StatCave Episode 2: Low-tech Inventory and Margin Planning

 

I pack my favorite tricks for maximizing the overall margin of your inventory into less than nine minutes!

If you're managing a catalog of more than a couple dozen items, then I'm certain you've struggled with how to balance purchasing, pricing, and profit. These are some of the simplest ways I've seen to tackle that, no data scientists or ERP required.

Video Transcript:
Big companies have the advantage of being able to look at an ERP that can do all kinds of inventory forecasting, but most of us don't have that luxury. In fact even if you're doing up to $100 million a year in revenue, you still might not be sitting on top of a fully automated stack for inventory management. I'm going to show you some tricks, this is all stuff you can do with spreadsheets, that should get you most of the way there and help you to take advantage of a few opportunities as they come along.

In order to figure out how many units you need to have in inventory to meet demand for, say, the next 90 days, you can use three pieces of data to come to a reasonably good estimate. The first two are from last year. That's the 90 days leading up to the point that we're at, and the next 90 days of last year as well. You compare these two to get a sort of sense of the seasonality on the calendar for this item. If we know that the next 90 days is double what the previous 90 days was, at least in terms of last year, then we can use that as a reasonable estimate to say that the next 90 days should be about double what the previous 90 days was. Using exactly that method, we can arrive at a pretty good ballpark that should be strategically valuable for us.

What if it's a new item? This is something in the catalog that was added in the past year, and so we don't have year over years comps for it. That's not a disaster. You can still use other items in the same category, you can use items that are in the same brand, or preferably both to get a sense of how the shopping around those types of products are moving around. That gives you at least pretty good guardrails for getting to the right number.

Let's say that you now have the units in inventory and you're looking from here out to the end of your season. You want to make sure you sell through all of the current inventory before a certain date. What you can do is determine your current estimated depletion date. That's the date where you expect to run out of units. Then if that date is ahead or behind your end of season date, then you can make decisions from there. In order to figure out what your depletion date is, it's pretty simple just to do a linear extrapolation. All that means is you're taking effectively the average change over time and just carrying it out in a straight line. That'll get you in the right ballpark.

Obviously, the volume is going to change from that to some degree and you end up with charts that are a little less linear, but if you just take the first week and the last week, I'm using weeks in this example, and you just draw a straight line through those, that ends up being the same as taking the average change. The fact that there's noise in between those doesn't matter too much. This'll obviously change as you look at it week to week, but they all should basically point in the same direction, and you end up with a fairly predictable outcome.

Once again, if this is a brand new product and these are, say, the first 100 units you've ever had on the site, and you don't have any way to estimate the sell-through rate, you're going to have to do a couple of things. One, you can obviously wait and see how fast they go. Even with just a couple of weeks of data, you can very quickly come up with a reasonable ballpark of how many months that inventory is going to last. The other thing you can do is, like we did with the buying, you can compare it to siblings in the same category or from the same brand. That'll get you in the right ballpark. Now let's say you've done that already, so you have your depletion date. If your depletion date is earlier than your anticipated and targeted end of season, then that means you are probably going to run out of inventory and either miss sales toward the end of the season, which is bad, or you might be leaving margin on the table.

You have two variables to play with when you're selling through your inventory faster than you anticipate, and you're not in a position to replenish. Your big lever is price. Obviously, you reduce your price, you eat into your margins partially, but you generally increase conversion rates, and so you can start to move more units. Doing so in small increments as you go and watching the effect it has on your depletion date relative to your end of season target, you'll get a sense of exactly how sensitive that item's pricing is within your competitive landscape, for example.

The other lever is your marketing spend. A lot of times, people will tend to go to this first, but it's not nearly as influential as changes to price, but it's still worth considering. That is because you have the ability to spend more as a percentage of revenue in order to try and capture more sales. Those sales, if they're not discounted, might be higher margin, but don't forget, you're still paying for those ads. Dollar for dollar, I tend to think that price changes are more influential. There's diminishing returns on both variables, and so there's always going to be just the right balance. I just recommend starting by doing some competitive price analysis. If you're already in a beautiful place for price, then start pushing more heavily into more aggressive ad spend.

If you are a financially-minded person, you might have realized a bit of a logical flaw in all of this. As inventory sits in the warehouse longer, it accumulates more total cost. Depending on how you're accounting for your overhead, you may actually perceive the COGS, your cost of goods sold, as going up over time in your warehousing system, for example. This is a reality. It's one way to keep track of the growth of that overhead cost. What it does is it produces tightening margins. With tighter margins, you are either less likely to want to discount the product, or you're less likely to want to increase your marketing spend, which cuts off your access to the main two levers that you have to affect your volume.

For most companies, what'll happen is as those items become stale, especially as they start to have an average shelf life or an individual shelf life of more than a year or something like that, you'll see people throw things onto clearance. You go from maybe it's full price, and then it goes to a deep discount, and you try and blow it out, turn it into liquid assets that you can then reinvest into other inventory. Those motives are all perfectly sound, but going straight from some sort of mainline pricing down to a clearance level and trying to blow it out quickly is not as margin-advantageous as an alternative I'd like to propose.

You could do a little slight of hand that makes your marketing a lot more effective. Instead of increasing your perceived COGS over time, reduce it. Obviously, this is not an accounting strategy. This is entirely a marketing strategy. Our ability to change prices improves because we have more margin to play with. It also means that you might be able to allocate more marketing dollars to it. If your marketing dollars come out of a percent of your margins, which is a perfectly reasonable way to do it, then as the margins increase, so does your budget. Either way, you have access to both of your levers, and those levers become more powerful over time.

A common way to do this is to leave the COGS alone for the first six months or a year. Wherever you see a cutoff where you say, "This is now stale inventory," is a great place to start this accumulation of additional perceived margin. The result is that you have instead of a drop-off to clearance, you have this gradual reduction in your price, or your gradual increase in marketing cost, or a combination of both. You're capturing as much margin as you can at each step along the way. If you just drop a price all the way down, you're giving up all of the area under the curve that might have been captured by having a higher than your clearance price for a little while and then slowly work your way down until your depletion date is exactly where you want it.

While you might want to let it just continue all the way down to zero because at that point you just need to move the item, you can also do the other thing where you have it go down to some sort of floor, say your break even point, so that no matter what happens, you never discount an item to the point where it turns into red ink. That's it. These are basically the steps that you can take on a per item basis when you're running a relatively small or medium-sized shop and maximize your margin, and therefore maximize the impact of the money that you're investing into your inventory in your catalog.