It’s a secret successful merchants know but rarely talk about. And for anybody outside the know, the costs of ignorance can be decimating.
From growing online businesses to global giants like Boeing, Target, and Hershey’s … many companies simply don’t have adequate systems in place for effective stock management.
If a customer has ever abandoned your online store because the pair of shoes they want isn’t available or if you’ve ever been forced to sell outdated products for a small percentage of what they originally cost, there’s a good chance that it’s because of poor stock management.
With an estimated $1.1 trillion of capital tied up in inventory, accounts receivable and accounts payable, you’d think companies would put more emphasis on this process. But incredibly, up to 43% of businesses don’t even track their inventory or use an outdated, manual process.
What many of these “pen, paper and spreadsheet” businesses fail to realize is that stock management is not just an internal process for keeping track of your inventory—it directly affects your relationship with your customers.
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What Is Stock Management?
The term stock management (also known as inventory management) refers to the process of determining how much inventory a company should have at any given time.
Effective stock management is all about keeping the right balance between customer satisfaction and company profits. You want to make sure you have enough in-demand products to sell to your customers, without spending too much on getting those products into your customer’s hands.
Stock management requires:
- Keeping track of stock levels
- Determining the cost of stock
- Calculating costs involved with shipping, handling, and storage
- Determining storage locations
- Analyzing past sales data
- Predicting future demand
- Determining when to replenish and how much is needed
The name of the game is keeping optimal levels at all times, and many fail to realize how fluid this process is. It can be affected by numerous external factors like the time of year, the state of the economy, and the shifting demands of the public, as well as internal factors like the size of your warehouse, your relationship with your suppliers, and your available capital.
The Short and Long-Term Value of Stock Management
Try this short quiz … here are four companies: Sony, Microsoft, Nintendo, and Atari.
Which company is the odd one out?
Even if you’re not particularly interested in video gaming, there’s a good chance you correctly picked Atari as the odd one out. While Sony, Microsoft, and Nintendo are the three key players in the $29 billion console gaming market. Atari is a relatively small software company that has recently turned to crowdfunding in an attempt to re-enter it.
What you may not know is that back in the 1970s and early 1980s, Atari was the pioneer of the home gaming market. It created some of the most iconic games that are still well-known today—household names like Pong, Space Invaders, Pacman, and Frogger. It had the best selling console in 1982.
Despite its incredible success, the company was soon on the brink of bankruptcy after suffering what is commonly considered one of the worst inventory disasters in business history.
Miscalculations when projecting consumer demand led the company to produce millions of new games and consoles that went unsold. One of the biggest problems for Atari was the infamous E.T. video game, which had an estimated 3.5 million out of a total 4 million produced units sent back to the company as unsold inventory or customer returns.
The company was stuck with the costs of producing, storing and disposing of incredible amounts obsolete stock, and eventually decided to dump them in a New Mexico landfill. This tale was actually considered urban legend until the landfill was finally excavated in 2014 and low and behold: a goldmine of obsolescence was unearthed.
Not only did poor stock management cause the demise of Atari, it was also considered one of the major factors in the video game crash of 1983, which saw industry revenues fall 97% from over $3 billion to around $100 million by 1985.
A real bummer, eh? Now let’s turn this around and look at how effective stock management can help you—especially when it comes to your finances.
In an example presented in Forbes, a heavy machinery manufacturer keeps four weeks’ worth of stock in their warehouse to cover demand. As heavy machinery components are often expensive, four weeks’ worth could be valued at up to $100 million.
By optimizing their stock management processes and reducing their stock coverage from four weeks to three, the company could potentially save up to $65 million per year. This would more than outweigh the costs involved in implementing new systems and training staff in new processes.
Identifying Stock Management Problems
Megan Lierley, Content Marketing Manager at Stitch Labs, states:
“Brands can undermine the direct correlation between effective inventory management and customer loyalty.
“Stock management can seem like such a backend, behind the scenes component of their business, but when a customer receives the wrong order or faces an out-of-stock, that directly affects whether or not they shop with that brand again.”
Before you assume that your own system is running effectively, it’s a good idea to ask yourself these questions:
- Do you regularly have customers ordering products that are out of stock?
- Do you have a congested warehouse with excess slow-moving inventory that takes up storage space?
- Do you often end up writing off a large amount of unsold stock?
- Do you have trouble allocating your stock to multiple channels?
- Do you find it difficult to quickly differentiate best selling and worst selling stock?
- Do you find yourself overpaying suppliers because you’ve mistimed stock replenishment points?
If you answered “yes” to any of these, there’s a good chance you could benefit from implementing the Goldilocks Principle.
Not sure what that is? I’m glad you asked.
The Goldilocks Principle
You’re probably familiar with the story of Goldilocks, the little girl who came across a bear house in the woods and made herself at home.
She went through three bowls of porridge, three chairs, and three beds—the first and second being too extreme, and the third always being just right.
This idea of finding something that is “just right” has become known as the Goldilocks Principle, and has been applied to a wide range of disciplines including psychology, biology, engineering, and economics.
The Goldilocks Principle is often used to describe optimal stock management, with the key being:
Having the right amount of stock, at the right price, at the right time, and in the right place.
Let’s take a look at each of these points, and see how getting stock “just right” can help you trim excess costs, increase turnover rate, and streamline your business.
Choosing the Right Amount of Stock
Keeping the right amount of stock on hand is a delicate balancing act.
If you have too little, you run the risk of disappointing your customers, driving them to your competitors, and damaging your brand image. Online consumers have come to expect a streamlined shopping experience that lets them order what they want when they want. Many have shown that they’re willing to pay higher prices for same-day shipping, overnight shipping, or in-store pickup to ensure that they get their product as quickly as possible.
Even the most loyal customers are put off by out-of-stock messages, and many turn to competitors instead of waiting for you to reorder from your supplier.
On the other hand, if you have too much, you risk having dead stock that will eventually require liquidation. Deadstock, or obsolete stock that just won’t sell, not only costs you in lost revenue. It takes up valuable warehouse space that could be used for storing other products, and the carrying costs for keeping hold of the stock (such as warehouse rental, insurance, utilities, security, and labor costs) have to be taken from the profits of other, more successful products.
Once you have dead stock, there’s no simple way of getting rid of it. You can try selling it at a big discount, bundling it with other products, returning it to your supplier, or donating it to a worthy cause. Sadly, you’ll end up losing money no matter which option you choose, so it’s important to build avoidance into your operations.
Calculating the right amount of inventory requires you to estimate future needs based on historical demand. This can be incredibly time-consuming if you’re still using spreadsheets to track inventory, but with a robust inventory management system, you can get accurate and detailed historical sales data with just a few mouse clicks.
Once you’ve collected the data, you can order based on recent demand, or apply your historical data to the economic order quanity (EOQ) formula. Since it was developed in 1913, the EOQ has helped businesses calculate the ideal quantity of inventory to order for any given product based on three variables: demand, ordering cost, and carrying cost (also known as holding cost, which we’ll look at in more detail in the next section).
The EOQ looks like this:
- EOQ = Economic order quantity
- D = Annual demand quantity
- S = Static (fixed) cost per order
- H = annual holding cost per unit
Here’s an example:
You run an online store that sells hats. Your most popular hat sells at a rate of 1000 units a year (D). You calculate that the static (or, fixed) cost per order (S) is $10. The holding cost per unit (H)—including storage, insurance, and other associated costs—is $2.
EOQ = square root of [(2 x 1000 x $10) / $2] = 100
To minimize order and carrying costs, the ideal order quantity for this product is 100 units.
To get an example of ideal stock amounts, you can try calculating the EOQ of some of your own products using an online EOQ calculator.
Calculating the Right Price for Your Stock
The EOQ is great for calculating an ideal order quantity, but what happens when your supplier says, “If you order an extra 30 hats, I’ll give you a 15% discount on the order”?
While this may sound tempting, it’s important to remember that choosing the lower order cost may not be the most profitable option. You’ll need to do the math before making a decision.
Knowing the right price of your stock is necessary for calculating how much you’re going to charge your customers and identifying how much profit you stand to make. But the price of your stock is more than just the order cost you pay to your suppliers. You’ll need to factor the costs involved in receiving and storing your stock (carrying costs), as well as costs that occur when there isn’t enough stock available to complete orders (stockout costs).
(1) Ordering Costs
Ordering costs (also known as setup costs) are the costs that you incur every time you place an order. Fixed ordering costs include fees for placing the order as well as clerical costs involved with communication and order processing. Variable ordering costs are based on the size of the order and include shipping, unloading and inspection fees
(2) Ordering Costs
Carrying costs generally fall into four categories:
- Capital Costs: Related to the investment and the interests on working capital. Capital costs represent the largest component of the carrying costs and are usually expressed as a percentage of the dollar value of the inventory (e.g. if the capital cost is 20% of a $10,000 inventory, the cost will be $2,000). It can be calculated using a formula like the weighted average cost of capital (WACC), or estimated using past experience or industry standards.
- Storage Costs: Related to housing the stock. This usually includes building purchase or rental fees, maintenance fees, utilities, and property taxes.
- Inventory Service Costs: Related to insurance, taxes, computer systems, human resources, staff management, and physical handling of the stock. If you are using a third-party logistics (3PL) provider, these costs may be included with the storage costs.
- Inventory Risk Costs: Related to the risk that your stock may drop in value over time. A large percentage of risk costs are due to shrinkage, or loss of stock somewhere between the supplier and point of sale, and may be caused by administrative errors, damage during transit or storage, and theft. Shrinkage can be difficult to calculate, but it’s estimated that it costs U.S. retailers around $60 billion a year. Other risk costs include products going past their expiration date and becoming obsolete.
Carrying costs vary depending on the size of your business and the type of product you stock, but you can get a general idea of costs by using an online calculator.
(3) Stockout Costs
Stockout costs refer to the extra costs involved with replacing out-of-stock products. This can include paying extra for emergency shipments, changing to suppliers with faster delivery times, and replacing stock with less profitable options.
Each of these three costs has to be factored into the overall cost of getting your product into the hands of your customer. Looking back at the original discount offer for hats, increasing your order size may reduce unit costs, but it also means you’ll be responsible for increased carrying costs.
If you have a high-demand product that’s flying off the shelves, increasing your order size may be a good idea. However, if your product turns into dead stock, the carrying costs associated with the extra 30% of stock could end up costing you more than you saved with the 15% discount.
Getting Stock at the Right Time
In a perfect world, a new shipment would arrive at the exact time your previous inventory sells out, eliminating the need for any extra storage space. But without proper stock management, it’s tough to get the timing perfect.
If your new shipment arrives too early, you’ll have to find somewhere to store it, which increases your carrying costs. It’s an added expense, but it’s generally not as damaging as the alternative.
If your new shipment arrives too late, you’ll have products out-of-stock, you’ll be losing revenue, and you’ll have to deal with unhappy customers. In the case of a stockout, there are four possible scenarios that your customer can choose:
- Wait for the product to return, which can reduce their satisfaction level.
- Backorder the product, which also reduces their satisfaction level and leaves you responsible for processing costs.
- Cancels the order and is unsatisfied, yet may order from you again in the future.
- Cancels the order and becomes a loyal customer to your competitor. Ouch.
None of these scenarios are particularly appealing, which means it’s vital for you to get your reorder point right.
To calculate an accurate reorder point, you’ll need to know your product’s lead time. Reordering from a supplier takes time, as suppliers have to pick, pack and ship your order. The lead time is the time it takes from placing an order with your supplier to having the new stock arrive in your warehouse.
Let’s use our previous hat order as an example.
Once you place an order with your Chinese supplier, it usually takes three days for them to pick and pack it. The order takes four days to be delivered to port, then spends 20 days on a cargo ship. Once it arrives, it takes six days to clear customs. It then takes four days to be shipped to your warehouse and unpacked.
To calculate the lead time for this order, you simply add up all the days:
3 + 4 + 20 + 6 + 4 = 37 days, which means you’ll need to have enough stock on hand to cover 37 days of sales.
You’ll also need to know how many items you’ll need during this period. You can calculate this by looking at average daily usage over an extended time and multiplying it by the lead time. The answer is known as the lead-time demand. For example, if you usually sell five hats a day:
5 hats x 37 days = 185 units lead time demand
It’s important to remember that this number is only accurate in normal situations.
What happens if your new shipment of stock is held up by customs or delayed by a natural disaster? Orif your supplier suddenly goes out of business and can no longer offer you the product? Or if a celebrity is pictured wearing your hat and demand for your product suddenly skyrockets?
This is when you need safety stock, the stock that you set aside to fulfill orders during emergencies or in unexpected situations.
There are complex formulas that can help you calculate required safety stock, but if you just want to get an approximation, you can use this simple one:
Safety Stock = (Maximum Daily Usage x Maximum Lead Time) - (Average Daily Usage x Average Lead Time)
For example, you know that your average sales are five hats per day, but in the middle of summer, this can increase to 10 hats. You also know that your average lead time is 37 days, but you remember that last year during Chinese New Year, your supplier was on holiday and the lead time during that period was 50 days.
(10 x 50) - (5 x 37) = 315, which means you should have 315 units of safety stock on hand at all times to cover emergencies.
Now that we know the lead time demand and safety stock, we can apply these numbers to the reorder point formula to calculate when we should reorder new stock.
Reorder Point Formula = Lead Time Demand + Safety Stock
For our hat example, 185 + 315 = 500, so we should place a new order with our supplier when our stock level for this product reaches 500 units.
Calculating reorder points is vital for effective stock management, but it can be incredibly time-consuming when dealing with a large number of products.
For quick calculations, you can use an online calculator. For most businesses, it’s a better idea to use a robust inventory management system. This will automatically monitor sales across multiple channels, calculate reorder points based on past data, and prompt you to make a purchase order when approaching a reorder point.
Keeping Stock in the Right Place
If you’re engaged in smart ecommerce, you’re probably selling products on multiple channels like Amazon, Ebay, Shopify and even a brick and mortar store. Whether you’re shipping products from one central location or from multiple warehouses, it’s important to make sure you keep your stock in the right place.
If you’re selling on multiple online channels, you want to be able to easily reallocate stock to each channel based on demand. You don’t want to have a product listed as out-of-stock on your Shopify store while the same product has multiple units available for sale on your Amazon store.
The same logic applies to offline commerce. It’s no use having excess stock in your warehouse that’s designated for online orders when the shelves in your brick and mortar stores are empty.
Keeping all your stock in one central location can help simplify allocation to various channels. You can adjust stock levels for each channel based on how many units remain in the central warehouse.
However, for large retailers, having multiple warehouses may be more cost-effective. Many customers will be put off by long shipping times, so you can save time and keep your customers happy by storing and shipping your product from a local warehouse.
Whichever method you choose, it’s important to remember that effective multichannel stock management is virtually impossible if you’re still keeping track of stock with spreadsheets. A robust inventory management system allows you to keep track of stock across multiple channels, automatically update levels as sales are made, and allocate stock based on demand for each individual channel.
Stock Management Made Easy
Shopify Plus customers have a number of great choices for inventory management systems that can easily integrate with most ecommerce platforms.
Stitch Labs is a popular system that focuses on providing exceptional customer service for businesses who are growing quickly and expanding into new channels. The goal of their service is to make sure your business is growing efficiently by having control over and visibility into their inventory across channels.
They offer onsite implementation and a dedicated account manager who takes the time to understand the nuances and unique workflow of each of their clients. Their customer success and support teams are unique because they are not only experts on Stitch, but on other integration partners, too.
“With Stitch’s virtual warehousing functionality, we were able to move products from our warehouse to our virtual warehouse, providing us with a threshold of reserve inventory to prevent a customer from ordering something that’s actually out-of-stock.”
With this preventative measure for our highest volume day, we decreased backorders by 93 percent from the previous year.
TradeGecko is another inventory management system that allows customers to make a sales order, track inventory levels, calculate the cost of goods sold, and manage those wholesale relationships all within one platform.
When using TradeGecko, customers instantly feel the time and cost savings by having complete visibility into their inventory operations. Having the proper stock control processes in place helps TradeGecko customers better understand the profitability of their business.
Dirty Knees Soap Co., a soap company that ran on the SWOS (see what’s on the shelf) stock management system, turned to TradeGecko for help after receiving their first large wholesale order from a national chain.
Dirty Knees owner Heidi Danos stated:
“After receiving a large wholesale order from Whole Foods, I knew I’d go nuts trying to stay on top of the inventory needed for that order, while also managing our other wholesale and day-to-day retail orders. That’s when TradeGecko swooped in and saved the day. I can’t imagine working without it. The platform definitely saved me a ton of time and helped us to prevent a ton of mistakes as we no longer had to manually transfer order information.”
Heidi was particularly pleased with the easy integration with her current systems.
“We are currently integrated with Shopify for eCommerce, Xero for accounting and ShipStation to manage all of our shipping needs. Once these platforms were integrated with TradeGecko, I input my first wholesale order and had a eureka moment.”
For the first time, I could see and track my entire inventory workflow. I can't believe I didn't do this sooner... it’s pretty freakin' awesome!
For more information about these inventory management systems and other Shopify Plus Technology Partners, take a look at this guide to choosing the right inventory management system or jump over to the Partners directory.