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How to Solve Out-of-Stocks (While Reducing Inventory)

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Solving Your Out of Stock Problem Once and for All

While inexperienced retailers may celebrate completely selling out of stock — retailing professionals know that out-of-stocks can be disastrous for a retail organization, both in the short and long term.

In the short term, out-of-stock causes lost sales (you can’t sell what you don’t have) and disappointed customers.

But in the long-term, chronic out-of-stocks become even more insidious. If you are consistently running out of stock, several things will begin to happen:

  1. Your profit margins will start to decrease. This is because you are not only losing sales (and thus revenue) but are also increasing your costs by having to replenish more frequently.
  2. Your reputation among customers will suffer. Would you want to waste your time going to a store that never has what you want in stock?
  3. Your competitors will steal sales. If there is demand for your product and someone else is selling it — customers will flock in their direction.

This is why most retailers are doing everything they can to reduce out-of-stocks. And while there is no silver bullet on how to prevent stock-outs, there are some tactics that retailers can use to prevent out-of-stock problems.

What is a stock-out?

A stock-out happens when there is no inventory left of a specific item at a specific location.

In other words, even if most of your stores have the item but one store does not – you still have a stock out (and will be losing sales). Moreover, if you notice a stock-out at one store at any given particular point in time, it’s likely that you’re experiencing similar stockouts at different stores at different times.

While some retailers will attempt to “resolve” a stock-out situation by offering alternative fulfillment options to customers (sending them to a store with inventory, transferring stock from store to store, shipping items directly to the customer, etc.) — this only works a portion of the time. In many cases, customers simply walk out of the store without making a purchase.

This means that, while alternative fulfillment methods can help retain some portion of lost sales, they’re merely a band-aid for a deep cut. The only way to eliminate the pain of out-of-stocks completely is to prevent them from happening in the first place.

As such, here are 6 ways retailers can prevent out-of-stocks and lost sales in their business:

Preventing stock-outs is necessary to prevent lost sales

1. Prevent out-of-stocks with accurate forecasting

When it comes to solving out-of-stock problems, prevention is the best medicine. Remember that once you have out-of-stocks, you will have lost sales. The best way to prevent stockouts is to know the demand for your products in advance. If you know how many units of each SKU you need at each store and when you need them, you’ll be able to prevent out-of-stocks.

The challenge is that most forecasting solutions on the market today don’t do a good enough job to anticipate demand. Their forecasts often have too many exceptions, which can lead to out-of-stock issues. To get a reliable forecast, retailers will need to invest in forecasting software that accounts for the most important factors influencing demand (price, seasonality, competitors, etc.).

In modern retailing, AI-powered retail forecasting tools are the most accurate and reliable methods for preventing stock-outs.

2. Identify and fix a broken assortment

The reality is that out-of-stocks are actually a symptom of several other problems. For example, your out-of-stocks may be indirectly caused by gaps in your product assortment.

While retailers may offer a wide range of assortment for any given category, not all products within that assortment will sell the same quantity. That’s why knowing how to balance assortment diversity vs depth for your products ensures that you don’t run out of stock on popular items.

Alternatively, you may be tying up too much money in an unnecessary assortment. If you have too much depth and diversity to your assortment, you will not have enough budget to invest in more units of your most popular SKUs.

But fixing a broken assortment is not easy.

Expanding assortment can be a risk because your new products may not sell. Reducing assortment can create unintended lost sales.

How do you find the perfect balance of assortment to maximize your revenue sales while reducing the cost of unnecessary SKUs?

Traditionally, this was done manually through the process of assortment planning. Planners would map out their product categories on Excel spreadsheets and make judgement calls on when to shrink or expand their assortment. In some cases, analysts would compile reports on store performance to help with the decision-making process.

Unfortunately, it is very difficult to translate this type of assortment plan to a precise number of units required at every store at every time frame to eliminate stock-outs. This becomes impossible for retailers with hundreds of stores and millions of SKUs.

This is why retailers have started to turn to AI to help them predict when they need to shrink or expand assortment to maximize GMROI.

3. Optimize unbalanced allocation

Retailers who have out-of-stocks in one location but plenty of inventory at another will need to optimize allocation. To do this, retailers need to better understand how to distribute inventory across their business.

But this is easier said than done.

It’s not just a matter of knowing exactly how many units of each product you’ll need at each store at every time frame (and that is difficult enough by itself). You’ll also need to account for dozens of additional factors (like seasonality, product cannibalization, competitors, promotions, events, etc.).

It’s very difficult to do this manually for a small retailer. It’s virtually impossible to do for a large one.

This is why retailers have been turning to software to help them balance and optimize their allocation. A good allocation tool is able to automatically account for plans, promotions, inventory levels at each location, seasonality, and other factors that affect demand. Using retail allocation optimization software can help you solve your out-of-stock challenges and ensure that each location has ample supply to meet customer demand.

4. Automate your replenishment with AI

Once your inventory has been allocated to stores, you still need to worry about replenishment. This is another area where retailers run into problems. Inefficiently replenishing inventory is a frequent source of out-of-stock problems for retailers managing large quantities of products and stores.

Even if you have a good demand forecast and optimized allocation, bad replenishment timing can still cause out-of-stocks. Ship inventory too early, and you’re tying up to much money in stock you don’t need. Replenish too late, and lose sales.

This is why optimizing replenishment is a major focus for many retailers. There are several common approaches to doing so:

  • Modifying replenishment schedules and quantities to take promotions and price changes into account
  • Leveraging data analytics to determine ideal order quantities
  • Improving collaboration and flexibility with vendors and logistics providers
  • Optimizing logistics routes and updating shipping schedules
  • Opening new distribution centers to allow for faster reactivity

But all of these are massive undertakings, many of which require major restructuring and change management to implement. And even when these changes are implemented, retailers will still find opportunities to optimize their replenishment process further. For example, if you improve your logistics routes to reduce transit time for your inventory orders — you might reduce your cost of replenishment and improve replenishment speed — but you’ll still be reacting to out-of-stocks (albeit faster) instead of preventing them. Sure, the damage will be reduced. But there will still be damage.

Alternatively (or even concurrently to these ideas), leading retailers have discovered that AI-based auto-replenishment can almost entirely eliminate their replenishment problems. Instead of trying to solve every constraint (vendors, logistics, MOQs, lead-time variability, etc.), AI can predict when you need to replenish and with how many units, taking all of these constraints into account. The result is automatically generated POs that are optimized for your demand, shipping times, shipping costs, vendor requirements, order quantities, etc.

This way, you will always replenish on time, in the most cost-effective way possible.

5. Optimize your safety stock

Optimizing your safety stock may seem like an obvious fix but in some cases, the medicine is worse than the disease.

In short, safety stock is the buffer inventory retailers hold in warehouses and back rooms to mitigate risks like vendor lead-time variability.

Increasing your safety stock arbitrarily may solve your out-of-stock problems with certain SKUs, but it also ties up a large amount of money in your inventory. It is also hard to know how much safety stock you’ll need throughout the year for different SKUs.

The trick is to increase your safety stocks by a minimal amount to protect you from out-of-stocks while minimizing inventory costs. Or, in other words, only add stock when it adds value.

Traditional methods for determining safety stock such as guesstimation or using common statistical modelling techniques do not work well in today’s dynamic retailing environment.

Today’s most successful retailers leverage software that specializes in optimizing safety stock based on an accurate demand forecast.

6. Be proactive about inter-store transfers

When a popular item is out-of-stock at their location, store managers are often faced with the decision to transfer inventory in from another store. Not only does this come at an additional cost (shipping cost, employee time, etc.), but it also doesn’t solve the root problem.

That’s because managers only request inventory transfers when it’s too late and a product is completely out-of-stock. In other words, sales are already being lost.

To mitigate lost sales and minimize costs, inventory should be transferred from store to store proactively. This means knowing in advance when ‘store A’ is running low on a particular SKU while ‘store B’ has too much of the same item.

But having this predictive ability is not enough. Even if you used transfers effectively to minimize out-of-stocks — you could destroy your margins. This is especially true if you are transferring inventory over large geographical distances (across states or provinces, for example).

Thus, it’s not enough to be proactive and time your transfers right. You also need to ensure that each individual transfer is profitable for your company, so you’re not selling transferred items at a loss because of shipping costs.

Although it’s possible to run these calculations manually — this task becomes too complicated for larger retailers. That’s why many retailers have adopted retail analytics tools that automate the entire process, by not only proactively identifying inter-store transfer opportunities but also making sure that they’re profitable for the company.

7. Use pricing as a lever to sculpt demand

In basic economics, demand determines the optimal price for each product. But the price also has an impact on demand — because changing the price of a product will impact how many people want to buy it. Sophisticated retailers like Amazon have figured out how to leverage this phenomenon effectively.

If you know that you’re going to sell out of a product (demand is too high and your suppliers can’t keep up), you can increase your prices. Taking this action can increase your profit margins per sale while decreasing stock-outs (through decreased demand).

But you’ll need to be very careful with this tactic.

Being too aggressive can lead to negative outcomes like damaging your reputation and brand image. Furthermore, some jurisdictions have anti-price gouging bylaws designed to curb predatory pricing during the COVID-19 pandemic.

But assuming it is ethical (and legal) to do so, this tactic requires a very careful balancing act.

You’ll need to increase prices only by the amount that helps you maximize your profits and not a cent more. This is because increasing your prices by too much might destroy demand completely, reducing your revenue from the product. And making this calculation manually is tricky because not all products have the same reaction to price changes.

In some cases, retailers will implement a pricing strategy like “high-low” — where they will price a product highly, and reduce it in increments to find the “sweet spot” between demand and profit. But this is not always possible and can end in very expensive pricing experiments.

In order to simplify this process, some sophisticated retailers have started to employ advanced pricing optimization technology to automatically identify the right price for each SKU to perfectly balance in-stock percentage and profit margins.

How leading retailers fix out-of-stocks

As you’ve seen above, although out-of-stocks may seem simple on paper, their causes and fixes are quite complicated. Bringing in more units of a SKU is simply not enough (and can do more damage than the out-of-stock).

To fix out-of-stocks while maximizing your profits, you need to:

  • Predict stock-outs before they happen
  • Fix assortment issues that are creating out-of-stock scenarios
  • Distribute your inventory across channels effectively and accurately
  • Time your orders perfectly so you don’t run out of stock, but inventory doesn’t sit on shelves for too long
  • Carry enough safety stock to mitigate risks, but not too much that it’s a major cost
  • Find profitable inventory transfer opportunities between stores
  • Use pricing as the ultimate fail-safe to sculpt demand

According to McKinsey, this is why retailers that use advanced analytics to solve these issues outperform the market by 68%.

Advanced analytics and artificial intelligence have given retailers an enormous advantage in the market. If you’d like to learn more about how AI and analytics can resolve your out-of-stock problems, don’t hesitate to send get in touch with our team of retail experts.

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