The 3 Rules of Inventory Management (And How to Live by Them)

Optimizing inventory levels has traditionally been a matter of answering the question, “How much inventory should we carry?” It sounds simple: Figure out how much you plan on selling by looking at past sales and making some projections, and then order accordingly. There really aren’t any “rules of inventory” beyond that.

...Or are there?

As a matter of fact, there are. Managing inventory is not just an exercise in coming up with numbers; it requires accurate real-time data so you can identify issues and deal with them before they affect operations. The rules of inventory, then, are business rules that define the timing of activities (such as purchasing) and purchase amounts.

We’ll outline the three main rules here. We go into much more detail in our other blog posts, and even have a comprehensive white paper on the topic. We recommend those resources to readers who want to dive deeper than this summary.

Rules of Inventory #1: Have Enough Inventory to Service Demand

In the past, when inventory ran out, companies would simply issue a backorder while they purchased or manufactured more items. Customers would simply wait for the item to be in stock again.

But today’s consumer is used to a higher standard of service, thanks to the promises of Amazon.com and other large internet retailers. This higher standard includes order processing within 24 hours, prompt shipping, and speedy delivery at a low cost. Needless to say, consumers with these expectations do not tolerate backorders.

To avoid backorders, then, you need to ensure that orders are made in anticipation of a Low Stock or No Stock situation. In short, have enough inventory to service demand.

Rules of Inventory #2: Don’t Overstock

It might seem like a simple thing to avoid running out of inventory—simply order more stock! Isn’t that ultimately what the warehouse is for, anyway?

Not so fast. Having lots of extra inventory means you have capital tied up, unavailable for other things. Pinched cash flow makes doing business that much more difficult.

There are hidden costs of having too much inventory as well. Lots of extra inventory means lots of warehousing—warehousing that would not be needed if your company had more realistic inventory levels. Extra inventory could also mean a shift in demand, resulting in the inventory eventually being sold at a steep discount. It’s better to avoid overstocking, to begin with.

Rules of Inventory #3: Know Thy Inventory

Most times, having the right level of inventory is not the main problem. The main problem is knowing your precise level of inventory and what state it is in. Having inaccurate data on your stock levels leads to a number of problems.

Besides the problems alluded to above, poor inventory data can ripple out and cause other inefficiencies:

• Inaccurate data on inventory make loss and theft harder to detect and prevent.
• Inaccurate stock levels are communicated to vendors and partners, causing supply chain problems.
• eCommerce sites and affiliates also get inaccurate data, creating missed sales opportunities or backorders, both of which damage the brand’s reputation. 

Really, all good inventory management starts with good data collection habits.

What About Lot Mixing Rules and Allocation Rules?

Lot mixing rules and allocation rules are different from what we are discussing here.

Lot mixing rules allow a warehouse or storage facility to specify how SKUs and lots can (or cannot) be mixed. This can be important, as some items (say, golf balls) could be mixed all day…but medicines can’t be mixed by, say, lot number. We discuss, lot mixing rules in more detail here.

Allocation rules (also sometimes called fulfillment rules) determine the order in which SKUs are picked for shipping. For example, a product might be “first-in, first-out” (FIFO) or labor-optimized. We discuss allocation rules in more detail here.

Both are important to know about, but not until you’ve mastered the three main rules of inventory above.

So What Data Should We Collect?

That’s a great question and one that takes us far beyond this post. But we do have a few pointers.

What SKUs do you have and in what quantities?

What is your On Hand quantity, your unavailable and/or damaged quantity, and open order quantity? How are these numbers changing over time?

Where is each SKU located?

This will be extremely important when it comes to forward staging and general warehouse layout.

What’s the lead time needed to order (or manufacture) each item?

This will help you determine how far out you need to plan and when you need to reorder.

Is there enough labor force to move the stock when needed?

Products are not the only assets that need to be coordinated. Having appropriate quantities and floor placement will not matter if you do not have the labor necessary to move those items in a timely manner. This is why having real-time data is important: Your organization can be made aware of spikes in demand and adjust the day’s activities as needed.

There’s more you could (and should) measure, of course. If you need help collecting this data, or you’re struggling to find ways to use, integrate, and report your data, let us know. We deal with warehouse data all day long, and we’re really keen on making the “Rules of Inventory” work for warehouses of all sizes.