Getting your inventory ‘just right’ with the Goldilocks principle
Originally Published by The Capterra Logistics Technology Blog
You’ve probably heard the story of Goldilocks and the three bears. The bears’ preferences range from one extreme to another (too hot to too cold porridge, too hard to too soft beds, etc.) But Goldilocks isn’t happy till everything is “just right.”
A children’s story to most of us, Goldilocks’ tale is the foundation of an actual economic principle. The Goldilocks principle dictates that the ideal should fall within certain extremes — basically, getting everything “just right.”
The principle applies to inventory management, too. You want to have the right amount of product, at the right price, at the right time, and in the right place.
1. The right amount
When it comes to stocking the right amount, you’re walking a thin line between understocking and overstocking.
If you’re ordering too little, you’ll find customers turning elsewhere when you’re out-of-stock of popular items. Customers that may never return to you.
On the other hand, stocking too much will leave you with tons of dead stock that you’ll be forced to sell at a loss to clear and prevent obsolescence.
Dead stock is basically product that just won’t sell — it hasn’t sold a single unit over the past month, and it’s sitting in your inventory collecting dust and taking up space that could be put to better use. Instead of helping you cover your costs by contributing to your revenue, you’re spending money on storing it.
When it comes to dead stock, there’s only one thing to remember: Even in the unlikely event of a sale, the product’s not going to turn suddenly desirable again, deserving a fresh shipment.
If you already have an inventory management software, the reporting function is going to be of great help when it comes to deciding how much to order. You won’t just know what your bestsellers are — you’ll know exactly how many pieces you sold every month last year.
On one hand, you can base your ordering decision off last year’s demand, or you can apply this information to the Economic Order Quantity (EOQ) formula to find the optimal order quantity after taking costs into account.
The advantage of using the EOQ formula is that it aims to use the lowest cost parameters — so you get to minimize inventory costs while matching customer demand as closely as possible.
2. The right price
The EOQ aims to minimize inventory costs, but it cannot take into account things like price quantity breaks — where your supplier offers discounts for orders above a certain amount.
Is ordering more than your EOQ to enjoy these discounts worth it? It’s easy to justify this by thinking, “If I’m going to have to reorder at some point, I might as well enjoy some better prices.”
But you’ve also got to consider things like carrying costs. Paying for the item is only the start. After that, you’ve got to bring it home, keep it safe and looking good — and the costs of these can even eclipse the cost of the item.
As a business owner, your goal is to reduce these costs as much as possible. To do this, you’ll face a whole range of carrying costs that include:
1. Capital costs: The opportunity cost of investing in your inventory instead of into your business — could you have earned more if you had invested this elsewhere?
2. Storage costs: How much are you spending on renting and maintaining your storage facility?
3. Inventory service costs: Do you have any other inventory-related costs like insurance, wages, or software applications like inventory management software?
4. Inventory risks costs: Sometimes, shrinkage and obsolescence can happen — stocks get damaged, get stolen, or go out-of-date.
While ordering less stock sounds like a surefire way to reduce your carrying costs,there’s also costs attached to ordering too little. If you decide to order less in a bid to cut down on your carrying costs, you may discover that you now need to expedite shipping from your suppliers to match customer demand — pushing your costs even higher!
3. The right time
When you’re placing an order, you want your shipment to arrive at the right time. Ideally, that would be around the same time you finish selling items from the last batch.
If they arrive too early, you’ll find yourself looking for space to store these items… but even that’s preferable to the other extreme.
That means your new shipment arrives too late, and you’re forced to announce that you’re out of stock.
When it comes to determining your reorder point, here’s a simple formula to help you out:
Once your stock levels hit this amount, it’s time to place a new order to top up. Butall your products aren’t likely to hit the reorder point at the same time, so you’re likely to be constantly writing new purchase orders, which can be time consuming to say the least.
But here’s a tip for those of you who are already using inventory management software: you can automate your reorder point by setting the amount in the system, and the software will prompt you to place a new purchase order once stock levels hit the reorder point.
If you’re wondering what safety stock is and why it’s included in the reorder point formula, it’s emergency stock, meant to tide you over when unexpected circumstances strike!
This stock shouldn’t be touched at all — it’s like an emergency button you should only push when stuff hits the fan.
By factoring in the maximum lead time possible (taking into account seasonal acts of nature such as blizzards, typhoons, floods, etc.), your safety stock will get you through these events unscathed.
I know it’s tempting to squirrel away enough stock to withstand the apocalypse… but always remember, carrying more stocks equals higher costs.
4. The right place
Do you sell on multiple channels? If you do, you want to ensure you’ve got sufficient stock spread across your different sales channels to meet customer demand.
With the growing popularity of eCommerce, the “right place” isn’t literal, since you’re probably shipping all your products from the same warehouse. To eliminate the risk of overselling, you’ll want inventory management software that offers real-time updates on stock levels across different sales channels.
But you still want to have enough for all your customers whether you’re selling from a brick-and-mortar store, an independent online store, a store on a marketplace like Amazon, selling business-to-business, or any combination of the above.
To accomplish this, you want to know exactly how much you’re selling on all your different channels. And here’s where intelligence reports will be a great help: You’ll know exactly how much you’re selling on every channel, which will help you determine the right quantity to meet your customer demand.
For those of you with a physical shop — you’ll know how much stock you’ll need to hold on hand to keep your walk-in customers satisfied.
Optimizing your inventory with metrics
So how do you know you’ve done a good job in getting everything ‘just right’?