your order to arrive. Bear in mind that lead times often increase at certain times of the year, for example, over the Christmas holidays when manufacturers might be overscheduled.
Calculate the lead time for each supplier e.g.
6. Keep the correct safety stock level per product
To make sure you can always meet demand, you should have a minimum number of each product in stock, above and beyond the average number you expect to sell. This is your “safety stock”. Safety stock protects you against unplanned variability in demand and in supplier lead times.
Calculating safety stock is a science on its own and although we provide a simple formula here, we recommend you cross-check with your inventory management software to identify the correct safety stock levels for your business.
7. Re-order at exactly the right time
Getting the timing right is a critical part of inventory management. If you order products too early, it costs you more to store them until they’re needed. If you order too late, you risk out-of-stock situations, which result in unhappy customers and lost sales. The right time to order a product is when your inventory level drops below the re-order point for that product.
Calculate your re-order point using this formula:
So, for example, if your supplier’s lead time is 7 days, you normally sell 1 pair of veldskoen a day and we assume your safety stock is 35:
Veldskoen re-order point = (7 x 1) + 35 = 42
8. Follow the FIFO principle
First in, first out (FIFO) is an inventory valuation method used to calculate the cost of goods sold. It assumes that the first products bought from suppliers are the first ones sold to customers. Most companies work on this basis as it reduces the chances of being left with dead stock that has to be liquidated, eating into profits.
9. Lower your back order rate
When customers place an order while a product is out of stock, back-orders are created. Sometimes these are unavoidable, for example, if sales of a particular product unexpectedly jump. If your back-order rate is often high though, it’s an indication that your forecasting isn’t as accurate as it could be.
Keep an eye on your back-order rate over time with this formula:
10. For multiple channels, plan your warehousing carefully
Managing your inventory becomes more complex as you add sales channels. For example, perhaps your warehouse has historically picked and packed only for your brick-and-mortar stores. If you then add online or international customers, or perhaps even B2B customers, internal warehouse processes start to become very complex as each of these segments has different requirements. For example, your brick-and-mortar stores may place bigger orders which are shipped less frequently, whereas online customers usually want small deliveries much faster and more often. As you try to accommodate these different sales channels, you may end up duplicating inventory management costs across silos.
To run your inventory optimally across multiple sales channels, you will need to consider some of the following:
- Strategically locating your warehouses
- Laying out your warehouses for maximum efficiency
- Segmenting your staff and training them accordingly
- Implementing a modern warehouse management system that allows for paperless operations, real-time inventory counts, flexible planning and client customisation
- Integrating your ERP and inventory management systems to your online shop, so your customer has real-time access to live stock levels
11. Measure the success of your inventory management
Your company may spend a significant amount of capital on buying stock. If that stock doesn’t get sold, that money is tied up in your inventory and you can’t use it elsewhere. Ideally, stock should be sold as soon as possible after it arrives at your warehouse. Then storage costs are lower, profits are higher and it’s easier to manage your cash flow.
Your inventory turnover ratio indicates your company’s ability to sell its goods. Calculate it with this formula:
- Don’t use your sales figures for cost of goods as this will overstate the ratio.
- Don’t use closing inventory for average inventory.
For example, let’s assume:
- Your company’s cost of goods sold was R3 million
- Average cost of inventory during the year was R400K
Then inventory turnover = R3 million / R400K = 7,5
So your inventory has turned over 7.5 times during the last year. Now compare this number with your figures from previous years and with other companies in your industry.
12. Don’t skip stock-take
Even if you count inventory as it arrives and update it as you sell, you should still regularly check that the numbers reflected in your inventory system match the stock that actually exists in your warehouse. Otherwise you may end up with dead stock or not enough to fulfil orders.
There are several ways to do this:
- A major stock-take once a year (usually at year end);
- Irregular random spot-checks; or
- Counting certain products at scheduled times over the year, so you check all of them at some point.
If you’re short on time, prioritise with the ABC analysis method. This method helps you to divide your products into three categories:
- High-value items that have the most impact on your inventory costs but sell less frequently
- Moderate value products with a moderate frequency of sales
- Low-value products with a high frequency of sales – these products will have less financial impact on your business and may need less attention
13. Maintain good supplier relationships
When people like and trust you, they will often go above and beyond the call of duty when you most need it. For example, you may need to negotiate on MOQs, place a rush-order on extra products for your biggest customer, return excess stock or ask them to temporarily hold items for you until you have space available in your warehouse.
To maintain those relationships, start by following good business principles, like respecting their processes and paying on time. Also communicate your business plans and product needs ahead of time so they can plan accordingly. Then go one step further and develop personal relationships with your supplier contacts. The occasional face-to-face meeting and a Christmas gift go a long way.
14. Make preventative and contingency plans
Even if you have great relationships with regular, reliable suppliers and other service providers, things don’t always go according to plan. Make a list of things that could possibly go wrong and put in place preventative and contingency plans to mitigate each risk. This list of possibilities is a good place to start:
- Your supplier may run out of stock when you need it most.
- Your supplier could discontinue a product without warning.
- You might suddenly find you have less stock than you thought.
- You could have oversold a product, using up all your stock.
- A product may move more slowly than you thought and sit on your shelves taking up storage space.
- You could have underestimated a month-end or seasonal holiday sales spike.
- Your warehouse may not have enough space, resources or staff to handle a high-season spike.
If these aren’t dealt with effectively, you could end up with lost sales, unhappy customers and extra costs.
Choosing e-commerce inventory management software
Your current ERP system provider may well have an inventory management module. If so, integrating that with your ERP and your e-commerce online store is likely to be your best choice.
If they can’t provide one that works for your budget though, there are other solutions available. These options are worth investigating:
Comalytics B2C and B2B e-commerce systems can integrate to any inventory management system you choose. Contact us to discuss your requirements.
The bottom line…
Effective e-commerce inventory management is critical to your business. Carrying too much stock has potentially fatal financial implications and too little puts you at risk of stock-outs. To get the balance right, and to make sure your inventory is always exactly where it should be, it’s important to implement the right systems, processes and procedures. Reducing costs and optimising efficiency benefits your bottom line.