Multichannel Inventory: What You Need to Know

It sounds like a sci-fi trilogy: Past, present, and future merge to provide a single, optimal inventory experience. Multichannel merchants manage inventory seamlessly throughout major business processes and across channels in order to find the perfect balance between customer service and profitability.

Few merchants today would claim to have reached this level of inventory management, as developing such a strategy can be complex. But there are compelling economic reasons to try.

In most multichannel companies, inventory is the largest dollar asset on the balance sheet, which means that how well you plan, forecast, and manage inventory will to a large degree determine your profitability. Inaccurate forecasting ultimately produces backorders, and backorders can result in dissatisfied current customers; they can also turn away potential new customers.

Although the cost of poor inventory management doesn't have a separate line on a company's P&L statement, it can be steep. According to our proprietary studies with dozens of companies, the true cost of a backordered unit of merchandise runs from $7 to $12. For a company processing 200,000 orders a year, with an average of two items per order and a 20% backorder rate, the operations cost to the company could run as high as $480,000. This does not include costs related to prospecting, expediting backorders by inventory control, returns because of late shipments, lost margin, additional air freight, and customer ill will or losing the customer all together.

Faulty planning and forecasting can also produce overstocks that must be liquidated, at a loss of as much as 4%-10% of merchandise margin (between initial purchase margin and maintained margin), depending on the product category.

Direct marketers are well aware that they need to resolve inventory issues across channels. In a recent AMR Research survey of retailers' plans for upgrading their multichannel systems, 22% of the respondents cited Web-enabled inventory management and visibility as a key strategy they will be working on in the next 12 months. The AMR report, “Technology Trends in Inventory for Retailers and CP Manufacturers,” went on to say, “The lack of data consolidation for inventory and order management further illustrates retailers' immature inventory management and order processes.” The report also lists customer loyalty and multichannel customer order fulfillment among the top five concerns of respondents.
Download: 14 Inventory Best Practices to Implement in Your Company

Creating a Strategy

Few would argue with the benefits of a multichannel inventory strategy, but many may struggle with creating such a program. We've identified a few steps to begin the process.

Start by analyzing key inventory metrics and P&L figures regarding inventory performance and customer service in your company. These include initial and final order fill rates, initial and final item fill rates, cancellations and returns as an erosion of gross demand, markdowns and liquidations, gross margin, and reduction of inbound freight costs and its effect on cost of goods sold. The chart “Key merchandise metrics for direct marketers” on page 66 compares some important statistics for various categories.

You should then compare your company's results to statistics that describe good inventory performance in similar types of businesses. If you are a high-end fashion retailer, for instance, metrics for an online gift business won't be of much use in comparisons. The kind of statistical information you need is not easily available, however. To gain this knowledge you may need to hire a consultant or exchange information with other businesses.

Next, review processes to determine where improvement can occur. Where are the problem areas? Your assessment should pay special attention to these issues:

    • How in sync are marketing events and media and merchandise plans? From a merchandising   perspective, are the demand and receipt plans in line with marketing's weekly projections?
    • Is there comprehensive product and campaign history with which to plan new promotions? If not, are you capturing history for a future planning system?
    • How effective is the preseason and event merchandise planning?
    • How accurate is the daily and weekly forecasting for the channels?
    • Does your company have a comprehensive postseason analysis for items and promotions that merchandising can use in planning the new season?
    • Do your existing systems help rebuyers to stay on top of fast sellers, write purchase orders, come up with candidates for liquidation, and follow through with vendors? Or must rebuyers wade through mountains of data to find where to take action?
    • Are there backup and cancelable purchase orders with vendors to correct for errors and omissions during the initial merchandise planning and the current rate of sale?
    • Do you have cost-effective methods in place to liquidate overstocks?
After completing this part of the analysis, you'll need to develop a list of options and solutions for improvement. Prioritize them based on benefits. Assess the risks associated with the plan as well as any gains you expect to achieve. You must also determine what these improvements will cost and then include the costs of systems to be developed or acquired, the organizational changes needed to implement the plan, and any additional inventory.

At a management level, agree on a plan to implement and change business practices. You need to determine how this plan will improve inventory performance and customer service.

Integrated Planning and Forecasting

For inventory purposes, it's important that e-mail and Internet promotions are a part of a total media/circulation plan that also encompasses catalog drops and in-store promotions. Only a few years ago, when Internet sales commonly represented no more than 10% of total sales for multichannel companies, the merchants would simply increase the overall buying plan by that percentage to account for the new channel. Now that online sales often account for up to 40% of a company's total sales, merchants must figure out how demand for individual items varies in each channel. You can accomplish this by performing a category/item analysis for each channel.

To integrate marketing and merchandising plans, start by developing a companywide calendar for all channels, which should include store promotions, catalog merchandise drops, e-mail blasts, display ads, and so on. In turn, merchandise planning by the merchants and inventory management for each channel must key off this integrated schedule. Integration of channels in terms of inventory planning is basically about preseason and in-season forecasting once the promotion is active.

Analysts today have access to quantitative forecasting and purchase-planning systems and numerical analysis approaches to historical data by season, item, and catalog or promotion. As a result, forecast accuracy has continued to improve. But to a large degree, given the nature of merchandising and customer preferences, effective inventory forecasting still must rely on the intuitive experience and cooperation of merchandising, marketing, and creative.

All the complexities of cooperation, intuition, and analysis that go into the forecasting process are part of a continuous cycle through the life of the promotion. Every new catalog or promotion begins a forecasting lifecycle, and the information determined in each phase of merchandise planning and analysis must be reconciled with other planning levels and with the overall business plan.

To improve overall forecasting accuracy and in-stock position, the marketing department should forecast demand weekly (if not daily for online sales) to create a detailed baseline. While merchandising may not be able to react via reordering or expediting stock each week — let alone every day — the department needs to be informed so that they can make decisions for purchase and receipt planning.

But the major planning issue for multichannel merchants continues to be the integration of plans and forecasts by product/SKU from all channels, beginning with seasonal planning and proceeding with in-season or active forecasting once a promotion is live.

The Best-Laid Plans

A multichannel inventory plan with the wrong infrastructure will face as many difficulties as an organization without a plan. Here are some of the organizational decisions required to implement a strategic plan successfully:

1. Separate buying responsibilities from inventory management
Best practice in many mature multichannel businesses is to separate the buying and inventory management functions. The merchants or the buyers focus on what the customer wants, product knowledge and styles, developing exclusives, product specifications and design, where to source merchandise, and negotiating the initial vendor purchase. In line with making the process strategic, the inventory management function takes charge of demand analysis, forecasting, merchandise planning, purchasing and rebuying, maintaining the vendor relationship, maintaining compliance standards, working with the vendors to get merchandise in on time, maintaining proper inventory levels, and postseason and campaign analysis. This division of labor gives the buyers more crucial time to source product; it also puts more personnel in place to improve planning, forecasting, and analysis.
2. Plan and analyze inventory across channels
Put in place individuals who can perform planning and analysis across channels, consolidating inventory data to a single set of buying and liquidation actions while combining inventory requirements across channels. Since individual channels often use specialized systems, the challenge is to interpret the selling trends properly and to come up with a single set of requirements for product to be purchased in the proper time frame.
3. Maintain channel inventory flexibility
When stocks are low, make decisions about which channel can best serve the customer, and free up available stock for that channel, on a day-to-day basis. Plan how these decisions will be made and who will make them.
4. Assign responsibility for liquidation of overstocks
Empower an inventory manager or a merchant to manage liquidation media aggressively.

To a large degree, the characteristics of your merchandise — the percentage of new products, exclusives, and imported items — determine your merchandise strategy. New products, being without history, are extremely difficult to forecast and can result in the greatest number of overstocks or backorders. The only reasonable approach to help the merchant reach a decision about the quantity of new product he might sell is to compare a new item with a similar product that has a selling history.

Even then, the range of error can exceed 40%. In such cases, historical sales figures of similar items and categories over an entire promotion period during a similar season are at best a gauge. On the other hand, runaway best-sellers can strip inventories, generate backorders, and destroy profitability by driving up backorder costs.

Products with long lead times — those sourced offshore, private-label products, items that require fabric design or component parts — call for a commitment to an inventory level long before any marketing decisions are made, sometimes 8-10 months in advance of a promotion. This means reorders, if you can get them, will be of large volumes and long lead times (six to eight weeks).

Strong Vendor Relationships

Planning and forecasting is an inexact science. One of the most effective strategies for achieving a high initial fill rate without overstocks is to develop and maintain good relationships with your major vendors. Merchants and vendors must develop a plan to provide backup stocks and cancelable purchase orders whenever possible. Optimal inventory requires products from vendors who can meet specific criteria on time and also supply sudden, unexpected demand.

Good vendor relationships require your company to take a proactive role with vendors, communicating with them weekly through the first few weeks of a promotion. Strong vendor relationships may rely on tools such as electronic data interchange (EDI) or Web-based information exchange systems. Vendors need to know total plans for a given item as well as timing for receipt of merchandise in relation to the overall marketing strategy. For catalogs it takes two weeks of selling (roughly 20% of orders, for instance) and three weeks on color/size SKUs to forecast needs accurately based on percentage-complete projections. Internet curves are generally shorter.

The participation and support of top management is essential to achieving better vendor relationships without stepping on the toes of merchandisers. Tightening vendor relations almost always involves difficult decisions, however. It may mean reducing the total number of vendors in order to increase the merchant's impact with a smaller number. It may involve extensive vendor education and negotiating penalty and payback fees for vendor mistakes.

The best way to work with vendors is to implement a proactive, planned buying strategy based on these tactics:

    • As purchase orders are written, negotiate back-up stock and planned cancelable purchase orders for an item.
    • Develop a coverage report broken about by SKU and by stock on hand. Get the inventory managers to follow up with all vendors several weeks in advance of the promotion in order to avoid surprises and early backorders. Does the coverage report show adequate inventory to cover the first four weeks, which is 50% or more of the drop for most catalog business?
    • In the second or third week of a promotion, reproject the number of units that will be sold, and note the effect that early sales numbers may have on other promotions featuring the item.
    • In the third week, communicate the color/size sales distribution for the early results.
    • Calculate 90% or another high percentage of your estimate of total demand for each item for the promotion.
    • After two more weeks of selling, assuming that the product sales curve holds, accept the remainder of the merchandise.
    • This means writing multiple purchase orders for the initial receipt and for subsequent deliveries, with the result that you can typically cover the first four to six weeks of selling and avoid a stock-out.

Multichannel merchants who treat inventory management as a strategic objective will improve customer service and reduce inventory at the same time they improve efficiency and profitability in warehouse operations. The route to developing such an inventory management strategy follows industry best practices, combining information across channels from planning, forecasting, and sales history to develop optimal inventory management processes.
Download: 23 Ways to Improve Inventory Management Processes

Effective Liquidation

No matter how thoroughly your merchants plan or how accurately they forecast, overstocks will still happen. Overstocks are a natural part of merchandising, the final step in managing inventory left over because, for whatever reason, the forecasting didn't work. Minimizing overstocks is of course the first goal, but liquidating overstocks must be an integral part of the business process.

Sometimes overstocks may represent the emotional investments of a merchandiser or an entrepreneurial owner in his belief that the product would eventually sell. This kind of thinking can relegate overstocks to a sort of warehouse purgatory where they linger far too long. Best practice shows that cutting the retail price as soon as you're sure it's a slow seller is the most effective way to free up invested cash and gain the highest cost recovery.

Effective liquidation management involves determining which methods (Website, phone clearance, sale catalogs, stores, warehouse sales, inserts) are most effective at recovering merchandise costs, which methods are best suited for liquidating different quantities of merchandise, and how those methods can be used in concert if necessary.