Inventory management is the cornerstone of a profitable business and depends on your ability to forecast demand trends. It's also crucial to understand the average inventory formula and inventory days formula.
Read on to learn more about inventory reduction, some examples, and strategies you can use.
Inventory Reduction Meaning: What Is Inventory Reduction?
Inventory reduction is the process of lowering inventory levels to a point where they meet customer demand. Reduction of inventory manually or by the SKU number is necessary to eliminate excess products, free up warehouse space, save money, and increase profits. SKU rationalization is also one of the most effective cost reduction strategies in inventory management.
Unfortunately, many businesses run into issues with excess inventory. It can be caused by a lack of warehouse organization, incorrect demand forecasting, poor inventory control, and more. Staying on top of inventory levels and calculating the optimal reorder point is key in avoiding this issue.
Inventory Reduction Examples
Since inventory reduction can be done in many ways, let's take a look at a couple of examples.
First, let's say you're a food wholesaler who currently has a large backlog of perishable food. Your demand forecast was incorrect and customers aren't purchasing in the quantities you expected. You choose to run a promotion on an online marketplace featuring those products to try to sell them before expiration. All you have to do is calculate a good discount and send out some eCommerce email marketing messages to entice customers and increase eCommerce sales.
For another example, we'll say that your business regularly runs into issues with too much safety stock for a range of products. Since the issue seems to persist, you can't blame a single instance for the cause. You decide to switch your entire operation to a just in time inventory (JIT) model.
Using this model, you receive orders only as needed to fulfill customer orders. Not only does this eliminate congestion in your warehouse, but it can help uncover the causes of your inventory variability.
They may be seasonal demand trends, improper order processing, or something else. The data gathered here will allow you to establish inventory KPI and make better decisions for streamlining your inventory management process.
Inventory Reduction Formula
While there isn't just one simple formula for inventory reduction, there are a couple of calculations that can help determine what inventory level you maintain.
First, you should calculate your inventory turnover ratio using the inventory turnover formula. This is the number of times you've sold through inventory over a set time period. It's a valuable metric that can help you understand what products have the most demand and where you should be investing your time and money.
Here's the formula for calculating your inventory turnover:
Inventory Turnover Ratio = Cost of Goods Sold (COGS) / Average Inventory
Second, another thing you should figure out is the economic order quantity (EOQ) for your products. That is, the optimal amount of a product you should keep on hand to meet demand without having to store any excess inventory.
Here's the formula for calculating your EOQ:
EOQ = √ (2 x Demand x Order Cost / Holding Cost)
Quiz: Inventory Reduction via JIT Is an Effective Tool for Identifying...
Were you paying attention to how inventory reduction works? Let's find out with a quick quiz.
Inventory reduction via JIT Is an effective tool for identifying:
A. Setup costs.
B. Causes of variability.
C. Inefficiencies in warehouse layout.
D. Holding costs.
If you chose B, you’re correct. The just in time inventory model can give you greater insight into fluctuations in demand, supply, and more. Nice work!
Effective Inventory Reduction Strategies and Tactics
Luckily for businesses with cramped warehouses, there are quite a few ways to reduce your inventory without suffering large losses.
Here are our top five effective inventory reduction strategies:
Perform an ABC Inventory Analysis
An ABC inventory analysis is an inventory management technique where you segment your products into three categories. These categories will identify what products offer the best return for your business and have a faster sell through rate. It will also identify your weakest products, so you can avoid ordering more products that offer little value to your bottom line.
Have an Inventory Reduction Sale
We touched on this in the example above, but one of the best ways to offload products that are nearing their expiration is through an inventory reduction sale. You can do a buy one, get one free sale, minimum order quantity (MOQ) discounts, or something else. Just make sure to use all the eCommerce marketing channels at your disposal, so you can draw in as many customers as possible.
For food suppliers, BlueCart eCommerce is a great way to sell off excess inventory and attract new customers. It even lets you send emails right from the platform using a built-in promotional function. So, you can set up a new deal in the digital storefront and send out an email blast in one place.
Lower Demand Variability
This may seem counterintuitive to the point above, but running sales too often can increase demand variability, lead to warehouse issues, and even cause a bullwhip effect in your supply chain. It also causes many customers to wait to place a purchase until your next sale. Instead, only run seasonal promotions that keep you competitive. If you find you regularly need to run sales to sell sitting inventory, you need to look into your demand forecasting and ordering practices.
Try Product Kitting
Product kitting is an order fulfillment technique where individual, but related, products are packaged and sold together as a single bundle. These bundles can be based on a theme or include one popular product with a few less popular ones.
It's a great way to sell off a lot of inventory without taking a major hit to your profit margin. You can also adopt a subscription box business model to maximize your ability to participate in product kitting and add recurring revenue. Your first step when doing this is to learn how to start a subscription box business.
Reduce Lead Time
Nobody likes to wait on shipments, particularly when your ability to meet demand relies on quick delivery. You should always pay attention to how long it takes to receive products that you've ordered and note when it impacts your customers. If you regularly run into backordered products (see backorder meaning) or lose sales due to missing inventory, that can lead to unsold supplies stacking up in your warehouse. Speak with your suppliers and see where the disconnect is, so you can eliminate warehouse problems and meet demand.
Reduce, Reuse, Resell
Inventory reduction will allow you to free up warehouse space, lower overhead expenses, and streamline your fulfillment process. Take a look at your current warehouse practices and leave no stone unturned. You can try any of the strategies above or use the JIT inventory model to uncover areas for improvement and decrease your warehouse costs.
Frequently Asked Questions About Inventory Reduction Tactics
Mastering inventory reduction is no easy task. It requires you to assess your inventory techniques, holding costs, and consumer demand level. Check out these commonly asked questions to make the most of your inventory reduction approach:
Why is inventory reduction important?
Inventory reduction is important for three reasons: it keeps holding costs low, it prevents spoilage and shrink, and it maximizes fill rate. Inventory holding costs are the expenses associated with keeping inventory any longer than the time necessary to sell them.
It should be any business’s goal to move inventoried products into the hands of customers as quickly as possible. This prevents products from getting lost, stolen, spoiled, or damaged.
Reducing unnecessary inventory also demonstrates you have efficient warehousing procedures and are able to forecast demand accurately. This translates to a high fill rate, which means you never have too much or too little inventory of any item.
Is it better to have more inventory or less?
If you had to choose between the two, it’s better to have a little more inventory than a little less. There are a couple reasons for this.
One, having a little more inventory than necessary usually means you have safety stock, which is a smart practice. Safety stock is sold in the event that customer demand surges or there are great per-unit purchases per customer.
Two, even if you have to tap into your safety stock, you won’t be missing out on sales in the meantime. Having zero safety stock means you have no products to sell while you’re waiting for emergency orders to be fulfilled, which leads to fewer profits.
What are the disadvantages of inventory?
There are several risks you incur when holding inventory, including the following:
- Inventory holding costs. Every day that inventory is sitting on a warehouse shelf but hasn’t been sold, there’s a cost associated with it. Inventory takes up physical space but is also accounted for on your balance sheet. Inventory must be quickly converted to a sale; otherwise, it deters profit.
- Risk of spoilage, theft, or shrinkage. Inventory spending too much time in storage may spoil, get stolen, or become defective. This is particularly important if you have a food business or perishable products.
Higher upfront costs. Stocking inventory in general means you must have the cash to purchase it before it can be sold. Businesses just starting out can only afford limited inventory, which means slower profit at first. The more you stock the more you can sell, but this also means your holding costs go up if demand hasn’t risen to match yet.
What is Inventory Reduction via JIT an Effective Tool For?
Inventory reduction via JIT is an effective tool for identifying causes of variability.