Opportunity Costs: What Demand Planning Can Do For Your Ecommerce Business
Replenishment is the life blood of any ecommerce site. If you don’t reorder stock in a timely fashion, you could have a stockout. And simply put, if you are out of stock, you are missing out on revenue.
Demand planning uses sales history to forecast what products and how many of those products customers will want to buy. When done well, ecommerce companies have enough stock on hand to meet demand, but not so much that cash is tied up in unneeded inventory sitting on warehouse shelves.
Know Your Goals
Know what your goals are for your inventory and make sure they are realistic. Most businesses have a lot of variables in their stock, and you have to consider these when setting goals. If you don’t have some reasonable idea of what will be needed, you might be unnecessarily tying up your capital. Unnecessary inventory means you have spent money that will not earn you an immediate return.
What is the cost of being out of stock?
There are two facets here to keep in mind.
- What is the forecasted lost revenue of missing a sale? If the potential lost sales are $100, then that carries different urgency for reorder than an item that loses $10,000 for every day it is out of stock. The forecasted lost revenue will vary by product and variant.
- What is the cost to your brand when you are out of stock? Will customers find the item to buy elsewhere? Or, does an occasional stockout contribute to a sense of scarcity for your customers that will increase demand in the future? This is a tricky balancing act. Think through your risk tolerance for being out of stock versus erring toward spending too much money on overstocked items. Is the greater value having products always available to customers or having money not tied up in overstock so that you can use it elsewhere in your business?
How Replenishment Works
Proper replenishment is ordering enough stock at the right time. Key considerations when calculating replenishment include:
- Sales velocity
In order to avoid stockouts, you must look at your sales velocity (sales / number of days in stock) instead of sales (number of units sold in a given amount of time) to determine the rate of sale. Sales velocity is a dynamic number; it gives you a more complete picture of what is selling when as opposed to just the sales number. An accurate forecast will consider the rate of sales when an item is in stock. This focuses more quickly on how much customers will buy when the item is available. If out of stock days are not removed from calculating the forecast, then you could be continually understocked and miss out on revenue.
- Lead time
Lead time (the amount of time from ordering a product to receiving it into inventory) is the second big metric when calculating replenishment. Don’t forget to consider how long it takes for your product to ship from your vendor to your warehouse, and from your warehouse to secondary locations like an Amazon warehouse (selling FBA).
- Days of stock
Days of stock is the length of time a new order should last after receiving. This can also be thought of as the ideal stock cover, or ordering frequency. If you order enough stock to cover 30 days, then you will order ever 30 days.
Taken together, the sales velocity tells you the rate of sales, which you can use to determine when you need to order according to the lead time, and how much you’ll need according to the days of stock.
Opportunity cost: what is the best investment?
Managing cash flow is critical to any business. In ecommerce, we balance ROI of marketing, inventory, and what can feel like an endless list of expense accounts.
Focusing on inventory, there are a few key metrics you can use as guideposts to determine where to find your best return on investment.
- Replenishment Profit/Replenishment Revenue
Replenishment profit comes from the units that must be replenished. Do not confuse this with forecast profit, which is the profit of all units forecast to be sold.
If you don’t have your costs entered into your spreadsheet or planning software (like Inventory Planner), a second option would be using replenishment retail value, which is the retail value of those replenishment units.
Use Replenishment Profit to sort the priority of which variants to replenish. For example, Variant A needs 1000 units replenished, which will result in an estimated $10,000 profit. That will be a higher priority than Variant B which needs 50 units to meet demand resulting in an estimated $500 profit.
- Forecast Loss Profit
How much money will you lose if you don’t order today? How much money could you potentially lose during your lead time? Forecast lost profit is calculated as stockouts during the lead time multiplied by profit. Forecast loss profit specifically looks at lost potential during lead time so if you ordered tomorrow, you would get that back in stock and stop the clock on lost profit.
The important distinction is that you are not using the full planning period of lead time plus days of stock. Forecast loss profit only looks at losses during the lead time.
- Sell Through and Stockturn
Sell through is how much of your opening stock levels you sold during a selected period. This is calculated as (Sales for the selected period / opening stock) * 100 to generate a percentage. If you look at turning over your inventory fully in a month, then you want to see 100% for the month for sell through. It’s about optimizing stock levels. Not overstocking, and not missing out on sales.
Stockturn is (sales / average stock for the selected period) * 100 to generate a percentage. It is how well you calibrated how much you need in the hope you will not go through that inventory in a reasonable amount of time, typically one year when calculating stockturn. This is a measure of how quickly you are going through inventory and what is driving revenue. It also helps to show which items are sitting on your shelves for too long, tying up cash that could be used to buy faster moving inventory.
- Cost Value of Replenishment
Cost value of replenishment focuses on your short-term cashflow. When you add this many units to your PO, how much will you owe your vendor? When keeping in mind a purchasing budget or cash flow for the business overall, it can be helpful to look at the replenishment cost. Think about payment terms. Are you going to owe the money immediately after sending your PO? Or do you have net 30 days with time to receive the merchandise and start selling it before you owe it to your vendor?
Inventory forecasting allows your business to determine which products will be available and in which quantities. In this way, you can ensure that you order items only when they’re needed, saving on inventory costs. The value of inventory forecasting spans across multiple areas of the business. Indeed, it is the key to effective cost management and continuous growth.
Guest Blog written by Jill Liliedahl
Inventory Planner forecasts customer demand, helping merchants save time and money by having the right products in the right place at the right time. Using sales history, purchasing information and stock levels, Inventory Planner makes replenishment recommendations. Merchants save time by easily creating a purchase order using these recommendations.