Inventory optimization is crucial to staying profitable. Your company must maintain that delicate balance between having too many and too few goods in stock.
But when you’re carrying many items or operating a multi-channel business, that task is so complex, it can’t be done manually.
Since each item requires a different stocking level, the complexity calls for an automated inventory optimization solution. Supply chain planning software that uses mathematical modeling can do the necessary calculations, and determine ideal stocking levels and locations automatically, for hundreds or thousands of goods.
Financial drivers for inventory optimization
Companies must turn over their inventory as often as possible to generate cash flow and minimize expenses. Excess inventory ties up working capital, limiting the cash available to run your business, decreasing profits. Surplus goods also drive up warehousing costs for storage. Worse yet, goods left unsold have to be written off or clearanced.
On the other hand, deficient inventory means there is less product for sale. This puts you at a high risk of stockouts and overselling if there’s a sudden demand surge for a particular product. The result is lost sales and customer churn.
That’s why determining the optimal amount of inventory for each product you sell is necessary to ensure the financial health of your business.
Mathematical approach required
Setting rules of thumb, making assumptions, or using simple spreadsheet calculations for setting inventory amounts leads to either product shortages or surplus stock. Complicating this is the need for most companies to set stock levels for hundreds of stock-keeping units (SKUs) and then regularly adjust stock levels in response to demand fluctuations.
Your company can use planning software with inventory optimization to solve this. These solutions perform AI-based mathematical calculations to specify the ideal amount of stock at the right location across the entire warehouse network. When the planning software works directly with your warehouse management system (WMS), it results in a multiplier effect for better customer experiences and lower operational costs.
Stock categories for inventory optimization
Inventory optimization starts with the output from the demand plan as to the amount of products that are expected to be needed to satisfy customer orders for a period of time.
But not all inventory is the same. To optimize stocking levels with higher accuracy, break down your inventory holdings and delineate them as:
- Cycle stock – The amount of products expected to be sold during a given period.
- Safety stock – The amount of stock needed as a buffer to protect against demand surges or delays in shipment replenishments.
- Fast-movers – Items with high inventory turnover due to frequent sales.
- Slow-movers – Products with low turnover generally stay in the warehouse for three months or more.
- Intermittent – Products such as seasonal goods sold during a specific time of year.
Inventory categorization is essential in setting up an individual stocking profile for each SKU.
Math engines to optimize inventory
Inventory optimization calculations are done in “engines” that analyze data using sophisticated mathematical models to determine the stocking amount for each SKU in each inventory category. The engines can be either:
- Deterministic – Use fixed inputs and produce the same output or result each time.
- Stochastic – Account for input variability and offer a probability range for output (i.e., the SKU has a 20% chance of stockouts if 1,000 items are kept in storage). These models are generally preferred because demand constantly fluctuates and the planner can assess the probability that certain products will be required for inventory needs.
Service-level tradeoffs for inventory optimization
Inventory optimization driven by AI models can establish granular levels of safety stock. As a result, the amount of each item in the warehouse network will be less than what had been kept in the past. The reduction of inventory, particularly in safety stock, results in both working capital and warehousing cost savings.
Your supply chain planning system should allow you to set your criteria for inventory service levels so you can determine your comfort level of risk for a potential stockout.
Working with service levels
A service level is the probability of sufficient inventory to meet demand without experiencing a stockout. In other words, you should be able to choose whether you have enough safety stock to cover a demand 90% of the time, for example. The vast majority of Deposo customers today operate on service levels between 95% and 99%.
Calculating your targets
The optimizer engine would perform the calculations to determine the inventory targets to meet your designated service levels. You can then examine the financial tradeoffs by conducting what-if scenarios for various service levels. That way you can consider the costs of holding a specific amount of stock versus the potential risk of lost sales.
Multi-echelon inventory optimization (MEIO)
Along with weighing service level tradeoffs, the software should have the capability for MEIO. If your company has more than one warehouse, a planning engine doing MEIO assigns a particular amount of inventory to the right distribution center or stocking location in the network.
Locating the correct amount of inventory at each node in the network allows you to align products more closely to the expected demand in a particular area. This reduces your logistics and shipping costs to fulfill customer orders. 
Recalculate often
Because demand is constantly fluctuating, inventory optimization must be updated periodically using current sales and inventory data. The cycle and safety stock levels for each SKU should be recalculated daily with output from the demand plan. These calculations should also be performed automatically.
Key benefits of inventory optimization
When done correctly with supply chain planning software with mathematical modeling, inventory optimization can:
- Reduce storage, logistics, and operational costs
- Improve customer service
- Rev up inventory turns
- Improve worker satisfaction and retention
- Free up working capital
- Increase revenue
- Boost profit margins
With all of this, most companies will see a quick return on their investment.
To gain the full range of benefits, inventory optimization should be done in combination with demand planning for forecasting, inventory replenishment for ordering frequency, and warehouse management software for 100% enterprise visibility.
An easy lift, especially for our WMS customers
Deposco brings together all of those applications in our integrated supply chain planning and execution platform. Interested? We’d love to show you. Schedule Here
For companies already using Deposco Bright Warehouse, SCP is an effortless add-on that can be implemented in a surprisingly rapid timeframe – with tailored, single-point-of-contact guidance from the same team that supports your WMS.
For more information, contact your Customer Success Team.