Businesses face a constant challenge to hold the right quantity of goods for sale—not too much, not too little. Striking the right balance is key for successful retailers and ecommerce companies. Understanding the risks of unbalanced inventory, and having an inventory risk management strategy ready can increase efficiency and customer satisfaction. It can also boost your company’s potential profitability.
Learn more about what inventory risk is, factors that affect it, and how to mitigate the risk for your business.
What is inventory risk?
Inventory risk is the probability that the amount of goods you have available to sell is either not enough or is too much. If it’s not enough, you face possible lost sales unless you can quickly find another supplier or persuade customers to wait until you restock products. If you have too much inventory, you risk products becoming outdated and storage costs increasing the longer items go unsold.
Either way, inadequate inventory risk management can hurt your business by tying up cash in unsold goods or missing sales opportunities, eroding profitability.
Types of inventory risk
A number of factors can create inventory risk for a business, including:
Failure to accurately forecast customer demand is perhaps the biggest inventory risk. Underestimating demand can lead to running out of stock and losing sales and customers, unless the business can find other suppliers quickly. Overestimating demand can result in too much inventory, which takes longer to sell, or may become obsolete, out of fashion, and unsellable.
The supply chain interruptions stemming from the pandemic lockdowns caused shortfalls, followed by resumption of normal economic activity, which led to overstocking for many retail businesses. This highlights the challenge of inventory forecasting accurately and its implications for inventory risk.
Problems with suppliers can arise because of a failure to maintain standards for product quantity and quality, and failure to meet delivery schedules. Suppliers that don’t deliver the right amount of goods at the right time can cause production delays, storage snafus, and a host of other inventory risks. For example, a supplier quotes a lead time of four weeks to deliver goods but delivers in two weeks, when the warehouse can’t accommodate them.
Retail goods typically have a product life cycle of four phases:
1. Product launch: to get consumers interested
2. Growth phase: when sales increase
3. Maturity phase: when the focus is holding onto the product’s market share
4. Decline phase: when demand wanes
Inventory risk management is about capitalizing on the first two phases by holding enough inventory and controlling the latter two phases by limiting stock.
Another significant inventory risk is when supplies suffer damage if stockrooms and warehouses aren’t well-maintained or are in vulnerable locations. For example, a warehouse in an area prone to bad weather or natural disasters could pose a damage risk. Or a poorly organized and maintained stockroom can result in damage. For example, employees place heavy goods on top of light goods, crushing them. Damage also may occur during loading and shipping by suppliers.
Shrinkage is the term businesses use for discrepancies in inventory count—for example, your business received 100 items two weeks ago, but now you count only 90 in inventory even though you haven’t sold anything yet. Shrinkage often is the result of employee theft and shoplifting, although it also results from counting errors and poor inventory management when ordering or receiving goods. It also can happen when you misplace goods or they are lost in transit or in warehouses.
How to mitigate inventory risk
- Better forecasting
- Vet suppliers
- Safer storage
- Reduce loss and damage
- Manage the product cycle
Businesses have several ways to reduce inventory risks, including following the principles of lean inventory management. These include:
1. Better forecasting
The first step in minimizing inventory risk is improving sales forecasting to get a better handle on consumer demand for your product. Inventory management systems and related inventory risk management software programs can be a big help. Many systems can analyze your historical sales data by product type, sales volume, and other criteria. This can give you insight into how and where consumers are most likely to buy.
A clothing retailer selling cashmere sweaters, for instance, could analyze the past year’s sales data to see which style of sweater sold more than others and plan this year’s orders accordingly.
2. Vet suppliers
Carefully screen suppliers for historical performance and reliability, particularly the ability to keep to a delivery schedule. Seek references from other businesses. Given the bottleneck in supply chains the pandemic caused, it’s important to find suppliers with firm lead times for delivery.
3. Safer storage
Keep inventory safe and secure by limiting warehouse and stockroom access to designated people, keeping inventory under surveillance, and doing regular inventory valuation and quality-control checks. The sweater retailer, for example, might be careful to keep its stock in a temperature and humidity-controlled environment.
4. Reduce loss and damage
Establish procedures for handling inventory management risks throughout the supply chain, from supplier delivery to customer sale. Use bar codes and QR codes to automate inventory count, and consider upgrading systems built around inventory management software. Retailers especially should consider anti-theft tags on products to deter shoplifting and employee theft, and set up electronic controls on registers to ensure sales transactions can’t be manipulated. Having insurance on your stock is another important way to limit inventory risk, as it is covered in case of accidents.
5.Manage the product cycle
Attention to a product cycle can help you avoid or minimize product obsolescence and deadstock, or outdated and unsellable goods. You can do this by establishing a product rotation system, such as first-in, first-out (FIFO), in which you sell old goods first. Inventory management software can also help identify stock that is close to expiring. It may be smart to keep some extra inventory, or safety stock, as a buffer to meet any unexpected increase in demand. But don’t hold onto too much excess inventory; sell or dispose of it.
Consider hiring third-party logistics services, an inventory risk management provider to handle receiving, documenting, storing, and tracking. Large or growing businesses may find the cost of these inventory services offsets the reduction in inventory risk and increase in profitability.
Inventory risk FAQ
What is the risk of high inventory?
A business with excess stock faces inventory risks such as holding unsold products that cost money to keep in warehouses and stockrooms, as well as suffer a decline in value. The lower value could result from falling demand for the products, obsolescence, damage, employee theft, and record-keeping mistakes.
How do you mitigate inventory risks?
Inventory risk management can help reduce the possibility of not having the right amount of inventory by automating and using inventory risk management software and other systems wherever possible to eliminate human error. Train employees to understand the importance of inventory control for the business’s success. Growing businesses might consider a third-party logistics service to handle inventory management.
What are the potential consequences of not having effective inventory risk management?
Overstocking or understocking are the two most obvious manifestations of inventory risk. Overstocking results in unsold goods that lose value, tie up your capital, and incur storage expenses that eat into profit. Understocking means not having goods to meet customer demand, leading to lost sales and dissatisfied customers, while potentially giving an opening for competitors to move in.