Inventory is the largest balance sheet asset in most companies. Optimizing inventory has a huge impact on company profitability and customer service. Inventory has an equally big impact on fulfillment space use, facility size, and efficiency.
Today’s commercial systems have dozens of inventory data points by product, category, and company. There is a big difference between an inventory data element and a Key Performance Indicator (KPI) or metric. Which ones are actionable and can give you the visibility to develop process improvement around?
It behooves fulfillment directors to partner with merchants and purchasing to get the most benefit from inventory performance. Merchants may make the purchasing decisions and in doing so they have a tremendous impact on fulfillment efficiency and space utilization.
This blog highlights 6 key inventory metrics every e-commerce company should measure; how to calculate the metric; and areas where a partnership between fulfillment and merchandising will benefit company profitability and efficiency.
Inventory turnover
Inventory turnover is the number of times a company sells and replaces its stock in a period of time. This can be measured at the total company, category, or item level. Another way to understand turnover is to express it as the number of calendar days to free up cash from inventory. A company turnover of 3 times annually means it takes 122 days to get your money out of inventory (365 days/3 turns = 121.6 days).
Inventory Turnover = sales at cost for 12 months/average inventory at cost for 13 months*
*"13 months" represents starting and ending inventory
Weeks of Supply
This is a measure of inventory efficiency. Generally calculated at an item level, this calculation will indicate how many weeks of stock for a product you have in inventory. If the product is seasonal, the quantity you may want to increase supply because of the expected increased sales; or lower the on-hand because the season is complete.
Weeks On Hand = Units on hand/unit* sales for a time frame
*"On-hand" can be in units or dollars
Inventory carrying cost
Inventory carrying cost is the total of all expenses related to storage or holding unsold goods. The total includes the cost of capital, insurance, facility costs (e.g. equipment depreciation, lease, utilities, maintenance) as well as labor costs to maintain merchandise. A business's inventory carrying costs can range between 20% to 30% of its total inventory costs. It will make decisions regarding slow-moving and low gross margin product liquidation decisions more apparent.
Inventory carrying cost % = [(facility costs + labor costs + facility costs + cost of capital)/total inventory] value at cost X 100
Initial Customer Order Fill Rate
This is a great measure of customer service using order and fulfillment data. This measures the percentage of orders shipped complete in your order fulfillment standard. Many e-commerce companies are shipping a high percentage of orders the same day as receipt of order. To understand the initial order fill rate, if you have 1,000 orders today and you ship 700 orders complete (every line and quantity ordered by the customer), your initial order fill rate is 70%. Learn more about the initial fill rate at https://www.fcbco.com/blog/use-initial-order-fill-rate-to-measure-customer-service
Initial Order Fill Rate = orders shipped complete in standard/total orders received X 100
The backorder rate and initial customer order fill rate are not the same things. The backorder rate is generally 5 to 10 percentage points higher than the initial customer order fill rate.
Cost of Backorders
This is a study worth doing annually. Processing backorders is very expensive because of additional picking, packing, dunnage, and shipping. To determine the costs, determine the customer service and fulfillment costs to service the back-ordered customer. Include contact center and chat rep costs; fulfillment costs for added labor to pick and ship backorders; additional supplies and shipping costs. Identifiable costs could be $15.00 to $20.00 per unit. However, the largest cost could be the potential loss of customer’s Lifetime Value. Do you have a report showing total backorders for 12 training 12 months? Most companies do not – there is no visibility of total costs without this.
Cost of a back-ordered unit = (customer service costs + fulfillment costs)/number of back-ordered units fulfilled
Return Rate
This is the percentage of gross unit demand returned. You should report returns by vendor, item, color, and size. Fulfillment reasons for returns may include wrong product shipped and damaged in shipping.
Return rate in units % = # of units returned*/total units shipped X 100
*Return rates can be measured in units, orders, or dollars
Partnering with the Merchants
These are areas that we have seen fulfillment directors partner with merchants to improve inventory performance and warehouse efficiency:
Increase inventory turn. Changes in the on-hand quantity of product in storage and greatly affects space utilization. It is often hard for merchants to dispose of overstocks. Reporting of weeks of supply, age of inventory, and turnover will show where action needs to be considered. We have found that the most effective companies establish procedures when the product does not sell to the expectation that they are liquidated through a variety of media. Read how other companies address this.
Impact of using inventory carrying costs. Turnover and age of inventory give you one perspective. Calculating and reporting inventory carrying costs will add another. Because inventory carrying cost is so high in most businesses, it doesn’t make sense to hold on to low margin or slow sellers very long. The margin earned is offset by the imputed cost. A monthly report makes candidates for liquidation more apparent.
Reduce backorder costs. Understand the components of your backorder costs and why the product was on backorder. Shipping and handling revenue often does not cover all costs today. As mentioned earlier, the cost per back-ordered unit of merchandise can easily be in a $15.00 to $20.00 cost in customer service and fulfillment.
Reason for reports. If you don’t have a report, this is helpful to identifying fulfillment and transportation errors as well as other reasons such as color, fit, creative and content, etc. Reducing these errors will improve customer service and reduce fulfillment costs.
Summary
Internal company partnerships using inventory metrics can help fulfillment become more efficient. Optimizing inventory is critical to profitability, labor costs, and space utilization.
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