Inventory management is the most important and expensive part of an ecommerce business, yet 43% of businesses in the U.S. use a manual system to track their inventory.
When I started my small business, I used to track all my inventory using a spreadsheet I made. For a while, this worked well as I could track the amount of stock at the manufacturer, in transit, and in my warehouse.
But, as soon as I had multiple warehouses and manufacturers, keeping on top of the spreadsheet became a full-time job in itself.
Without an efficient process in place, managing inventory can become extremely difficult. Stock is the largest cost in an ecommerce business and, as your business scales, stock management will inevitably become more complicated.
While it can be daunting, it’s important to have a process in place. Even if your business is in the early stages, it will save headaches down the line.
This guide will explain why inventory management is important and the best practices for creating a process that works for your business.
We'll also look at different software tools and technologies you can use to help you create a system that works for your business.
- Why Is Inventory Management Important?
- The Inventory Management Process
- Inventory Management Best Practices
- Inventory Management Software
Why Is Inventory Management Important?
Inventory management isn’t just about inventory tracking, it’s a fundamental part of how an online store works.
Having a solid inventory management strategy will have a positive impact on the value of your business. A business with good inventory management processes is worth a lot more to a potential investor or buyer should you choose to sell the business.
If you don’t manage inventory correctly, you could overspend on materials, incorrectly forecast shipping volume, and create many other expensive and time-consuming issues.
As it touches on every aspect of your business, having poor inventory management processes can ultimately result in unhappy customers. If they have a bad customer experience, it is unlikely they will return, which could negatively impact the business value.
Let’s look at six reasons why inventory management is so important.
1. More inventory, more sales
Obviously, you can’t make any sales if you don’t have any stock. If you are tracking inventory levels incorrectly, you could go out of stock by mistake, missing out on sales and letting down your customers.
When you have a good inventory management process, it is easy to see how much stock you have and where the stock is.
More importantly, when you have a good idea of your sales velocity for a particular item, you can understand when you need to reorder.
A good inventory management process will work across your supply chain and involve your manufacturers, wholesalers, and suppliers. Let them know when they need to provide you with more stock.
2. Less wasted money and time
Cash flow is important in any business, but an ecommerce store is a particularly cash-intensive business model. This is because you often pay for things months before you see any cashback in your bank account.
For example, if you sell your products in the U.S. but are manufactured in China, it could be three to six months of sourcing raw materials, manufacturing, freight, customs clearance, and warehousing before your products are available for the customer to buy.
In the meantime, you will still have other outgoings, such as marketing, operations costs, and wages.
This is why inventory control is essential to ensure you order the right amount of stock for each product. You must have enough stock for the customers, but you also don’t want lots of dead stock leftover that could go to waste or cost you a lot in storage fees.
When you have a great inventory management process, you can stay on top of stock levels and make sure you have enough money to keep the business running and restock as the business grows.
Depending on your needs, you can even turn to free inventory management software to save money as you first start out. Keep in mind: any free software has its ups and downs. You may have fewer features than a paid account, for example.
3. Accurate reporting and tracking
Inventory management reporting will include real-time information about each unit, such as costs. This is particularly important when you have stock in transit, as understanding the potential value of that stock will help you forecast your marketing spend.
A good inventory management process will also help you see where the stock is and how long it has been in that location. This becomes especially important when your business has lots of sales channels, is multichannel and omnichannel, and you have stock held in stores, in warehouses, in transit, and with wholesale partners.
Understanding the inventory data and stock location will help you to manage pricing and make more sales. For example, you could have a price drop sale for stock that has been in the warehouse for longer than forecasted. You don’t want to guess the sales velocity and then accidentally put a sale price on for one of your best sellers!
4. Repeat customers
A customer who sees stock on your website, or marketplace listing, will expect to be able to purchase that product. It isn't very pleasant for a customer to be told that the product is out of stock after they have already made a purchase.
Unhappy customers often won’t come back, and you may have lost a customer for life.
If you know where your stock is, you can sometimes pre-sell the product to the customer before it is in the warehouse. Amazon is good at this by showing longer shipping times when a product is not currently in stock but is on its way to a warehouse.
That is why it is so important to have accurate stock levels.
5. Less spending on warehousing
When your inventory management process has good reporting, you will know exactly how much stock you need to hold. Overstocking can be very expensive for an online business. This will help you to reduce your total square footage of storage, lowering your costs.
6. Stock forecasting and seasonality
Different businesses will have peak seasons at different times throughout the year. The big selling periods are days such as Black Friday, Cyber Monday, and Christmas.
There are also different seasonal peaks for different products, for example, swimwear in the summer or chocolate around easter. Understanding these peaks is a huge part of inventory management. A good inventory management process tracks the peaks to help you keep the right amount of stock in your warehouses.
The Inventory Management Process
Inventory management isn’t just about managing the stock you keep in the warehouse. Managing the inventory starts right at the beginning when you place an order with your manufacturer, start making your products or you contact your suppliers to place a new order.
The key stages of inventory management are:
- Placing initial order: Whether you are a manufacturer yourself, you have a manufacturer working for your business, or you sell ready-made products, the initial order is when you place the order to get more stock.
- Production and shipping: The new products must be made and shipped to your warehouse.
- Warehousing: The products must be checked in and stored in a warehouse, ready to be picked and packed to send to the customer.
- Sales: When the customer buys your products, you need to send the product to them.
- Reporting: All of the above processes need to be included in reports so you can understand how the inventory management process is performing.
There are a lot of things to manage, and that is why I use cloud based inventory management software to help me, which we will go through at the end of this article.
Inventory Management Best Practices
Whilst there are many different techniques for managing your inventory, some aren’t really relevant for a small ecommerce business owner. There are eight main techniques you should know about, and I will go through the pros and cons of each one.
Economic order quantity (EOQ)
Economic order quantity is a principle you should use when making stock decisions. Essentially you want to ensure you have enough stock to keep up with demand but not too much inventory so that you are always out of stock.
Too much inventory can incur higher storage fees, wasted products, and shipping fees because of the volume.
On the other hand, having too little stock can mean disappointing your customers and losing out on potential sales.
Working out your EOQ will be different for all businesses, and it is something you can improve over time. This is because you don’t know your sales velocity until you start selling.
In my inventory management system, I work out the sales velocity over the last 3-12 months to make sure that new orders always have enough quantity for around six months of sales. This usually gives me enough runway to place a new order with my manufacturer, and get the stock back on the shelves, before the current stock runs out.
Generally, the larger your order is, the cheaper the cost per unit will be and the higher your profit should be. When you place larger orders with manufacturers or wholesalers, you will get the best prices, and often you will get preferential treatment in busy times.
On top of this, you can usually save money on your shipping and freight as you can start to use whole containers, which are more cost-effective than Less than Container Load (LCL) shipments.
Most ecommerce businesses will move to whole containers at some point, especially if they are growing and seeing high customer demand. For example, if you’re selling on Amazon, Etsy, or eBay, you can get high sales volumes quite quickly with the right products.
The main downside to large bulk shipments is paying a large upfront cost to the manufacturer. You may also have higher warehousing costs as you have a large amount of stock to store.
There is also a risk that your products don’t sell, increasing warehouse costs even further.
If you deal in large volumes of products regularly, enterprise-grade inventory management software will be the way to go.
ABC inventory analysis
Some of your products will have more importance than others, and with ABC inventory analysis, you can make sure your focus is on the products that will make you more money.
The most important products can be placed into a list labeled A and the least important in list C.
List A would most likely be products with a higher investment return. When you decide where to spend your money, this list of products will get priority.
This is a good way to focus your attention, as it’s very easy to overstretch yourself and then not have enough money to invest in the inventory that will give you the best return.
The main downside to ABC management is it could take time to set this system up, as you first need to understand the sales velocity for your products.
ABC inventory analysis is commonly used to help with Cycle Counts, which are smaller inventory counts which happen on an ongoing basis. ABC analysis ensures that the most important stock (list A) is counted more regularly, so your business has a better idea of what is in stock, and the systems accurately track the stock.
Backordering is when your business continues to sell a product, even when it is out of stock. This process only works if you can restock quite quickly after going out of stock, as most customers are not likely to wait for a long time for replenishment.
The exception is if your brand has a strong following of fans willing to wait longer for your products (e.g., fans of Apple products).
The key to a successful back-ordering process is communicating with customers about when they can expect their products to arrive. As we discussed earlier, Amazon excels at highlighting the delivery time and showing a customer when they can expect to receive a product that is out of stock.
This is a more risky inventory management technique, as you only order inventory a short time before the sale.
This is the technique that most supermarkets use due to sell-by dates on fresh foods.
The pandemic highlighted this technique’s weakness, as trucks couldn’t successfully cross borders in time to deliver all the food.
However, there are some benefits. Just-in-Time inventory management lowers the amount of stock you need to keep in warehouses, reducing costs and removing many wasted products. It is also great for cash flow, as you don’t need to spend large amounts upfront.
JIT only works when you have a mature business and understand seasonal changes and sales trends. On top of this, you must have very reliable suppliers who can deliver your stock to tight lead times to keep your customers happy.
Consignment is where the manufacturer or wholesaler sells their stock on your ecommerce website, but you don’t pay the manufacturer/wholesaler until a customer has purchased it.
This is a great system for ecommerce sellers as there is very little risk because you don’t have any money tied up, and you can quickly increase your product range.
It also means you won’t have additional warehousing costs and wasted stock, as the purchase order is made when the customer pays for their product.
Typically, this type of relationship works when the manufacturer is confident that the ecommerce site will be able to sell the stock.
As an ecommerce seller, this could be a great option to test new products without risk, but you need to be aware that the profit margin will typically be much lower. So if you sell a product on consignment and it is successful, it might be worth considering a bulk order in the future.
For more on consignment: What is consignment and how to approach it?
A dropshipping site never holds the stock and sells stock directly from another brand or manufacturer. This is similar to how marketplaces work. Most ecommerce platforms can be used for dropshipping by connecting a simple integration or plugin.
Usually, the other brand will pay a fee for their products appearing or being sold on your site, so it is quite a good way to increase your product range without having too much risk.
Dropshipping solutions have had quite a bad reputation in the past for selling cheap products sourced directly from Aliexpress. However, new dropshipping sites in specific niches are gaining traction, such as Peace In The Wild and Not On The High Street.
Inventory valuations: FIFO vs. LIFO
Two main methods are used to understand the value of the inventory you have in stock: FIFO and LIFO.
FIFO means “first in, first out,” and LIFO means “last in, first out.”
These terms are important when valuing your stock for bookkeeping and accounting, as they will help you understand how much your warehouse stock is worth.
FIFO and LIFO are also used to manage the stock in a warehouse. If the stock is perishable, like food, the oldest stock would be sold first as it might be close to the sell-by date. But there is no sell-by date for products such as electronics or tools, so it doesn’t matter if the new stock is sold first.
Inventory Management Software
Some of the techniques we have discussed today are quite technical and can involve a lot of manual processes. That is why many businesses use ecommerce inventory management solutions to help them optimize the whole lifecycle.
As mentioned, when I started selling online, I used a spreadsheet to help me manage my inventory, but this quickly became too time-consuming.
Some inventory management software will integrate with your other software, such as order management, warehouse management tools, or your ecommerce platform, such as Shopify.
There are different types of inventory software for different budgets and different-sized businesses. In this article, we go into much more detail about the best inventory management software and the benefits of each one.
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Inventory management is one of the most important parts of an ecommerce business. It can get complicated, so it is good to implement best practices as early as possible in your business. Understanding where your stock is at any one time will help your business to make more sales and keep customers happy, so it is very important to get it right. However, understanding this can be a full-time job is why inventory management software can help you keep on top of it all.