Inventory reduction is one of the best ways to improve business performance. I’ve watched businesses completely turn around by optimizing inventory levels. You’ll release capital, reduce storage costs, and optimize cash flow. This strategy isn’t about being cheap. It’s a very effective strategy to make your business more efficient and profitable.
Inventory Reduction Strategies
Inventory reduction is one of the most impactful changes you can make to your business. I’ve personally witnessed the transformation of businesses and profitability by simply cutting excess inventory. Here are some of the most effective strategies to reduce inventory.
Just in Time (JIT) inventory management is the solution. This approach involves only stocking what you’re about to use. Here’s how JIT works:
- Order materials right before you’re about to use them in production.
- Produce products right before you’re about to sell them.
- Minimize inventory holding costs and minimize waste.
The only downside to JIT is that it requires very precise timing and coordination. Demand forecasting allows you to predict what you’re going to sell. So you only stock what you need. The challenge is that if you don’t use the right demand forecasting technique, you’ll be wrong more often than you’re right.
Lean manufacturing principles are all about wasting nothing. These principles don’t just apply to manufacturing – you can adopt these for any business to increase efficiency.
Identify things you do that customers wouldn’t want to pay for and stop doing them.
Constantly try to make things more efficient.
Get every single employee involved in discussing problems and coming up with solutions.
Write down what the most efficient person is doing and make sure everyone does it that way.
ABC analysis is a simple strategy to focus only on the inventory that matters.
- A items: you check frequently to make sure you’re not out of stock.
- B items: you check less frequently.
- C items: you hardly check at all.
Having too much inventory of a product drives two costs: You have to discount products that aren’t in demand to move them, and the cost of capital to buy all of the inventory that ends up not being in demand. By combining these strategies, you’ll be well on your way to more efficient operations.
Benefits of Inventory Reduction
Lowering inventory levels can have a dramatic impact on your business. I have advised many businesses to lower inventory levels, and the impact is often more than they expected.
Increased cash flow is perhaps the biggest benefit. When you don’t tie up as much cash in inventory, you free up working capital. This additional liquidity can save your business during a recession.
Lower storage costs is another big benefit. The less inventory you have, the less space you’ll need to store it, which means you’ll pay less in rent, utilities, handling fees, and other warehousing costs. This cost savings can be substantial, especially for a business with a large warehouse.
Reduced risk of obsolescence is essential in today’s fast-changing market. When you hold excess inventory, you increase the risk of the products becoming obsolete or irrelevant. Lowering inventory levels reduces this risk and protects your investment.
Increased operational efficiency is a natural byproduct of lowering inventory levels. With less inventory to manage, your team can focus on other value-add activities, improving productivity and resource utilization.
Studies have shown that JIT inventory reduces inventory carrying costs by 20-40%. This will impact your business performance, almost certainly for the better. What could you accomplish with these cost savings reinvested back into your business?
And don’t forget that these benefits are compounding. As you optimize your inventory management strategies, you’ll likely see an even larger increase in business performance.
Implementing Inventory Reduction Techniques
There’s an efficient and systematic way to execute inventory reduction strategies. I’ve walked many businesses through the process of reducing inventory levels, and it’s always rewarding to see the positive change.
Begin by defining specific reduction goals and associated key performance indicators (KPIs). If you don’t set specific goals, you won’t have a way to measure your progress. For example, your goals might be:
- Reduce overall inventory value by X%
- Increase inventory turnover to X
- Lower storage costs to X
Then take stock of current inventory levels. This is a critical step. You can’t improve what you don’t measure. Look at:
- Inventory levels for each SKU
- Sales velocity for each SKU
- Reorder points
- Lead times for each SKU
Typically, identifying slow-moving SKUs is a bit of an “a-ha” moment. You realize that these slow-moving items are tying up a lot of capital and a lot of space. You might mitigate this by:
- Liquidating or discounting slow-moving skus
- Adjusting purchasing patterns / minimum order quantities
- Discontinuing a SKU entirely
Then, optimize order quantities. There are various formulas like Economic Order Quantity (EOQ) that help you find the right order quantity that balances the cost of ordering too frequently and holding too much inventory.
Improving your relationship with suppliers is crucial as you implement inventory reduction strategies. For example, you may:
- Communicate inventory reduction goals
- Negotiate for smaller, more frequent deliveries
- Explore vendor managed inventory opportunities
- Develop backup plans for sourcing issues
Lastly, remember that this isn’t set it and forget it. Instead, it’s an iterative process. Continuously check how you’re making progress, and be flexible enough to pivot if something isn’t working.
Demand Forecasting for Inventory Reduction
Demand forecasting is arguably the most powerful inventory reduction skill I’ve developed over the years. It’s something you can practice and it will drastically improve your inventory management.
Demand forecasting is rooted in historical data analysis. Look at your past sales to find sales patterns, trends, and cycles. This will help you forecast future demand.
Identifying seasonal trends is key for many businesses. By understanding exactly when demand is highest and lowest, you can adjust your inventory levels accordingly. Stop being surprised by demand fluctuations you know are coming.
Consider market trends (not just your own sales data). What are industry trends and consumer behavior changes? Are there any relevant economic indicators that could impact demand for your products?
Forecasting software can take your demand predictions to the next level. These tools can process large data sets and identify patterns in data that you might miss as a human.
Machine learning and advanced analytics are transforming demand forecasting. These tools can analyze hundreds of variables for each SKU in each store, meaning you have far more accurate demand predictions and can better manage inventory.
Accurately predicting demand is only possible if you analyze hundreds of variables for each SKU in each store. It’s a complicated task, but the amount you’ll save from reducing inventory and the customer service improvements make it well worth the effort.
Don’t forget that forecasting isn’t a one-off task. You need to continually check and update your forecasts to ensure they’re accurate and relevant.
Just-in-Time (JIT) Inventory Management
Just in Time (JIT) inventory management is another excellent inventory reduction strategy. I’ve seen JIT completely turn around businesses and make them much more efficient and profitable.
The JIT principles are simple:
- Only produce or purchase inventory when you need it.
- Keep inventory levels as low as possible.
- Produce high quality items to avoid unnecessary waste and rework.
JIT has many advantages:
- You reduce carrying costs.
- Better cash flow.
- More agility to respond to changes in demand.
- Control of quality.
There are some JIT challenges:
- It requires precise coordination.
- Dependent on a steady supply.
- It can increase shipping costs.
Implementing JIT includes the following high-level steps:
- Analyze how you currently produce inventory.
- Look for areas to improve.
- Create a specific plan.
- Train employees on the new process.
- Slowly roll out the JIT process.
- Continuously refine the process.
JIT success really hinges on strategies to collaborate with suppliers. You must have a strong relationship with suppliers to implement JIT:
- Can they produce inventory just in time for you?
- Have a backup plan if something goes wrong with the supplier.
- Make ongoing improvements to communication / information sharing.
Implementing JIT requires you to be in lock step with suppliers and accurately forecast how much demand you’ll have. It’s a lot of work, but when done well, it can have a massive impact on your business.
ABC Inventory Analysis
ABC inventory analysis is a great strategy for reducing inventory. I’ve personally used ABC analysis to help businesses optimize their inventory and make it more profitable.
The ABC classification breaks down your inventory into three categories:
- A items: These are high-value products that contribute most to profitability.
- B items: These are medium-value products with average profitability.
- C items: These are low-value products with minimal profitability.
To perform ABC analysis, you need to:
- Calculate the annual consumption value for each inventory item.
- Sort items by annual consumption value from highest to lowest.
- Calculate the cumulative percentage of items and value.
- Assign ABC classifications based on the Pareto principle.
In retail inventory, the top 20% of SKUs typically represents 80% of the profits (which is the Pareto principle). This helps you to focus your inventory management efforts where they will have the greatest impact.
Then, you’ll want to introduce different inventory management strategies to optimize each category:
- A items: Tight control. Review frequently. Use safety stock.
- B items: Medium control. Review occasionally.
- C items: Loose control. Review infrequently. Order in bulk.
Using ABC analysis to optimize inventory helps you:
- Determine which items to eliminate from your inventory.
- Optimize inventory storage and handling processes.
- Improve the cash flow of the business because you narrow down the focus of the inventory to only the most profitable items.
Keep in mind that ABC analysis isn’t a one-off task. Make sure you periodically review and update your classifications to ensure they’re still accurate and relevant.
Visual Inventory Management Tools
Visual management tools are another excellent way to reduce inventory and improve the inventory level. I’ve personally used visual management systems in various businesses, and the results are always impressive.
One of the most well known visual management systems is the kanban system. You essentially use cards or bins as a signal when you need to reorder inventory. Here’s how it works:
You assign a specific number of kanban cards to each item.
When you use an item, you remove a kanban card from the bin. When there aren’t any cards left, it’s time to reorder that item.
Visual management has many benefits:
- Simplifies inventory management
- Prevents mistakes and overstocking
- Improves communication between departments
- You can instantly check inventory levels at any time
- You can use visual tools to manage inventory through a few steps of the process:
Identify opportunities for visual management in your business.
- Design the visual signal (cards, boards, etc.).
- Train employees how to use the system.
- Start with just one area of your business as a pilot, and then expand the system.
- Continuously improve the system.
You can also use visual management and digital tools together. For example, you might display the status of each item on a digital display for all employees to see. Or, perhaps you integrate barcode scanning with your visual management system.
Using visual inventory management tools (like a kanban system) is an effective way to manage inventory levels. You can simplify the inventory management process for employees who have no formal inventory training. And remember, the key to an effective visual management system is to keep it as simple as possible while still accomplishing all of the above objectives you outlined.
Closing out
Inventory reduction isn’t a one-and-done effort. It’s an ongoing journey that demands commitment, persistence, and continuous improvement. These strategies have helped countless companies revolutionize their operations. And these strategies will help you do the same. Remember, each step you take to minimize inventory is a step closer to a more efficient, profitable business.
The road won’t always be easy, but the rewards are significant. Continue optimizing your strategy. You’ll eventually see the payoff in better cash flow, lower expenses, and a more nimble business. Stay the course. You’re well on your way to achieving success in inventory management.
