At the heart of every retail business is the ability to profit off the sale of its goods. Inventory is simply a numbers game, where you buy low and sell high, ideally at the right time, to the right people, and at the right quantities. In a perfect world, you buy the right amount of inventory without the implications of markdowns or missed sales. Understanding how much you can profit off the sale of each unit can help drive strategic decisions about product assortment, brand, and the overall business.
Despite your best efforts, you will inevitably overbuy or simply not buy enough inventory. It’s important to be aware of how much excess inventory you’re carrying and what the risk to sales is if you don’t meet demand. Overspend can be calculated by subtracting your ideal stock on hand from your actual inventory ownership by SKU. The inverse of this gives you your underspend.
What does overspend and underspend tell you about your business? What kinds of trends would trigger you to use a new strategy?
The biggest implication of overspend is its constraint on cash flow. With cash tied up in inventory, a retailer can’t invest in the areas that drive sales such as marketing and product innovation. In order to sell through excess inventory, retailers have to liquidate either through third party sellers or markdowns. These methods not only erode brand equity and train customers to wait for sales, but they also hinder profitability. In some cases, brands may even experience a loss on the sale of these goods.
Underspend is not much better. Aside from leaving sales on the table, the lack of product offering can also cause a negative customer experience, resulting in long term losses. So how can one manage what seems like a goldilocks strategy?
Ideal stock on hand is the appropriate amount of inventory to satisfy your WOS or inventory turn. For example, if you’d like to hold 13 weeks worth of inventory at any given time or have a 4x turn, any inventory you carry in excess or below this target would denote your over/underspend respectively. This metric is crucial in monitoring your investments and planning for your future cash positions.
When you don’t have enough inventory, you’ll experience some stockout periods and thus, missed sales. Tracking upcoming stockouts and missed sales can help you prioritize orders, influence marketing decisions, and plan for anomalies in your demand.
You’ll also have some variances to plan, whether a result of misforecasting or inadequate stock,. It’s important to track your performance to LY and to plan and understand what could be the root cause. Sometimes there are things that can be executed to get back on track. At the very least, you’ll have some insights to inform future forecasts.
Sell-through rates and WOS can provide insight to how much inventory you are carrying and what its lifecycle may be. Perhaps you didn’t sell-through a seasonal item fast enough during its first few weeks of launch. This would be an indicator of having excess past an ideal selling point, thus resulting in markdowns and lost margin dollars.
It’s important to have visibility of each SKU and category performance by channel, inclusive of the raw materials and components that make up these goods. There is often a story to be told in these numbers--all you have to do is look for it.