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Inventory Risk: The Comprehensive Guide for 2024

3.7 Minutes

In this article, we will cover what inventory risk is and share our step-by-step process on how to effectively manage and mitigate it. Read on to learn more.

inventory risk

What is Inventory Risk?

Inventory risk refers to the potential challenges and losses a business can encounter with its stored goods. This includes obsolescence, theft, damage, excess holding costs, or stockouts. 

Example: A retailer ordered 500 units of a specific smartphone model, but a newer version was released earlier than expected. This led to a significant drop in demand with 300 units remaining unsold, which became obsolete and led to a financial loss for the retailer.

inventory risks

Types of Inventory Risk

There are numerous types of inventory risks. Below are some of the most common types of inventory risks. 

1. Excess Inventory

Excess inventory risk is the scenario of having an overstock that leads to increased holding costs and the potential for goods to become obsolete. For example, a clothing retailer might overstock winter coats, but a warm winter leads to low sales leaving the store with unsold inventory. 

2. Stockouts

Stockouts happen when there’s insufficient inventory to satisfy customer demand. A real-world example could be a tech store running out of the latest smartphone model during a holiday sale leading to lost sales opportunities and disappointed customers.

3. Obsolescence

This risk occurs when products lose value or become unsellable due to evolving trends or technology. For instance, a computer shop may have an excess of laptops with outdated specifications that become difficult to sell after the release of newer models.

4. Supplier Risk

Supplier risk emerges when vendors are unreliable leading to inventory replenishment issues. An example could be a restaurant facing ingredient shortages because a key supplier is experiencing shipping delays, thus impacting the restaurant’s menu and service.

5. Theft and Damage

This risk pertains to the loss of inventory due to theft or damage. A classic example is a jewelry store suffering a burglary resulting in a significant loss of inventory or a warehouse being damaged by a fire, rendering the stored goods unsellable.

6. Forecasting Error

Forecasting error risks are the result of incorrect demand predictions leading to overstock or stockouts. For example, a toy store underestimating the popularity of a new toy might face stockouts missing the opportunity to maximize sales during the high-demand period.

what is inventory risk

8 Steps to Manage Inventory Risk

To manage stock levels efficiently and minimize inventory risks, you can follow our simple 8 step process below.

Step 1. Demand Forecasting

This step involves predicting the quantity of goods that customers will purchase in a given period. Accurate forecasts help businesses prepare adequately to meet customer needs while minimizing costs.

Example: A tech store predicts the sale of 500 units of Smartphone X in November based on historical sales data and upcoming holiday trends. This forecast aids in aligning inventory levels to anticipated demand.

Step 2. Supplier Relationships

Strengthening relationships with suppliers ensures a consistent and reliable flow of inventory. It also aids in negotiating favorable terms and conditions enhancing flexibility in inventory management.

Example: A bakery maintains a strong relationship with Flour Supplier Y allowing for quick replenishments and flexible order adjustments. The bakery can order an extra 50 bags of flour at short notice to meet a sudden surge in demand.

Step 3. Safety Stock Calculation

Safety stock acts as a buffer against uncertainties in demand and supply ensuring business continuity during unforeseen fluctuations. Accurately calculated safety stock ensures product availability while minimizing holding costs.

Example: A toy store keeps 100 extra units of Toy Z as safety stock to cover unexpected sales spikes or supplier delays. This buffer allows the store to satisfy customer demand while awaiting the next shipment.

Step 4. Inventory Turnover Analysis

This process involves analyzing the frequency at which inventory is sold and replaced. A higher turnover rate indicates optimal inventory levels and lower holding costs.

Example: Electronics Retailer A sold 1000 units of Laptop B within a month and restocked achieving a high turnover rate. This rapid turnover indicates efficient sales and stock replenishment practices.

Step 5. Quality Control

Quality control ensures that inventory meets the set standards and specifications. This step is crucial to prevent defects, returns, and damage to the brand's reputation.

Example: Clothing Store C conducts rigorous checks to ensure that all 200 units of Dress D meet quality standards. This prevents potential returns and dissatisfaction among customers.

Step 6. Real-time Inventory Tracking

Implementing real-time tracking allows businesses to monitor their inventory levels and movements continuously. This technology aids in making informed decisions to mitigate risks.

Example: Auto Parts Store E uses a real-time tracking system to monitor the stock levels of Brake Pad F. They notice a rapid decline in stock and quickly place an order to replenish the inventory before a stockout occurs.

Step 7. Contingency Planning

This step involves developing plans to address potential inventory risks like stockouts, excess inventory, or supply chain disruptions. A well-crafted contingency plan ensures business continuity during unforeseen events.

Example: Electronics Store G can quickly source 500 XR Smartphones from another supplier if their main one faces delays ensuring steady stock and avoiding stockouts.

Step 8. Periodic Review

Regularly reviewing inventory processes and data helps in identifying areas for improvement. This ongoing assessment ensures that inventory management remains efficient and responsive to market changes.

Example: Electronics Store I reviews its sales data and realizes that 300 units of Camera J are not selling as anticipated. The store then adjusts its future orders and considers offering promotions to clear the existing stock.

what are inventory risks

Case Study Example

GreenValley Electronics is a renowned electronics retailer specializing in offering a wide range of products including smartphones, laptops, cameras, and accessories. Here's how they applied our inventory risk management framework:

Step 1. Demand Forecasting

Based on historical sales data and market trends, GreenValley Electronics predicts the sale of 2,000 units of the Galaxy S34 smartphone in the upcoming month. This forecast is informed by the sale of 1,800 units of the Galaxy S33 during the same period last year coupled with the increased market hype around the new model.

Step 2. Supplier Relationships

GreenValley has built a strong partnership with TechSupply Co. ensuring they can quickly and flexibly replenish their inventory. For instance, this relationship proved invaluable last Christmas when GreenValley adjusted its order at short notice to include an extra 500 units of Smartwatch X to meet the unexpected surge in demand.

Step 3. Safety Stock Calculation

To mitigate the risks associated with unpredictable fluctuations in demand and supply, GreenValley maintains a safety stock of 300 units of the popular VioLaptops. During a supplier delay last fall, this safety stock was instrumental in covering sales preventing potential stockouts. 

Step 4. Inventory Turnover Analysis

GreenValley closely monitors its inventory turnover by analyzing the frequency of sales and restocking. For example, the 1,200 units of Camera Pro12 were sold and replaced within two months indicating well-maintained inventory levels that effectively cater to consumer demand without overstocking.

Step 5. Quality Control

Quality is paramount at GreenValley. Every product, including the 500 EchoEarbuds in the recent batch undergoes a comprehensive quality check before being placed on the shelves. This rigorous process ensures that all products meet the expected standards minimizing returns and enhancing customer satisfaction.

Step 6. Real-time Inventory Tracking

Using state-of-the-art technology, GreenValley tracks inventory levels and movements in real time. When they noticed a rapid decline in the stock levels of Brake Pad F, the real-time data allowed them to swiftly place an order to replenish the inventory before a stockout occurred.

Step 7. Contingency Planning

GreenValley effectively mitigates inventory risks with solid contingency plans. When a supplier issue threatened the stock of GameStation 5 consoles, they quickly sourced 500 units from an alternative supplier averting potential stockouts.

Step 8. Periodic Review

Regular reviews of inventory data are a norm at GreenValley. For instance, after realizing that 300 units of Camera J were not selling as anticipated during their routine reviews, they adjusted future orders and considered promotional activities to clear the existing stock. 

We hope that you now have a better understanding of what inventory risk is and how to implement our management practices to minimize these risks.

If you enjoyed this article, you might also like our article on inventory impairment or phantom inventory.

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