How to Avoid Inventory Overstocks and Understocks

Overstocking and understocking inventory issues have befuddled sellers since the first market stall went up in a town square.

Unsold vegetables rotted away, but if you didn't bring enough shawls or earrings, you lost the opportunity for a sale.

Even today, you can't maximize revenue when sales orders go unfulfilled, but you have to carry excess inventory when items aren't moving.

This is the point most supply chain professionals start wishing for a crystal ball to predict the future of their products and services. If only it was that easy.

According to Retail Wire, overstocks cost average retailer, 3.2 percent in lost revenue, while understocks (out-of-stock) item cost 4.1 percent. Overstocks may be costing retailers $123.4 billion every year, and out-of-stocks take away another $129.5 billion from the bottom line. 

However, the right inventory management software helps your firm develop the appropriate strategies to avoid overstocking and understocking inventory.

Poor Inventory Management Has Consequences

Let's look at how bad processes, bad people, data disconnects, theft and supplier issues can eat away your profitability. It's also important to understand how understocking and overstocking inventory affects your business as a whole. Then, let's look at what you can do to make positive changes in your company.

Inventory Management Statistics

Bad processes cost $284.9 billion in losses.

These problems include mechanical issues like inadequate refrigeration, inadequate relationship building with vendors and other departments, and inadequate training. Technology overhauls often involve long transitions that bring problems of their own.

Typically, bad processes once made sense for the business, so people are slow to get rid of them, even if they've become a bottleneck.

People Problems cost $259.1 billion in annual losses.

This topic is an umbrella for a broad range of challenges, including employee mistakes, apathy, lack of training and fraudulent discounts.

Take a closer look at your training processes, install labor scheduling automation and make sure there's enough staff to serve customers.

Data Disconnect and Systems Issues rack up $222.7 billion in losses each year.

About 60 percent of these issues are thanks to retailer’s bad inventory tracking that leads to overstocks and understocks.

Another 25 percent result from tracked data not being shared with other parts of the enterprise. The remaining 15 percent arise when systems aren't connected.

Supplier Issues tally up to $158.5 billion in lost revenue due to suppliers delivering more product than the forecasted need.

When supplies are delivered off schedule, orders can't be filled on time.

The recent trend of offshore manufacturing punctuates the challenges of out-of-stock items. Integrating systems and sharing data among retailers and suppliers should ameliorate these problems.

Theft pockets $161.6 billion that should go to bottom lines.

Retailers can solve these problems by having more data and business intelligence at their fingertips.

Further, it requires systems that let you ferret out the root causes of your inventory and data woes. Implementing a robust technology solution enables you to enact operational changes swiftly so that you can cauterize areas that are draining your resources.

Understocking Inventory

Understocking includes shortfalls and out-of-stock items that cause unfulfilled orders to build up. You may not be fully aware of the impact until it's too late. Here are some of the issues the arise due to poor inventory management.

• Missed sales opportunities. You can't sell what you don't have, and your customers are forced to go elsewhere.
• Loss of favorable prices. Companies often get favorable prices by buying earlier. In 1994, coffee companies that didn't have extra inventory paid for it dearly when prices soared for the next three years.
• Missed discounts. Often, companies that buy component parts, raw materials or finished products in large lots can receive favorable pricing terms. If your company has just enough goods, you could miss these reduced prices.
• Place large orders infrequently. This lets you save on shipping and processing.
• Lost consumer loyalty. Constantly running out of inventory shakes consumer confidence and costs you plenty in lost customer loyalty.

How to Avoid Understocking

Forecast sales based on historical data.

By understanding the amount a certain product or group of products sold in a previous period, you can predict the future. This can be done at a weekly, monthly, quarterly, or annual level - and its important to understand which of those is going to be the most effective for you. 

Two good examples are a pool equipment business and a business that sells gifts.

While the pool equipment business may have much higher sales in the summer, due to the increased pool usage, the gift business may have steady sales throughout the year, with spikes during holidays and at the end of the year.

Each business needs to look at forecasting differently, because high volume periods occur at different times of the year and frequencies.

Set alerts or notifications when stock reaches a certain threshold.

Coupled closely with forecasting is setting up an automated notification when stock levels reach a certain point. Most likely based on your inventory KPIs, this allows you to 'forget' about inventory levels until a notification occurs.

When it happens, you'll know to reorder. The alert should be set up so that there is ample time, based on your supplier's timelines and yours, to order, ship, and receive the new inventory before you run out.

Overstocking

Overstocking impacts your warehouse related costs and reduces working capital thanks to dead stock languishing on shelves. Let's take a hard look at how this poor inventory management practice can tank your financial metrics.

• Lower Working Capital. It’s often hard to find capital. You can't grow the business without cash infusions for expansion or investments. Keeping inventory down means you have more cash on hand. This increases your ability to finance your own growth.
• Warehousing Costs. Renting a warehouse, organizing it and protecting its contents is expensive. The last thing you need is extra inventory raises your costs.
• Depreciation. Wear and tear decrease the value of your inventory. There's also a risk that technological advances and market demand can make your inventory obsolete. Keeping a smaller inventory lets you quickly adapt to these events.

How to Avoid Overstocking

Practice a proven inventory management technique

First-in, First-out is one such inventory management technique. It's exactly what it sounds like - oldest inventory is shipped first. This requires an organized warehouse, but is definitely worth the extra effort.

Set minimum and maximum inventory levels

Minimum levels are the most important, since maximum levels may be affected by seasonality or sales. Use your KPIs to understand what these levels should be, and how they might change throughout the year.

Use a single system of record for inventory

This practice makes sense to keep the right amount of inventory on hand - and is as simple as having a single source of truth for the most up-to-date inventory count. There should be a single location or system that has this information, so that anyone across the organization can find and see it.

Both understocking and overstocking hurt your business and your bottom line and investing in better inventory management simply makes sense.

One Source of Truth

It doesn't really matter how big your operation is. If you have inventory, it all needs to be tracked in the same system. 

Whether your business is an e-commerce website, physical storefront, dropshipping or hybrid operation, you need to constantly work to get your inventory data centralized under a single source of truth.

Everyone has to follow the process in order for it to work.

The best way to ensure compliance is making sure your team understands the process behind the technology.

Train your team to enter the required data in the source system so inventory counts remain accurate. 

• Inventory audits should be conducted on a regular basis to correct inaccurate counts that can lead to overstock and understock scenarios. This is also the best way to keep your inventory forecast accurate. 
• FIFO and LIFO accounting help you manage inventory and the financial impact of carrying inventory. Choose the methodology that works best for your industry so that you can have the clearest picture of what you have tied up in produced goods, parts and raw materials.
• Refine your inventory and order management processes and look at other solutions if your current system isn't meeting your needs. 

When you're ready to grow your business, consider a close look at the systems you're using to determine if a change is in the wind.

SkuNexus offers real-time inventory updates, as well as full omnichannel order management, creating a single source of truth for warehouse, operations, and ecommerce professionals. Schedule a demo to see it in action.