Cost Reduction in Inventory Management: 5 Ways to Do It

Storing stuff is expensive. Really expensive.

For a typical logistics operation, inventory costs are around 20 to 30% of the total budget.

That means for every $1 million in products you store, you're paying $200,000 to $300,000 to store them in a warehouse and move them in and out of your inventory.

Inventory management is incredibly important to your business's bottom line. Depending on how much inventory you're in charge of, a cost cut of just 5% could save you millions of dollars.

Up ahead, we'll look at five practical ways to reduce your inventory management costs and end with some resources that break down other tricks and techniques to managing your inventory.

5 ways to approach cost reduction in inventory management

Inventory management systems are complicated, and change is hard. But to achieve success, you've got to be willing to adjust.

Cost reduction in inventory management is vital in an exploding market that is continuously attracting more competition. One report predicts that the logistics market will surge from around $8 trillion in 2015 to more than $15 trillion in 2023.

As competition increases, logistics businesses must take a few straightforward steps to reduce inventory costs to stay in the game.

Here are five ways to do just that.

1. Slash supplier lead time

Is there a supplier you work with that takes forever to fill an order? Maybe it's time to take a hard look at whether that relationship is really working for your business.

You can keep inventory levels (and therefore costs) lower by speeding up supplier lead times. The median supplier lead time for purchased materials is eight days. If you can shave two or three days off of that, it will have a major impact on your bottom line.

Shop around for suppliers that can meet your needs, quickly. If you're already working with a supplier that isn't moving as fast as you'd like, think about the costs of staying with a slower supplier.

You need to keep more safety stock around for orders that need to be filled, and that means you're paying to warehouse stuff you wouldn't need to have at all if your supplier could deliver inventory to you more quickly.

Calculate how much you're paying for that safety stock, and you'll have an idea of what kind of savings are possible if you find a better supplier.

2. Get rid of obsolete inventory

Safety stock isn't the only product you're carrying that you don't need. Chances are you've got obsolete inventory, too.

It's tough to get rid of stuff when you're in the inventory management business. Those are products, after all—products that are theoretically worth real money. But if they're obsolete and not selling, they're just taking up space.

Take a deep breath, and chuck 'em (or recycle).

Resist the hoarder mentality. It's easy to think that the additional space you're dedicating to that inventory is keeping valuable product on hand and a good financial decision, but you're really just throwing good money after bad by paying to store stuff on the hope that it'll sell at some point.

Gather data on how much of your inventory consists of items that haven't sold in the past year. A full breakdown of what you're spending on such products is almost always eye-opening.

Once you've gotten rid of the obsolete stock, you need to prevent it from building back up. Adjust your demand forecasting based on expected future sales so you're ordering the right quantities of merchandise. This is a fairly simple way to reduce costs in inventory management, but most managers get so caught up in the day-to-day demands that they never get around to it.

3. Choose better software

Quality logistics software can do incredible things for your business. And there are dozens upon dozens of options out there—231 in our directory, to be exact.

You need to keep track of your inventory levels, or risk overstocking and seeing your inventory costs balloon. If you've been relying on a simple spreadsheet or a basic software solution with limited features to manage everything, you probably aren't getting the full picture of your inventory situation.

Find a software solution that keeps inventory info automatically up-to-date, so you can quickly make decisions when necessary.

Logistics software also helps centralize control of your inventory, which cuts costs by eliminating redundant effort. This is particularly important for complex logistics operations that require a detailed inventory plan.

Centralizing supply chain models also helps you avoid excess and obsolete stock. Remember: it's always better to be preventive than reactive.

4. Set up automatic re-orders when inventory gets low

Thanks to technological advancements, automation is accessible even to small businesses. You must use this to your advantage.

When your inventory runs low, automatic re-orders ensure you aren't left with shortages. Software combined with a perpetual inventory system will help you avoid those costly shortages.

A perpetual inventory management system provides real-time inventory updates by tapping into a database that tracks all of your inventory to determine when supplies are running low and when it's time to re-order—all without any human input.

5. Monitor your SKUs

Stock keeping units (SKUs) are identification codes for products that help you track them through inventory. Relatively straightforward products may have just one SKU, but items that come in multiple shapes, sizes, and colors (like clothing) have multiple SKUs.

This can become an inventory headache, as products with multiple SKUs can send confusing signals when it comes to demand. You might think that there is no interest in a particular product, only to find that the reason people aren't ordering that shirt is because the size they want is never in stock.

For these products, you need to use software that can manage all of your SKU data in one place so you know how these products are really performing on the market.

Want to have a look at some best practices that might help you with your inventory management? Have a look at this video.