How to reduce inventory? Tips to optimize cost for e-shops in 2023
E-shops have not had an easy year. The last year has been an unpleasant sobering up for e-shoppers after the beautiful increases that were "steroidized" by COVID. Many e-shops have been (and may still be) hoarding inventory and are now shaking their heads at the monetary value of stock. This is, of course, very expensive, as e-shops often borrow supplies with interest.
In this article, we will show you some proven tips and procedures that lead e-shops to more efficient turnover of their goods, lower inventories and consequently, higher profits.
Purchasing department is under pressure
Buyers bought mostly on a growth strategy, i.e. they took for example the last period + 30 %. But now stocks are not disappearing and customers are buying on average 15 % less than a year ago. In that case, if I calculate correctly, you can currently have 45 % more in stock.
If you were lucky, you sold off a large part of the stock during Black Friday or "classically" before Christmas. Logically and unfortunately, it is no longer possible to copy the last order and send it to the supplier. Now is the right time to go through the inventory in detail and calculate the (preferably net) profit at the level of individual products. E-shops often do not calculate net profit - most are only interested in total profit and whether they have the main products in stock. Unfortunately, it should be noted that this very superficial approach can lead the e-shop into financial problems - now it will no longer be possible to calculate profit only at the level of the e-shop, and it probably won't even be enough at the level of product categories. You can increase turnover and keep wages below market value tooth and nail, but if you don't calculate the net profit, you can sell a lot of products at a loss, and that is definitely not a good strategy next year.
Now, what about that? How to get out of such a situation? How to learn from it?
For e-shops, we recommend asking the following questions and thinking about the strategy for the next year. First, go through the following questions with the marketer or agency.
- We only promote those products on which you have a sufficient margin
- Do we control cost per conversion at the product level?
- Do we know exactly which keywords we are paying for?
- Do we include shipping costs?
- Are we looking for competitive prices?
- Do we have marketing communication set up correctly?
- Do we only stock products that bring in the most profit?
- When we raise prices, are we looking at the elasticity of demand?
The questions are very general and need to be adapted to your e-shop. However, we often see entrepreneurs treat marketing as a one-sided expense, i.e. they don't focus on how their campaigns are put together, but only on the final amounts. Accordingly, they forcefully and immediately adjust the marketing budget, which is not an appropriate approach to such a pivotal part of the company.
The ABC method – a handy tool for every business
To simplify purchasing and marketing, the so-called ABC method is widely used. It is a way of classifying products into 3 categories. A different priority is then given to each category. In a simplified way, your assortment can be divided into:
A) Products that are central to you. They sell well and you have the highest margin on them. You give them the maximum priority and care in campaigns and stock. Some sources also recommend that your stock should consist of 80 % of "A" products viz. picture below.
B) Products that are not core. For example, they are from local suppliers and you are worse off with a margin. Even so, you still have the products in stock and consider them important because they have a good turnover.
C) Products that are a mere accessory, on sale or so-called lager. You want to remove these products from your inventory at the cost of not making a profit as they take up valuable inventory space. You want to promote them as little as possible, as the margin barely covers the cost.
Carefully go through the warehouses and the offer of your e-shop. Do you really need to offer all the products you are currently viewing and shopping for? In all variants? How many do you keep in stock? Is it worth it? Now is not the time to process orders on which you don't have a satisfactory margin, because inflation is probably adding to wages, which just reduces your final margin. Clicks also make it more expensive, we don't even need to mention energy, and all that just takes away from the final profit. Now the ant work makes sense, don't you think?
How to start inventory analysis?
We recommend an Excel spreadsheet that you create using values from your accounting system.
In the table, you should primarily have the product code, inventory status, turnover for the selected period, and most importantly, profit. We recommend adding the percentage change in turnover (inventory turnover), according to which we rank the table (from the smallest changes or vice versa). By this, we mean the change in sales of an individual product compared to the previous period, ideally in the same period last year. That way, you have in front of you the products that either move the most or the least (depending on the order of the values). It is also possible to use conditional formatting, thanks to which you will have a red colour for more dramatic changes, on the other hand, for products that sell the same or a hair better, you will have a green colour, for example.
Thanks to this smart table, especially if it is connected to current data, you have an overview of whether some products are sold more or less. If less, the price, lack of marketing care, or, for example, higher competition, may be to blame.
Now it's up to you how you handle the table. We recommend updating the table every week (connecting it to the database) and monitoring how sales develop - according to them, either stock more often and in smaller quantities, or, for example, sell out at a reduced price.
Note: thanks to this table, you can also very flexibly monitor changes in sales about your increased or decreased prices (so-called elasticity).
The risk associated with low inventory
Of course, it may happen that you don't hit the exact customer demand. Either there will be too much or too little of certain goods in stock. But that's okay, because thanks to the methods we mentioned above, you'll have a more accurate estimate. It is this estimate that will save you a lot of money even though you will not hit the exact demand in the short term and risk not having enough stock.
The goal is to reduce stocks to the necessary amount (safety stock), which you can turn around in a short time and turn into a profit.
- Stock up more often and in smaller batches (you will improve cashflow)
- Also, include in the margin the fixed costs of warehousing and handling products + the cost of capital (interest)
- Always base yourself on hard data, don't rely on feelings
- Beware of marketers not spending budget on products that do not make strategic sense
- Keep a higher amount of cash for any fluctuations in demand
- Don't borrow more than you have to - the bank is always happy to lend, but is it worth it?
- Have "A" products near packing areas (for fast order fulfilment)
- Automate processes wherever possible.
This article only covers the mentioned procedures superficially. This topic is very broad, so if anything needs to be explained, do not hesitate to contact us.