Tips and Tools for Balancing Inventory Management
In August 2023, Under Armour reported a substantial 38% increase in its inventory levels, and profit levels took a hit. Too many leftover undies, in short (or, shall we say, shorts?), undercut their underwear profit. This spike in stock shook its stock, knocking down share price for months. The plunge brought to the fore a crucial question facing business managers who deal with logistics and inventory management.
Does an excess of stock tend to hurt profitability? Or is it wise to modestly over-order to keep essential products in reserve and prevent dreaded stock-outs? To explore the topic in depth, let’s consider the complex interplay between inventory levels and financial performance.
The Balancing Act: Inventory Levels and Profit Margins
Effective inventory management is a linchpin in a company's journey toward financial prosperity. Surplus stock increases carrying costs, including expenses for warehousing rentals, utility bills, insurance premiums, and heightened security. Collectively, these overheads can increase the cost of goods sold (COGS), diminishing a company's gross margins.
In industries where demand fluctuates, the challenge of maintaining optimal inventory levels is even more pronounced. The key is to find the sweet spot where stock levels are neither too high to incur unnecessary costs nor too low to miss sales opportunities. Efficient inventory management involves strategic planning and use of advanced tools for real-time inventory tracking and analysis. This approach helps businesses maintain a balance in their inventory, ensuring they have enough stock to meet demand without the financial burden of overstocking.
To keep a finger on the pulse of inventory, managers need to carefully track the relevant KPIs:
Inventory Turnover Rate (ITR) measures how fast a company can sell and replace its inventory. A high turnover rate indicates efficiency.
Days Sales of Inventory (DSI) calculates how many days it takes for a company to sell its entire inventory. Lower values are better.
Stockout Rate measures the frequency of running out of stock for specific items, helping to identify lost sales opportunities and customer dissatisfaction.
Obsolete Inventory Percentage (OIP) represents the percentage of inventory that has become obsolete or expired, indicating the efficiency of inventory management.
Gross Margin Return on Investment (GMROI) assesses the profitability of inventory, calculating the gross profit generated for every dollar invested in inventory. Higher values are desirable.
Inventory to Sales Ratio compares the value of inventory to the value of sales. A high ratio may indicate overstocking, while a low ratio could mean stockouts and lost sales.
Lead Time measures the time it takes for an order to be fulfilled from the moment it's placed. Longer lead times can result in higher carrying costs and stockouts.
Fill Rate measures the percentage of customer orders that are filled completely and on time. A high fill rate indicates efficient inventory management and customer satisfaction.
The Many Risks of Overstocking
Let’s take a deep dive into the different risks of overstocking. Then we will look at strategic tools to prevent this and maintain an optimal inventory balance.
Obsolescence and Market Value
Stockpiling inventory poses substantial risks. Items lingering in inventory for extended durations run the gauntlet of obsolescence, potentially necessitating markdowns or write-offs. This inevitably casts a pall over a company's profitability as the initial cost of these items remains constant, “sunk.”
Sunk costs can overload and even sink an otherwise stable operation. Mitigating these risks calls for vigilance, requiring businesses to perform regular inventory assessments and stay attuned to shifting trends.
Increased Opportunity Cost and Capital Allocation
Remaining nimble in adjusting inventory levels is paramount. Aligning stock with market dynamics is key to financial well-being. Efficient inventory management ensures that businesses are agile in responding to market shifts, ensuring they remain in sync with supply and demand.
Effective inventory management isn't just about controlling costs but understanding opportunity costs associated with excess stock. Capital tied up in surplus inventory could be deployed more profitably elsewhere. When funds are over-allocated to maintaining excess inventory, businesses miss out on investment opportunities that could significantly enhance their profits.
This opportunity cost extends beyond immediate financial impact. It affects a company's capacity to adapt and innovate. Businesses that strategically allocate their resources are better positioned to invest in research and development, explore new markets, or acquire cutting-edge technologies. Better for an operation to run “lean, mean and green”, leveraging opportunities to catalyze exponential profit growth, reduce waste, and ensure long-term sustainability.
Longer Discounting and Holding Times
To liquidate excess stock, businesses often resort to offering discounts or promotions. While these strategies may expedite inventory movement, they frequently result in reduced per-unit revenue, thereby squeezing gross margins. Furthermore, excess stock can lead to extended holding times in warehouses. As products linger in inventory for extended periods, associated costs escalate, and overall gross margins dip. Streamlining inventory management can empower businesses to reduce holding times and curtail the necessity for aggressive discounting.
For additional insights into how industry giants navigate their inventory challenges, you can explore the article on how different approaches that big box stores like Walmart and Costco take to balance their stock and manage their inventory. These retail behemoths are renowned for their efficient inventory practices and offer invaluable lessons for businesses of all sizes.
Higher Potential for Damaged or Spoiled Goods
Another peril associated with excess stock is the potential for products to degrade or reach their sell-by dates. This can lead to additional costs and losses, impacting margins, disappointing customers, and thus degrading brand reputation. Efficient inventory management acts as a shield against the risk of products deteriorating or becoming damaged due to prolonged storage. Goods get swiftly dispatched, minimizing the likelihood of spoilage or damage.
Strategic Inventory Management to Balance Stock and Increase Leverage with Suppliers
Consistent overordering and maintaining excess inventory can inadvertently weaken a business's negotiating power with suppliers. Suppliers may become less inclined to offer discounts or favorable terms if they perceive that excess inventory is sitting on shelves or stacked in warehouses. You want to keep those vendors hungry to offer their best deals. Lingering stock doesn’t incentivize deals.
By implementing efficient inventory management with BoxHero, businesses can kill several birds with a single cloud-based application. It tracks the essential inventory management KPIs in real-time. By using the app to maintain an optimal balance of omnichannel inventory, with full transparency from warehouse to shelf to online page, they can optimize their stock levels and bolster negotiating power with suppliers. When vendors see a consistent demand for products and streamlined inventory practices, they are more willing to negotiate advantageous terms.
The multifaceted impact of excess stock on a company's profitability presents a daunting challenge. Businesses need to keep enough inventory in reserve to minimize the chance of stock-outs and to handle spikes in demand or unpredicted supply shortfalls. Due to the many damaging effects of overstocking, businesses must tread carefully to delicately balance stock with probable need. Efficient inventory management, powered by visualization and analytical tools like BoxHero, plays a pivotal role in optimizing efficiency and maximizing profit potential.
Conclusion: Use Smart Software to Strike the Stock Balance
Maintaining the right balance in inventory levels is an ongoing challenge requiring a keen understanding of market dynamics. With BoxHero, businesses gain an automated strategic partner in inventory management. As businesses grapple with fluctuating demand, it’s a secret weapon for the fine art of balancing inventory management with business profitability. Learn what Under Armor discovered the hard way: Better to balance stocks than to lose your shorts.