While brick and mortar stores are convenient, nowadays ecommerce platforms are growing fast in popularity among consumers and retailers alike. Online stores created with Amazon, BigCommerce, Shopify, and other platforms make the sales process easier for both customers and businesses. However, a digital storefront invites some supply chain management challenges for merchants. Inventory management is essential for smooth order fulfillment, and it directly impacts your online store’s efficiency and growth potential.
What exactly is inventory management, and why should you, an ecommerce business owner, focus on optimizing it? In this article, we’ll go over the ABCs of inventory management, detailing the terms and formulas in this field and how you can optimize inventory management for your online store.
What is ecommerce inventory management?
Ecommerce inventory management is a vital link of the ecommerce supply chain that starts from order placement and ends with the products getting delivered. It consists of the products being picked from the suppliers, stored in the warehouses, and upon the order placement, being picked, packed, and shipped to the destination.
Many 3PL companies handle outsourced fulfillment and inventory management for small and large businesses. Through inventory management, ecommerce companies get a better idea about how products are stocked and how they should be stocked in the future.
What happens if ecommerce inventory isn’t optimized?
Inventory management is related to the direct estimation and organization of the products. It determines the proper functioning of the whole supply chain and can have dire consequences for the businesses if it isn’t optimized. Let’s take a look at some of these consequences.
Stock-outs or too much inventory
If inventory management isn’t optimized, your inventory levels could cause problems. For example, overstocking can cause deadstock, especially in the food and fashion industry. No one wants to buy spoiled food or fashion that isn’t in line with current trends. Understocking can hold up the whole supply chain and cause delays that ultimately cost you customers.
Heavily manual inventory management processes
If you’re reliant on manual inventory management, it can slow down the whole supply chain. It also doesn’t allow for the business to grow quickly. For example, using a warehouse management system integrated with barcode scanners could save you a lot of time and labor costs compared to workers with manual scanners.
The wrong products get shipped
Not having an organized inventory means more errors when fulfilling orders. Customers aren’t happy when they get the wrong products delivered. Having a proper inventory management system with automation can reduce these risks.
Hard to track inventory across sales channels and multiple warehouses
Not having a proper inventory management system also means that it is harder to sync with different fulfillment centers in real-time, resulting in potentially dire consequences on sales. For example, let’s say you sell on both Amazon and Shopify. If a customer places an order on Amazon, a lack of coordination can result in orders not being fulfilled or the same order being fulfilled multiple times.
If all the inventory details aren’t accounted for through proper channels, it can become hard to keep track of products. This potentially results in the loss of inventory records and can cause losses for the company in the end.
No data or insights into inventory performance
If the inventory management system isn’t equipped with the proper tech stack, it can often become hard to track the data and then analyze that data. A lack of data analysis means that you cannot correctly measure the inventory performance and often affect future decisions – especially when it comes to demand forecasting and inventory reordering.
Getting started with ecommerce inventory management
Now that we’ve covered the dangers of not investing in proper inventory management, let’s cover inventory management basics. Of course, inventory management differs from business to business, based on their individual needs and setups, but the blueprint is similar.
Understand basic inventory demand
You can get an idea of which inventory levels you might need by analyzing past sales performance. Look at your orders based on time frame to look for seasonal trends. Once you have this data analyzed, you can order the right inventory to prevent overstocking or understocking.
This also helps save money on storage costs as you won’t need to lease more warehouse space to keep up with the increase in inventory.
Set minimum viable stock or minimal stock levels
If your ecommerce shop is already up and running, you should set up the minimal stock levels for each product category. These levels measure how much stock you should have at a minimum to ensure smooth operations and prevent a stockout.
Prepare for seasonality
To ensure a better customer experience, it’s vital to prepare for busy shipping seasons like holidays. This way, you can ensure enough inventory to cater to the fluctuating purchase orders during a busy shopping season.
Implement inventory management software
To correctly manage inventory, ecommerce businesses usually employ inventory management software. You can typically add integrations like a POS system for purchase orders. QuickBooks for keeping tabs on the bills and receipts, etc.
Essential inventory management terms
Inventory management is a versatile field and can be customized according to the needs of your business. There are many inventory management systems like ABC analysis, Set Par Levels system, etc. Here are some essential inventory management terms and systems that you’re likely to encounter.
First in, first out (FIFO)
This inventory management system relies on the principle that the first products to be received by the warehouse should be the first to be shipped to the users. This method ensures that the stock is cycled properly and is especially useful in food inventory management where expiration dates come into play.
Last in, first out (LIFO)
This inventory management system is essentially the opposite of the FIFO mentioned above method. Here, the items that are added last to the inventory are the first to be shipped. This method is not suitable for perishable items but is also becoming obsolete in other industries as well.
This particular inventory management system isn’t for those who like to play it safe. Here, the inventory stocks are kept at the minimum possible levels where demands are still met. This is not a suitable system to prepare for emergencies and runs a high risk of out-stocking.
Safety stock is like the safety net for your inventory and helps you overcome emergencies. Safety stock quantities can be estimated by using the safety stock formula that uses the maximum daily usage estimates. The formula for safety stock is mentioned in the next section.
The reorder point measures the minimum inventory level that a business should have before they reorder. This point helps you avoid overstocking and understocking situations and ensures that you reorder the goods at the right time.
Inventory distribution is best when you think that one fulfillment center isn’t enough. This especially helps with cutting down the transit times and shipping costs upon order placement. If your ecommerce business receives a high influx of orders, inventory distribution might be the thing for you.
Perpetual inventory system
A perpetual inventory system records the real-time sales and restocking of the inventory stock through inventory management methods. Inventory management software can be used to automate this process. The system records changes in the inventory systems and updates the inventory counts automatically as goods are bought and sold.
Inventory metrics, formulas, and terms
When going about inventory management, it’s crucial to get things right. A few formulas and metrics related to inventory management can help with the analysis and you can make your future decisions based on them. Here are some commonly used metrics and their formulas.
Finished goods inventory
The finished goods inventory tells about the total stock available for customers to purchase that can be fulfilled. This metric can be used to estimate the amount and value of goods available for sale and how much inventory you need to prevent stockouts. The total value of finished goods can be calculated by this formula below.
- Value of Finished Goods = (Cost Of Goods Manufactured – Cost Of Goods Sold) + Value of Previous Year’s Finished Goods
Inventory holding cost
To estimate the total costs for holding the unsold inventory including warehousing, insurance, transportation, labor, shrinkage, and opportunity costs, inventory holding costs are used. The following formula can calculate the total inventory holding costs.
- Inventory Holding Cost = (Storage Costs + Employee Salaries + Opportunity Costs + Depreciation Costs) / Total Value of Annual Inventory
Inventory safety stock formula
Inventory safety stock helps you prepare for unforeseen circumstances by stocking enough for fluctuations. This metric enables you to stay prepared for emergencies and supply chain failures, etc. It is thus the safety net for your inventory stock. You can use the following formula to estimate the inventory safety stock for your business.
- Inventory Safety stock = (Maximum daily usage x Maximum lead time in days) – (Average daily usage x Average lead time in days).
Inventory turnover rate
Measuring the inventory turnover rate helps you properly estimate and forecast future inventory needs. It essentially is a ratio of how many times inventory is sold and restocked in a specific period to determine the turnover frequency. To calculate the total turnover rate for your business, you can use the following formula.
- Inventory turnover rate = cost of goods sold (COGS) / average inventory
Inventory days on hand
This is another formula that tells you about the frequency of turnover and lets you assess how many days of inventory you have on hand so you can restock in time and prevent a stockout. You can also estimate the stock lead time with this metric. Use the following formula to estimate the total inventory days on hand for your ecommerce business.
- Days on hand = (average inventory for the year / cost of goods sold) x 365
Inventory reorder point formula
This formula estimates the minimum quantity of stock you should have on hand before you reorder. This ensures both overstocking and understocking. It also makes sure that you reorder before it is too late. Many inventory management systems remind you about this in time. The inventory Reorder point formula is as follows.
- Reorder point formula = demand during lead time + safety stock
Inventory shrinkage occurs when the accounted inventory levels aren’t the same as the actual inventory levels with the latter being lesser than the former. This can occur because of consumer theft, employee theft, management errors, or inventory damage. It is calculated as a ratio. To estimate the total inventory shrinkage rate for your business, use the following formula.
- Inventory shrinkage rate = (recorded inventory – actual inventory) / recorded inventory
Reorder quantity formula
The reorder quantity is the number of goods you should request from a manufacturer or supplier when you restock your inventory. This reorder quantity mustn’t be so high that you overstock, and not so low that you run the risk of understocking. The optimal reorder quantity can be estimated by using the following formula.
- Optimal Reorder Quantity for an SKU = Avg. Daily Units Sold x Avg. Lead Time
Ecommerce inventory management FAQs
While you might have a working knowledge of inventory management now, some questions are still unanswered in the above sections. Here are some of the typical inventory management-related questions and their answers.
What are the 4 types of inventory?
The four primary inventory types include raw materials, work-in-progress (WIP) inventory, finished goods, and sellable inventory. The WIP inventory includes raw materials, labor, and other overhead costs. Out of the four mentioned inventories, sellable items are the only ones ready to be shipped.
How do ecommerce stores get inventory?
Ecommerce stores get their inventory in the form of finished goods directly from a manufacturer or supplier. These goods are then shipped to a warehouse or fulfillment center where they are stored until they are ready to be shipped.
What are the 3 major inventory management techniques?
While there are plenty of inventory management techniques, like the ones mentioned in the section above, the commonly used ones include First In First Out (FIFO), Forecasting Demand, and Setting Reorder Points. These techniques can be used for the inventory management of your business.
What is the EOQ model?
The Economic Order Quantity (EOQ) is also referred to as the optimum lot size. It is a metric that measures the optimal order quantity for a business such that overstocking and understocking situations are prevented. It also helps a company minimize logistics costs, warehousing space, stockouts, and overstock costs.
Improve inventory management with ShipHero
ShipHero is a warehouse and fulfillment management software that connects eCommerce sellers and retailers to 3PL companies worldwide. ShipHero works with integrations of popular ecommerce platforms like WooCommerce, Shopify, Amazon, Etsy, Magento, and eBay, etc. With ShipHero, you can do comprehensive inventory management by managing warehouse locations, returns, low stocks, cycle counts, and many other things.
ShipHero allows you to sync your channels through integrations with ecommerce platforms, optimize shipping through robust shipping features, simplify operations through order management, and help from our dedicated customer support team.
With ShipHero, you can set reorder alerts for each product that notifies you when some stock needs replenishment. This way, you can stay on top of your restocking game and ensure that you do not run the risk of being out of stock.
Detailed analytics & reporting
With inventory tracking, replenishment, and reporting all in one place, you don’t have to worry about your inventory’s visibility. ShipHero helps you collect the data through inventory logs and reports and then analyze it to devise optimal inventory management strategies. With reporting and analytics, you can get an idea about how different products are performing on your ecommerce store.
You can create new purchase orders with ShipHero by specifying the supplier and the receiving warehouse. You can also replenish any depleting stock with just a click through the ShipHero dashboard. With ShipHero, you can also keep tabs on any PO change. For the returns processing, you can indicate whether a product is to be restocked or not.
By now, we’ve established why inventory management is vital for an ecommerce business and how organized order fulfillment encourages a better customer experience. While traditional selling through brick-and-mortar stores requires only one channel to be managed, the modern-day ecommerce setup with multi-channel selling can be more demanding to manage.
But you don’t have to worry about managing your inventory alone because robust logistics solutions like ShipHero provide you with the best inventory management solutions.
So, get started with ShipHero today to make managing your inventory that much easier.Contact us