Mitigating risks of a low inventory level

Effective cashflow management is key to business success. Operating working capital needs to be kept as low as possible, even down into negative values, in order to improve the cash position. To control the stock level, the purchasing volume needs be fine tuned to the latest sales trend and forecast.

The optimal supplier chain should be able to meet all your customer demands, while maintaining the lowest cost and possible inventory level. A low inventory level helps you to save on inventory costs, but it comes with the risk of stockouts. Stockouts are primarily caused by the following reasons:

• Late shipment from supplier (on top of a delayed order from your side)
• Higher customer demand than anticipated

Assuming you’re not selling in a niche segment where scarcity is part of the business concept, a stockout will always hurt your business. In the best case, an out-of-stock situation will only cause you to miss a sales opportunity, but most cases will result in disappointed customers that could turn to a competitor.

When dealing with the risks of a stockout, you have essentially two options:

1. Take precautions to reduce the possibility that a stockout is happening (risk prevention)Reduce the potential impact in case a risk is materializing (risk mitigation)

Ideally, you should prepare for both and make your business resilient in the face of any event. With inventory management software like TradeGecko , you’ll always stay in control of your inventory levels. You can run detailed reports that show your total stock on hand, along with filters by location, product type, available stock, and committed units. Moreover, you’ll also be able to run reorder reports so you can check for products and variants that have fallen below the reorder point so you can take measures to replenish your stock.

However, risk management comes at a cost and you have to choose wisely which risks you want to reduce and the cost you are willing to pay for it. When you’re trying to decide on the right choices to reduce the risk of stockouts in your specific case, you need to assess the quality of your suppliers and the importance of the product for your customers.

Understand the importance of your products

You need to understand your customers and how important a product is for them. In the B2C world, it is a question of market share and other customer insights; in the B2B world you need to understand your customers’ business demands. Are your products crucial to their business, and how much are your customers relying on you to deliver the right quantities in time?

You also need to know how reliable your suppliers are. As mentioned in our earlier article on How to build a KPI dashboard for inventory management, you need to assess your suppliers on a regular basis. For a start, you need to track your suppliers’ performance in terms of delivering in time, delivering the right products, and delivering the correct quantities. By building up a performance history of your suppliers, you’ll gain a very clear understanding on which suppliers you can rely on and which suppliers are a potential risk to your business.

Create a fallback plan to manage stockout risks

After the assessment has been made, you are in the position to tailor your countermeasures to avoid or mitigate the risk of a stockout. When a supplier is proven to be reliable, you can also rely on him in case you are running short of stock to help you out. These reliable suppliers are part of mitigating the risk of stockouts, but you still need a backup plan for weak suppliers. You are most exposed to risk when dealing with products that are critical to your customers and their businesses, but are sourced from weak suppliers. In these instances, you’re running the risk of losing customers for these products, and that could really hurt your business.

On the other hand, you might consider taking less precautions around products that aren’t critical to your customers and are sourced from reliable suppliers. For these products, you can maintain a low inventory level by reducing the reorder size and lower the inventory level significantly without putting your business at risk. 

If the product is not critical to the customer and the supplier is not reliable, you might not even have to consider workarounds to negate effects on the customer. In this case it isn’t necessary to take expensive precautions. In this case, you could simply explain that you’re out of stock and ask the customer to be patient for a belated or split delivery (but you need to be sure that they’ll accept it, since it’s not a critical product).

While reducing the inventory level has many benefits for your business, it also increases the risk of stockouts. Managing these risks will always increase costs or your financing needs. However, truly understanding your customer needs is important when it comes to making the right decision. Always ensure that you constantly assess your suppliers’ performance, as this knowledge helps you to make the best decision for your business.

Ultimately, while it’s best to have the lowest possible level of inventory, there will be situations where you have to pinpoint your activities and investments on critical products for which you need to maintain higher levels of safety stock, or need to source a backup supplier. With this in mind, you can reduce the stock level and keep the risk at bay. 

This is the third article in a series by our guest author Thorsten Ohm. Click here to read his second article: Reduce working capital by improving inventory management

About the Author:

Thorsten Ohm is a cofounder of Waypoint Ventures. He has 20 years of international experiences spanning across many geographies, where he has set-up organisations and developed businesses. As a senior corporate executive and a board member he is experienced in growing businesses organically and via M&A. Waypoint Ventures helps companies to accelerate their growth, improve their performance, and enter new businesses or markets.