Inventory management is the most important and expensive part of an ecommerce business, yet 43% of businesses in the USA 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 really 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 a daunting task, 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.
In this guide, we are going to break down 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 that has 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, not forecast shipping volume correctly, 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 have a negative impact on the business value.
Let’s look at 6 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 in place 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 and 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 are often paying for things months before you will see any cashback in your bank account.
For example, if you sell your products in the USA but they are manufactured in China, it could be 3-6 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 so important to make sure you are ordering the right amount of stock for each product. You must have enough stock for the customers, but you also don’t want to have 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.
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 to see where the stock is located 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 is very disappointing 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, then sometimes you can pre-sell the product to the customer before it is actually in the warehouse. Amazon is very good at doing 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 also know exactly how much stock you need to be holding. 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 tend to be 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 work 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 need to be made and shipped to your warehouse.
- Warehousing - The products need to 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 inventory management software to help me, which we will go through at the end of this article.
Inventory Management Best Practices
Whilst there are lots of different techniques for managing your inventory, some of them aren’t really relevant for a small ecommerce business owner. There are eight main techniques that 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 whenever you are making stock decisions. Essentially you want to make sure you have enough stock to keep up with demand, but not too much inventory so that you are always out of stock.
Having too much inventory can incur higher storage fees, wasted products, and higher shipping fees because of the volume.
On the other hand, having too little stock can mean you are disappointing your customers and losing out on potential sales.
Working out what your EOQ is will be different for all businesses, and it is something that you can improve over time. The reason for this is 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 6 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 starting to see high customer demand. If you’re selling on Amazon, Etsy, or eBay for example, you can get really high sales volumes quite quickly with the right products.
The main downside to large bulk shipments is you have to pay 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, making the warehouse costs go up even further.
ABC Inventory Management
Some of your products will have more importance than others, and with ABC inventory management you can make sure your focus is on the products that are going to 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 that have a higher return on investment. When you need to make decisions about where to spend your money, this list of products would get priority.
This is a really 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 management 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 are accurately tracking the stock.
Backordering is when your business continues to sell a product, even when it is out of stock. This process only really works if you are able to restock quite quickly after going out of stock, as most customers are not likely to wait for a long time for replenishment.
The exception to this is if your brand has a really 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 being really communicative with the customer around when they can expect their products to arrive. As we discussed earlier, Amazon is really good at highlighting the delivery time, and showing a customer when they can expect to receive a product that is out of stock.
Just in Time (JIT)
This is one of the more risky inventory management techniques, 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 the weakness of this technique, as trucks weren’t able to successfully cross borders in time to deliver all the food.
However, there are some benefits, as JIT lowers the amount of stock you need to keep in warehouses, reducing costs and removing a lot of wasted products. It is also great for cash flow, as you don’t need to spend large amounts upfront.
JIT only really works when you have a mature business and you understand seasonal changes and sales trends. On top of this, you need to 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 it has been purchased by a customer.
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 any 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 very 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.
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 has 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 at the moment, such as Peace In The Wild and Not On The High Street.
Inventory valuations - FIFO vs LIFO
To understand the value of the inventory you have in stock, there are two main methods that are used—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 it will help you to understand how much the stock in your warehouse 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 for products such as electronics or tools, there is no sell-by date, 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 with the optimization of 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.
Inventory management is one of the most important parts of an ecommerce business to understand. It can get quite 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 really help your business to make more sales and keep customers happy, so it is very important to get right.
However, understanding this can be a full-time job, which is why inventory managements software can help you to keep on top of it all.
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