Sometimes, having abundant inventory is a good thing. Maintaining high inventory levels lets you meet surges in customer demand, and carrying a wide array of products helps you serve a broad market. The downside is that stocking inventory costs money, and the cost of unsold items plus the warehouse space can be a significant expense for small and medium-sized businesses. And if inventory sits too long, it can spoil or become obsolete, taking your investment along with it.
One way to lower your risk and carrying costs is to reduce inventory. Here are some time-tested inventory reduction strategies and tips that won’t disrupt your day-to-day operations.
What is inventory reduction?
Inventory reduction is when a business intentionally lowers the amount of stock it holds. This involves identifying and eliminating excess inventory or slow-moving stock across the supply chain, from raw materials to finished goods.
Shedding excess stock is a critical component of efficient inventory management because it can streamline your operations and reduce inventory costs. Companies can consider inventory reduction as a regular step in maintaining streamlined operations or as a one-off to lower storage and carrying costs.
Inventory reduction methods
In most cases, an inventory reduction strategy involves four components:
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SKU rationalization. Analyzing stock keeping unit (SKU) performance to identify and discontinue slow-moving items.
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Process optimization.Improving supply chain management processes, such as lead times and order fulfillment. This helps businesses operate effectively with lower safety stock levels.
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Liquidations. Getting rid of excess stock by having clearance sales or selling to liquidation companies.
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Value adjustment. Formally adjusting the inventory value on financial statements if its value is deemed lower; this is known as a write-down. If the stock is deemed unsellable, it’s known as a write-off.
Why is excess inventory a problem?
Exceeding your optimal inventory levels can hinder supply chain management, reduce cash flow, and disrupt operational efficiency. Here are some common problems associated with carrying too much inventory:
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Cash flow strain. Excess inventory ties up your working capital, reducing the money available for marketing, payroll, growth investments, or your manufacturing operations.
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High carrying costs. Inventory carrying costs include storage costs, employee pay, insurance, and utilities, which eat into your profit margins.
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Obsolescence. The longer inventory sits in a warehouse, the higher the risk that it becomes outdated, spoiled, or damaged. This obsolete inventory, also known as dead stock, forces you to take a financial write-down on the inventory value, turning a potential asset into a realized loss.
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Operational inefficiencies. Excess inventory can indicate inefficiencies caused by inaccurate demand forecasts or poor supply chain management, including inaccurate vendor lead times and production schedules.
Challenges with inventory reduction
While inventory reduction, whether as a one-off or as part of regular operations, can lower costs, there are some potential pitfalls to watch out for:
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Risk of lost sales. Aggressive inventory reduction can diminish safety stocks, leaving you vulnerable to unexpected demand spikes. Unless your demand forecast is impeccable, you run the risk of stockouts, lost revenue, and disappointed customers.
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Strained fulfillment process. Lowering the amount of inventory you keep on hand can stress your fulfillment processes, especially for higher-demand products. To keep customers happy, you may have to resort to faster, more expensive shipping.
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Increased purchasing costs. Buying smaller, more frequent batches of new inventory may disqualify you from discounts on bulk purchase orders, raising your per-unit cost.
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Strained supplier relationships. Frequent last-minute purchase orders can strain supplier relationships, potentially leading to higher prices or slower response times.
5 inventory reduction tips
- Improve demand forecasting using historical sales data
- Optimize safety stock and reorder points
- Consider a just-in-time (JIT) approach
- Prioritize higher-demand products over slow movers
- Improve cross-functional collaboration within your organization
You have many tools at your disposal as you optimize inventory levels. Here are some ways to strike the right balance between fulfillment readiness and reducing costs:
Improve demand forecasting using historical sales data
Improve your forecasting accuracy by leveraging historical sales data and market trends to accurately predict future inventory needs. While it’s important to consider how seasonality and planned marketing campaigns might affect demand, don’t over-rely on short-term trends. Where possible, study years of historical data to understand sales patterns.
Optimize safety stock and reorder points
Once you know how long it takes for your products or raw materials to get to you, you’ll know how much safety stock you need to have on hand. Use this information to set up automated reorder points that trigger orders to replenish items so inventory levels never fall below the buffer stock point.
Shopify’s built-in inventory management tools can help you identify top-performing products, track sales across multiple channels, and set alerts from one centralized platform.
Consider a just-in-time (JIT) approach
A JIT inventory approach means ordering only what is needed for immediate manufacturing (known as lean manufacturing) or sales (like made-to-order or dropshipping businesses do). You can place these orders once customers have purchased products or just before existing inventory levels run out. This eliminates the need for buffer stock and reduces carrying costs. However, JIT works only when you’ve established extremely reliable logistics and rock-solid supplier relationships.
Prioritize higher-demand products over slow movers
Focus capital on fast-moving SKUs with proven market demand. This reduces holding costs and increases revenue from goods customers actually want. Use hard data when assessing this. If you rely on gut instinct rather than historical performance, you could prioritize the wrong merchandise.
Improve cross-functional collaboration within your organization
It’s important to align every segment of your organization behind your new inventory initiatives. Inventory managers should know what products the marketing department is planning to promote. Designers and engineers should know the current cost of goods sold (COGS), in the event that they can strategically replace components for cost savings.
If everyone has access to key metrics and performance reports, you set yourself up to make the most informed inventory decisions possible. Take care not to let collaboration override the decision-making process. At the end of the day, inventory managers should make the final call about what to order and what to hold back on.
Inventory reduction FAQ
What is an inventory reduction?
An inventory reduction is a deliberate effort to lower the amount of stock a business holds to cut costs and improve efficiency.
How can businesses reduce inventory?
You can reduce inventory by improving demand forecasting, tightening replenishment practices, and managing production or purchasing to better match actual sales. You can also reduce inventory by eliminating slow-moving or obsolete stock with discounts and clearance sales.
What situation brings about an inventory reduction?
An inventory reduction typically occurs when a business identifies that it is carrying more stock than needed and lowers those levels to better match actual demand.
What are the benefits of reducing inventory?
Reducing inventory improves cash flow, lowers storage and carrying costs, and reduces the risk of holding obsolete or unsellable stock. It also helps you operate more efficiently by aligning inventory levels with real demand.
