Run out of stock and you'll pay. It's as simple as that. Backorders are a result of a failure of a business' inventory process. Sometimes, this is a good problem: your store is unexpectedly selling a large volume of a product that is typically a slow seller. Typically, however, running out of inventory is the symptom of an actual flaw somewhere in your supply chain.
This article is designed to provide a guide for a basic inventory management process: stock-to-sell, one of the lowest risk strategies. There are higher-risk strategies (like just-in-time inventory or stock-to-ship), but these won't be considered here.
What do we get?
No stocking strategy is perfect for every situation, but this type of strategy is best for businesses with the following properties:
- SKU count on the low side (under 1,000): This strategy involves investing capital in creating a safety stock (this strategy is risk-averse), so an excessively large SKU pool is typically incompatible with stock-to-sell.
- Good markup: Higher markup typically means you can afford to invest your capital in an inventory without your capital reserve suffering too much.
- Reliable vendor lead times: This strategy is only effective for small-to-medium businesses if your vendor(s) get your product to you in a predictable amount of time. Unpredictable lead times means a much more significant capital investment is required to overcome their unpredictability.
If your business is a good fit to these requirements and it is executed properly, an inventory-over-time plot will look something like this:
This strategy is very simple: as soon as the inventory of this product drops below 15 units, immediately order 35 units. The lead time is fixed, so given a constant demand, the product never goes out of stock.
For comparison, look at the following real data for a business using this strategy despite a highly unreliable vendor lead time. Any time below the axis is time spent out-of-stock!
This is a complete disaster for the business, as they can almost never keep the item in stock nor get enough product to reliably fulfill back-orders which are several weeks old.
First, a quick enumeration of the steps to maintain inventory for a given product or SKU:
- Calculate the supply chain parameters for the product.
- Automate the monitoring and re-ordering of your product.
- Repeat step 1 periodically or any time your safety stock is seriously compromised.
Now, let's look at these steps in more detail.
1. Calculate the supply chain parameters for the product.
First, you'll need a baseline estimate of the units sold per day for this product. Most warehouse management software will give you this quantity over time periods. ShipHero does a really nice job with some interactive plots as well as units per day and units in the last 30. Below is an example.
Lead time is arguably the most important quantity. You can get this directly from the delay between your purchase orders and invoices (making the order and getting the product). It's good to have an average for this quantity.
Now, you can calculate your bare-bones reorder level/safety stock/etc. This is simply units sold per day * lead time in days. It is good practice to increase this stock level by 10-20% to account for normal variances in lead time and demand.
Now that we have our reorder level/safety stock figure, you'll want to decide approximately how much time you'd like to have between orders. This is days to stay in stock * units sold per day. This quantity will be your reorder amount.
This new quantity is also known as the reorder amount and is the amount of product I order once my reorder level is breached.
2. Automate the monitoring and re-ordering of your product.
The overhead involved in manually checking, recording, and analyzing stock levels can be extremely costly. I recommend a good automated system for this, like ShipHero's. I can set the reorder level and reorder amount for every product and I get an email anytime the product hits the reorder level. Furthermore, ShipHero will automatically push a purchase order to a connected vendor.
We actually use ShipHero to manage our shipping supplies and it proves to be an excellent solution for the task. See a screencap below:
The settings in the second image mean that whenever we go below 500 of those poly mailers, someone is cued to immediately order 1,000 of them.
3. Repeat step 1 periodically or any time your safety stock is seriously compromised.
The effectiveness of your stocking strategy should always be periodically revisited. It also needs to be re-evaluated immediately if it suffers any kind of failure. Out-of-stock events are an obvious failure, but going down to 10-20% of your reorder level should also be considered a failure. Either demand has grown or you had an exceptional lead time. The root cause should absolutely be ferreted out.
This is your product we're talking about here. Without that, what have you got? What's an eCommerce business without product? A cute website? People come to your to buy your product and consumers have expectations. If you meet or exceed those expectations, they'll come back. Fail on things like transit time or being in-stock and they may take their business elsewhere. At the very least they'll cost you some opportunity and potentially profit as you dole out discounts to counteract their negative experience.
Bypass all of this pain and get serious about your inventory management!