Are you struggling with maintaining the right inventory level for your retail business? If yes, you are not alone. Inventory management is a common challenge for retailers, and not getting it right can quickly add up to significant costs.
Inventory is Too Important to Get Wrong
If you keep too much inventory, you tie up precious cash in an investment that does not provide any return until you sell it. This cash could be used for other important business expenses, such as payroll or purchasing equipment. Additionally, excess inventory takes up valuable storage space and may require you to consider costly expansion options. Moreover, if your inventory has an expiration date, and it doesn’t sell quickly enough, you may need to mark it down, resulting in lost revenue.
On the other hand, not keeping enough stock can lead to stockouts, which can jeopardize customer relationships and drive them to competitors who have better inventory management. You also have to consider administrative costs associated with frequent reordering.
Tools for Managing Inventory
Thankfully, there are mathematical tools that retailers can use to minimize these costs, such as Economic Order Quantity (EOQ), Reorder Point (RP), and Safety Stock (SS).
EOQ helps you determine the optimal quantity to order from suppliers. The formula is the square root of (2DS)/H, where D is the demand in units per year, S is the cost to place an order, and H is the cost to store a unit of inventory per year. This formula strikes a balance between obtaining enough stock to satisfy demand without keeping excessive stock or incurring high ordering costs.
RP is the remaining quantity of an inventory item that triggers a replenishment order. It limits the amount of inventory occupying storage space, and it is the demand of the stock item during the order lead time. For example, if the period of time between placing an order and receiving it is one week, and demand for a widget is 20 per week, the RP is 20.
SS is the quantity kept on hand in addition to RP that’s kept in case stock depletes faster than expected. Your SS quantity will depend on how well your customers tolerate stockouts. If the tolerance is high, you could get away with keeping a low or no SS. If the tolerance is low, your SS will need to be higher and added to your RP. There’s no standard formula for SS, but depending on the stockout tolerance level, your SS could be one standard deviation of the demand during order lead time.
Optimizing away all costs associated with storage, stockouts, and ordering is impossible. However, using these tools can help reduce these costs and improve your profits.