Effective inventory management is a critical aspect of retail marketing success. Poor inventory control can lead to stockouts, causing a loss in revenue by not meeting consumer demand. Fortunately, retailers can leverage many stock control techniques to maintain production levels and invest capital in items with the highest revenue value.
This guide will uncover five expert inventory management strategies and which businesses they complement, so retailers can define and determine the best inventory control techniques for their supply chain and sales.
5 Best Inventory Control Strategies
A few of the best inventory management strategies for organizations include ABC analysis, which focuses on categorizing items based on their level of importance, and safety stock, so retailers never run out of products. A second strategy is the render point formula (RPO), which enables retailers to determine when to replenish inventory, while economic order quantity (EOQ) and just-in-time (JIT) management take unique approaches to minimize inventory and logistics expenses.
Here is an overview of these stock management strategies and how to calculate them.
- ABC Analysis
ABC analysis is a popular inventory control technique that categorizes products based on their revenue contribution. This analysis evaluates products based on cost, demand, and risk and classifies each product based on that criteria. Class A refers to products critical to business success based on sales volume or profitability, B refers to moderately important items, and C is the least imperative. Here is an overview of each of the Classes for ABC analysis:
- Class A: This is the most essential product with the highest value. Class A items only make up 20% of your inventory but generate 80% of your revenue—they are considered a small group of goods with the most returns.
- Class B: Items in this category have a slightly lower value than C. Your inventory should include 30% of category B products, which equates to 15% of your revenue.
- Class C: These products account for 70% of your inventory, but only generate 5% of your revenue. Category C items are considered your highest volume category with the lowest value.
In addition, to conduct ABC analysis for your retail store inventory, follow the five steps below:
- Calculate the consumption value of each product per annum with this formula: The annual number of units sold (per item) × cost per unit.
- List all the products in descending order based on the annual consumption value.
- Divide the total annual revenue by each consumption value to determine what percentage of earnings are attributable to each product.
- Split the products into a class (A, B, or C)—items that generate the most revenue will be A, followed by B at slightly lower profits and C being the least profitable. While the rule of thumb is 80%, 15%, and 5%, respectively, this may be slightly different for each business.
2. Safety Stock Inventory
This retail inventory control strategy refers to storing surplus items to avoid running out of stock. Retailers may employ this technique during seasonal trends, as it helps them adapt to demand quickly. For instance, if a retail store sells different types of school uniforms, they may order reserve inventory when parents do back-to-school shopping after the holidays.
A survey conducted by NetStock confirms that customers experience more obsolete inventory when shopping online compared to in person. In addition, 43% of respondents said they would abandon a product if it is unavailable more than twice, while 65% have tried competitor products due to stockouts. Retail businesses must maintain consistent sales and have sufficient inventory to meet the demand.
While there are several ways to calculate reserve inventory, we will review the standard method below:
- Multiply the maximum number of units sold daily by the maximum lead time (the longest time the supplier has taken to replenish products).
- Subtract the average number of units sold daily multiplied by the average lead time.
- Use the final figure to determine how many surplus units of products to order.
The calculation should look like this:
Safety Stock = (max number of units sold per day × max lead time) – (average number of units sold per day × average lead time).
- Reorder Point Formula
This retail inventory technique is essential for companies that keep safe stock. The RPO describes the lowest quantity of items a business must store to avoid running out of products—the RPO determines how many units of safety inventory retailers must hold.
Retailers prefer this technique to avoid over or under-stocking products, which can lead to profit loss. RPO is a strategic approach to maintaining healthy inventory and demand levels while giving companies a robust insight into their sales performance.
Retailers should calculate the RPO for individual products—consider each product’s delivery time, demand, and safety stock level (if applicable). As a result, calculating RPO should be consistent, as these variables are volatile, and products that are high in demand can lose traction based on various factors.
For instance, J.P. Morgan reported sunscreen sales dropped by double digits as vacationers canceled their trips during the COVID-19 pandemic. While retailers can never prepare for an event as economically impactful as the health crisis, RPO equips them with what they need to cope with urgent market changes. In this instance, if companies had significantly overstocked sunscreen products, they would have experienced a drastic decline in profit margins.
But through employing RPO, retailers can have increased control over when to order more products to maintain healthy inventory levels, which would, in an unplanned disaster, make minimal or no negative impact on the business.
To calculate RPO, follow these two steps:
- Multiply the lead time by the demand rate.
- Add the quantity of safety stock.
The calculation should look like this:
Reorder Point = (lead time × demand rate) + safety stock
- Economic Order Quantity
This inventory control technique enables retailers to store the most appropriate quantity of products to meet the demand while minimizing inventory costs and storage. This strategy is ideal when there is a continuous demand to meet the inventory levels. If retailers place many orders for low volumes of units, the ordering, and storage costs will be much higher than purchasing in bulk and having a constant flow of sales to consume that inventory.
However, this technique also serves as a limitation for businesses that sell seasonal products or have an inconsistent demand. On the other hand, the ultimate goal of the EOQ is to optimize and minimize expenses through discount buying.
There are three variables to calculate the EOQ, which include each product’s annual:
- Unit demand (D)
- Order cost (S)
- Holding cost (H)
The formula for EOQ is slightly more complicated than the retail inventory techniques we have reviewed—this is how it looks:
EOQ = √ [2 × D × S / H]
- Just-in-Time Inventory Management
In addition to EOQ, (JIT) management aims to minimize inventory storage and holding costs. However, the latter takes a parallel approach, as retailers only purchase stock on demand. JIT management also leverages smart technology to reduce inventory waste and maintain product levels tailored to consumer demand.
Furthermore, retailers should source their inventory locally to avoid extended lead and delivery times and strengthen supplier relationships to secure reliable supply chains. They can sell to customers on-demand and potentially eliminate or minimize warehousing.
JIT management is ideal for small businesses that do not have the resources to receive and stock large volumes of inventory, or those that do not have a consistent sales flow. Small companies can also benefit from lower capital investment as they do not have to manage, inspect or maintain inventory. When these companies order stock on demand, they do not have to consider warehousing, controlled temperatures for specific goods, or the costs and effort of managing a large mass of stock.
In addition, retailers can employ these strategies for specific high-end products that customers would be willing to wait for. For instance, companies specializing in and selling high-end jewelry are more likely to have customers willing to wait for pre-ordered items.
These five techniques for inventory control can help organizations maintain healthy stock levels and minimize their inventory and warehousing expenses.
The ABC analysis is ideal for retailers that sell large quantities of products and want to categorize their inventory based on the items their shoppers value most. In addition, safety stock inventory ensures businesses do not run out of products, and RPO helps determine when retailers need to order additional items. EOQ is a fourth retail inventory strategy that works for businesses with a consistent demand to match bulk stock purchases. Finally, JIT management is an excellent option for small companies that do not have the upfront capital to invest in warehousing and large volumes of inventory.
Overall, retailers must consider their demand, budget, and logistics to find the best product inventory strategy.