Inventory Forecasting 101: Methods, Formulas & Examples
Combat the $1.75 trillion lost annually in sales and costs for retailers worldwide through inventory forecasting.
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E-commerce inventory management is a complex process, but we’ll make it simple for you.
This is a step-by-step guide on inventory management for e-commerce, covering what it is, why it’s important and how to optimize inventory for your online business:
E-commerce inventory management, or stock management is an organized approach to sourcing and storing stock for your online shop, as well as selling, shipping and tracking of goods.
It helps you determine which goods to restock, how much and when to order.
Inventory management for e-commerce is a multi-staged process involving multiple stakeholders, such as your supplier, warehouse staff as well as customers.
This section discusses the process of e-commerce inventory management.
An inventory management cycle begins with buying inventory from your supplier. As the goods become yours, they get into your warehouse.
The next stage is holding stock. Typically, e-commerce businesses have stock management warehouses to store their inventory. This is where your inventory stays until they are shipped to customers.
A sale occurs when a customer places an order for your goods. To fulfill the order, you’ll have the goods shipped to the customer.
E-commerce inventory management doesn’t simply end when the goods leave your warehouse. The last step of the process is an inventory audit, in which you check the theoretical amount of inventory against the actual quantity, so that you’ll know whether the stock count in your books is correct.
As a critical element of your supply chain, inventory can be the most important asset of your business. Inventory optimization is particularly important for e-commerce retailers, whose businesses rely heavily on sale of goods.
Below are five benefits of e-commerce inventory optimization:
The world today moves at a fast speed. Customers don’t like to wait. A recent research report by McKinsey & Company revealed that over 90% of online shoppers expect product delivery in 2 to 3 days. If delivery takes too long, almost half of consumers will buy from another shop. It is therefore crucial to manage your e-commerce inventory and maintain it at a level that meets your customers’ demand. This helps prevent lost sales and revenue.
If you want happy and returning customers, order fulfillment is something you don’t want to mess up.
Imagine this. A customer placed an order at your online store. He has already paid and expects to receive the goods shortly. Yet, as your warehouse staff prepares the goods for shipment, they realize that one of the purchased items is out of stock. Oops, that’s a problem arising from the absence of a proper inventory management system. You lack inventory visibility — you don’t know what’s in your warehouse and what’s not.
In this scenario, the unlucky customer either has to wait for you to restock, or he can request a refund for the item that is currently unavailable. Either way, he isn’t going to be happy.
This is why e-commerce inventory management is crucial for creating positive customer experiences, hence building customer loyalty.
Inventory management for e-commerce retailers is a delicate balancing act. Understocking could lead to lost sales and unhappy customers, but overstocking has problems too. One of these problems is impeded cash flow.
Typically, you pay your suppliers before you sell the goods to your customers. It means your money will be tied up in inventory before you make a sale. For e-commerce businesses, holding some inventory is unavoidable. But having too much money sitting in your inventory is undesirable. This is because you’ll have less cash to invest in other areas of your business operations.
Worse still, there could be a budget squeeze where you don’t have enough money to make repayments on loan, pay your staff and still manage to maintain the day-to-day operations of your company. You’ll need extra capital, or your business shuts down. The importance of e-commerce inventory management should be evident at this point. It plays a key role in maintaining the healthy cash flow of your company.
Note: Prevention is better than cure. The best practice is to keep inventory at optimal levels. But if you really need a quick cash injection to overcome short-term cash flow gaps, inventory financing is something you could consider. Choco Up’s funding for e-commerce companies could lend you a helping hand too! (It’s called revenue-based financing, FYI.)
Inventory carrying costs refer to the various expenses that you incur by holding unsold inventory. As the definition suggests, poor e-commerce inventory management doesn’t only cause problems when cash flow issues emerge. Rather, it costs you money every day. For example, whilst holding unsold stock in your warehouse, you’re actually paying for its storage and insurance. Although these costs are unavoidable, they can be minimized by keeping inventory at the right level.
Some goods have limited shelf life. As time passes, they’ll become unfit for use, consumption or sale. An everyday example can be found in grocery stores. Sometimes the stores stock up so much food products that they cannot sell all their inventory before the expiry dates. As the sell-by dates draw close, these perishable goods may be sold at deep discounts. Or they may be thrown away.
Though spoilage and expiry are inevitable for perishable goods, inventory management is one way to minimize the loss from these events:
The above are some examples of how e-commerce inventory optimization boosts efficiency and reduces the costs of running a product-based business.
Next, we’ll delve into the e-commerce inventory management process, explaining how you can manage your inventory with the right techniques.
Before you get started on anything related to your e-commerce inventory, you must have a stock management strategy in place.
Here are some common methods for managing e-commerce inventory.
The just-in-time (JIT) inventory method originated in Japan, where Toyota Motor Corporation ordered raw materials from its suppliers only when it received orders from customers. Parts always arrived just in time to move along the production process, but no sooner. This technique enabled the car manufacturer to process inventory quickly and efficiently. It also helped reduce the costs of holding inventory, hence increasing profitability. Applying the JIT inventory methodology to e-commerce businesses, goods can be ordered from suppliers only as they are needed, i.e. when customer orders are received. This way, e-commerce sellers can keep inventory levels at a minimum.
In theory, the JIT technique has the benefits of cost reduction and efficiency boost. In practice, however, it could be difficult to implement. With the JIT inventory method, there is very little room for error — demand forecasts must be accurate, and you must have a reliable supply chain. Otherwise, there are chances that you won’t be able to fulfill orders in a timely manner. There may also be lost sales due to unexpected demand spikes that you cannot capture.
First in, first out (FIFO) is another inventory control method that you can use. As its name suggests, the goods that first come into the warehouse will be the first to be sold.
Below is an illustration.
Assume boxes number 1, 2, 3 and 4 contain identical goods. These boxes enter the warehouse at different times in ascending numerical order.
When a customer order comes in, the goods in box number 1 will be dispatched first, according to the FIFO principle. This is because box number 1 is the first to come in, hence the first one out.
The next customer orders will then be fulfilled with the goods in box number 2, and after that, with goods in box number 3, so on and so forth.
Essentially, the inventory that arrives first will be dispatched first, whereas inventory that arrives last will be dispatched last.
The FIFO inventory method is commonly used by sellers of perishable goods (e.g. food), so that the oldest items can be sold as quickly as possible.
That being said, the FIFO technique applies to non-perishable inventory management too.
By selling the oldest items first, you can avoid holding too much obsolete inventory, such as fashion items from past seasons.
Third-party logistics, sometimes known as 3PL or TPL, involves much more than logistics. 3PL providers offer a suite of services to e-commerce companies, ranging from distribution, warehousing to order fulfillment. Working with a 3PL provider means you will outsource your inventory management, as your 3PL partner will store and handle your goods at their warehouse.
E-commerce inventory management is science, not art. It requires a combination of techniques, experience and tools. This section will give you the set of skills and knowledge to manage your e-commerce inventory. It is structured as a step-by-step guide, so that you can follow the steps and start managing your inventory right away.
“Which products should I order from my supplier? How much should I get?” are common questions asked by e-commerce sellers who are new to optimizing inventory management. While there is no simple or model answer to these questions, understanding product demand certainly helps you decide.
Below are some steps you can take to understand consumers’ demand for your product.
When it comes to product demand forecasting, the best place to start is your past sales records. As you are planning to stock up for, say, the next quarter, you can take reference from sales performance in the past quarter. Assuming the future demand stays largely the same, you will have a rough idea of how much of each product will be needed in the coming three months.
Past demand analysis is a helpful indicator of future demand, but this analysis alone is not enough. Instead of just looking at the sales records, you also have to factor in seasonality. Seasonality is what causes consumer demand for certain products to shift in a predictable way.
Here are some examples.
The Christmas holiday often goes hand in hand with a nation-wide shopping spree. The onset of winter causes swimsuit sales to drop. The flu season stimulates demand for over-the-counter drugs. These seasonal fluctuations could cause your historical or upcoming sales to spike or fall, and should be born in mind as you make demand forecasts.
Product promotion may not be a responsibility of your company’s operations division, but it is closely related to the e-commerce inventory management process. This is because your spending on product-based marketing will bring more sales (at least it is supposed to, or else your marketing team will have to figure out a better strategy). It is therefore advisable to work closely with the marketing division in your company. Their advertising strategy impacts your demand planning greatly.
Reorder point (ROP) is an e-commerce inventory management term that refers to the level of stock falling below which inventory should be replenished. It helps you determine when to place an order with your supplier, hence minimizing the occurrence of stockouts.
Computing the reorder point for a particular product is a two-step process. Below are the steps that you can follow to set a reorder point:
Step #1: Calculate safety stock
Safety stock, sometimes known as minimum stock level, is the amount of extra stock that you keep in storage to prepare for demand fluctuations. It can be computed using this formula:
Safety stock = (Maximum daily sales x Maximum lead time in days) −(Average daily sales x Average lead time in days)
Note: Lead time refers to the amount of time between placing an order with your supplier and receiving the goods at your warehouse. In other words, it is the amount of time needed to re-stock.
Example: You have the following information about a necklace sold on your online jewelry store.
Working drafts for the computation are as follows:
The safety stock level for the necklace is calculated by:
= (5 x 67) − (3 x 60)
= 155
Step #2: Calculate reorder point
After getting a number for safety stock, you apply the following formula to set the reorder point for your item:
Reorder point = (Average daily sales x Lead time) + Safety stock
Assuming that the lead time for your order is 60 days, the reorder point will be:
= (3 x 60) + 155
= 335
It means that once the stock level for this necklace hits 777 or less, you’ll have to re-stock.
In the process of auditing physical inventory, you’ll have to count the actual amount of inventory in your warehouse, then compare it with the inventory level listed in your records. The theoretical and actual stock levels should match.
Audits are a crucial part of e-commerce stock management, key to maintaining inventory accuracy. The best practice is to perform audits regularly, such as on a daily, weekly or monthly basis.
However, this procedure is labor-intensive and time-consuming. It may also put pauses to order fulfillment as you perform a count (you don’t want to have goods going out while you’re counting). The process, if conducted manually, is prone to human errors too. This is why inventory management software is important. It helps you keep all data in one place, automates tedious tasks and provides valuable insights on your inventory (more on this below).
Many e-commerce business owners start small and stay lean. They operate on small budgets and refrain from ‘unnecessary’ spending. For many small businesses, inventory management software is not on the list of must-have items. It means their stock management process is a manual one — counting, tracking and data-logging are all done by hand.
Managing inventory without the relevant software is fine if your online shop is still in the early stage. However, as your business scales, your product catalog gets larger. You have more SKUs (each SKU represents a distinct item for sale). You have more inventory.
Manual inventory management thus becomes inefficient and costly. It takes a lot of time and man hours.
That’s why you need inventory management software.
An inventory management software is a system that tracks your inventory by item or in bulk. It is useful for both e-commerce and physical retailers to get visibility across a business’s supply chain.
Here are some features commonly found in inventory management software:
Inventory management is a deep and complex topic.
This article covers the basics of inventory management for e-commerce, but there’s a lot more to explore as you grow your business.
Choco Up provides flexible growth funding for e-commerce businesses, helping fuel your company’s growth. We also provide a variety of resources and tools to help you along the way.
Check them out below!
• E-commerce Financing: Options to Finance Your Online Business
• E-commerce Funding: A Guide to Your Options
• E-commerce Lending: Loan Options and Alternatives
• 4 Reasons Why E-commerce Companies Should Consider Revenue-Based Financing
Grow your business with Choco Up
Combat the $1.75 trillion lost annually in sales and costs for retailers worldwide through inventory forecasting.
In this article, we explain what order fulfilment is, as well as actionable tips for optimising your fulfilment process
