How to ensure that business inventory management is done right? What metrics are essential for eCommerce businesses to measure their performance, growth, and success?
These and several other crucial questions related to your business can be answered with the help of Inventory Management Metrics!
Managing Inventory is critical to the long-term success of any eCommerce business. As the owner of an eCommerce business, inventory management metrics are a window for you to look into the health of your store.
Without these metrics, it can be hard to know what all of the moving parts are doing about each other. As a result, you may not realize there’s a problem until it has already cost you money or sales.
Several inventory management software and tools come with relevant insights to help you measure and make sense of these metrics.
The exact metrics used will depend on your business type and the product you sell, but some fundamental metrics can help manage your inventory much more manageable.
This post uncovers some of the most critical inventory management metrics that you can use to improve your operations and optimize sales.
Let’s get started!
1. Average Order Value
The average order value or AOV measures the average dollar amount spent on each customer’s order on a website. To calculate the AOV, you have to divide the total revenue by the number of orders placed.
For example, if your store has a total revenue of $10,000 and has received 120 orders over a specific duration, the average order value is $83. It means that, on average, a customer spends $83 for each purchase.
How does AOV help inventory management?
The average order value may not be enough to influence decisions on Inventory. Still, it should be considered with other metrics in the customer profile like order size, purchase frequency, and the number of orders per year to improve decision making.
One of the essential aspects involved in inventory management is understanding your audience’s buying patterns. Average Order Value can help you with this by telling you about your customers’ average spend on your site and what they are ordering most often.
Armed with these insights, you could then take steps like increasing stock in popular items or offering freebies for certain products that aren’t selling as well.
AOV is one of the most important metrics to track, resulting in an immediate boost in ROI and profits. But how do you work on increasing it?
Here are some excellent tips and advice to capitalize on the average order value from your eCommerce store’s customers:
Use a Minimum Order Amount for Free Shipping
If your AOV is, for instance, $83, you could offer free shipping for a minimum order of $99. However, make sure not to set the minimum order for free shipping too high, leading customers to abandon the cart.
You could give a coupon code for orders over a certain threshold to encourage buying additional products as an alternative to free shipping. Of course, it may require some work on your side to find and use eCommerce tools and programs that let you economize, but the results will be worth it.
Create Product Packages
Another way to incentivize customers to buy more items is to create product bundles or packages, making the collective price lesser than purchasing each product separately. It is possible to create packages of products that fit together and help the customer better in what they need, enhancing customer experience and boosting sales.
Upsell or Cross-sell
Ask customers if they would like additional complementary products or add value to what they have already in the cart. Helpful recommendations always work.
But, how to upsell when a customer has already decided what they need? Again, the best practice is to provide low-cost products as recommendations.
For example, If a customer has already purchased a $100 product, adding another $20 or $30 to it is easy, but do not ask them to buy an additional $100 product.
Offering related products is another upselling method. For example, if your customer buys a phone, you can offer a phone cover or other accessories as upselling. Another example can be to upsell for a discount, ensuring that if they buy a second product of the same value, they get an additional discount on the full order value.
Introduce a Loyalty Program
Setting up loyalty programs or incentive programs like cash back, gift cards, and earning points to get gifts can be a huge motivator for the customers to buy more from your store.
Loyalty programs succeed because they are easy to use, incentivize customers to purchase more and keep them hooked to your brand.
2. Gross Margin Return on Investment (GMROI)
Gross Margin Return on Investment is the amount of money you receive (i.e., ROI) for every dollar spent on Inventory. It tells you how much profit you have made from the money you invested in your stock.
To figure out the GMROI, divide the gross margin with the average inventory costs:
Gross Margin / Average Inventory Cost
The gross margin is a business’s net sales revenue minus the production costs.
For example, an eCommerce business has a gross margin of $60,000 and an average inventory cost of $30,000; the GMROI is 2. It means that the company earns $2 for every dollar in Inventory.
A ratio above one means that the business sells its products for more than its costs, and the company is going in the right direction. Conversely, a GMROI ratio of less than one signifies you are losing money.
Why should you care about GMROI?
GMROI measures how efficient your retail operations are in turning Inventory into profits. It is one of the most important metrics in eCommerce, and it allows business owners to see if they’re making an appropriate amount of money off their customers’ purchases.
Once you’ve calculated your GMROI, you can take the following actions to improve it:
- Work on decreasing the cost of goods sold (COGS); see what can be cut out in costs, like workforce, employees, and materials. Lower costs mean increased ROI on sales.
- More careful management of markdowns.
- Increasing your gross margin will generally increase your GMROI because there are fewer costs to recoup. An excellent way to do this is by increasing pricing without decreasing quality.
3. Inventory Turnover Rate
Inventory turnover rate tells you how well an online store generates sales from its Inventory. This metric measures how many times a company sells or turns over its Inventory during a set amount of time, usually one year. This key metric tells you about both supply chain efficiency and overall business health.
A low turnover means too little sales and maybe extra Inventory, and a faster turnover ratio implies a lot of sales or not enough stock.
A business would strive to keep a higher inventory turnover rate because it means reducing the capital tied into Inventory and at the same time improving cash flow. In addition, a high inventory turnover rate reduces the possibility of goods damage, spoilage, or technological obsolescence.
Here’s how you can calculate the Inventory turnover rate:
Inventory Turnover Ratio = Cost of Goods Sold ÷ Average Inventory.
Here is a practical example of a company, Target. The table below shows the average inventory costs and cost of goods sold with resulting inventory turnover ratio:
The inventory turnover ratio is calculated as follows:
$46,872,000(Cost of Goods Sold) / $8,455,000 ( Average Inventory) = 5.54
It showcases that within a year, Inventory was replaced 5,54 times. It is possible to compare the inventory turnover ratio with similar businesses in the same niche and see which business or eCommerce is more effective in selling its Inventory or overstocking.
How to use the inventory turnover rate, and why should you track it?
- It measures how efficiently Inventory is managed.
- A higher ratio is better and indicates fewer costs in terms of storage.
- A low ratio tells you to improve sales, remove excess Inventory, or that you have inefficient inventory management to sort out.
- Sometimes, it is possible to determine a company’s liquidity using the inventory turnover rate.
The inventory turnover rate is an essential metric for any company, and it’s not just because you can use it to track the health of your business.
It also provides insight into what products are earning money for you, which means that if one product doesn’t seem to be doing well in this regard, then maybe that’s why you’re finding your business’s profit struggling.
4. Days Sales in Inventory (DSI)
Days Sales in Inventory (DSI) measures the average number of days for a business to convert its stock into sales.
The DSI is calculated by dividing the inventory balance by the cost of goods sold (COGS). The result is then multiplied by the time taken into consideration, in days, years, quarters, or months.
A smaller DSI value is better since it indicates how long your business’s cash is tied into Inventory. A smaller number would tell that the eCommerce business frequently sells off its stock, leading to potentially higher profits.
On the other side, a more significant DSI value indicates either you struggle to sell Inventory or you’ve invested too much into stock.
DSI values can vary a lot between industries. Therefore, values should be compared with other businesses in the same niche.
For example, automobile and furniture DSI would be very different from an industry where products are perishable. Thus, Inventory was moving out and replaced at a higher rate.
Why does DSI matter?
DSI put a business efficiency in turning Inventory into sales in terms of days, providing a more accurate picture of the company’s inventory management health and overall productivity.
eCommerce business owners can decide whether to invest more into Inventory and compare the business’s efficiency with competitors evaluating how good they are doing in the market.
5. Cost of Goods Sold (COGS) per Unit Sold
The cost of goods sold is the cost of producing the goods sold by a company, and it includes the costs of materials and labor that went into creating the products. Thus, it is also referred to as “cost per sale.”
Here is the formula to calculate the cost of goods sold:
(Value of Beginning Inventory + Cost of Goods or Purchases) – Ending Inventory = Cost of Goods Sold
The value of the beginning Inventory is the stock’s value at the beginning of the year. The cost of goods is the cost of any product bought or produced during the year.
For example, an eCommerce business sells bracelets. To find the cost of goods sold, it is necessary to find the value of Inventory at the beginning of the year and then the cost of producing the bracelets throughout the year (raw materials, labor costs, shipping or freight costs, sales force costs, cost of parts used to make a product, supplies used in either making or selling the product, utilities for the manufacturing site, etc.)
The value of the company’s ending inventory is subtracted from the beginning Iinventory’s value and costs.
Why should you track COGS?
COGS is important to track because it is subtracted from a company’s income to determine the profit. Therefore, only the actual profit with COGS in consideration will tell if the eCommerce business efficiently manages workforces, supplies, and production.
Additionally, knowing about your business’s COGS helps managers and investors estimate the company’s net profit. For example, when COGS increases, net profit will decrease.
Companies try to keep COGS as low as possible to increase profits.
6. Net Profit Per Unit Sold ($)
The overall net profit for an eCommerce business is the amount of money it earns from selling its products after paying all the expenses. But, we want to calculate the profit for selling a single unit. For example, it will help determine if you need to raise prices or keep the current prices.
To calculate the net profit for a unit sold, you have to do the following:
(Total Revenue – Total Expenses) ÷ Unit sold
For example, an eCommerce business sold 30 pairs of shoes within a month for $50 each. Then the total revenue is $1500. The total expenses of the eCommerce business for the same month are $600 between the purchased Inventory sold, advertising, utilities, supplies, income taxes, and other costs.
Therefore, the net profit per unit sold would be: $1500 – $600 ÷ 30 = $30
When you have the profit per unit as a metric, you can price your products better. In case of negative profit, that is, expenses higher than the revenue, it is evident that the price is too low, or there are too many discounts that you can remove.
eCommerce businesses need to know the net profit for a unit sold to manage price and make money online, reducing expenses.
8. Item Fill Rate
An item fill rate is a ratio of what a customer has ordered and how many items have been delivered through immediate stock availability, without lost sales backorders or other incidents.
It is calculated in this way:
Total Number of Customer Orders Shipped / Number of Customer Orders Filled) * 100
For example, a customer places an order of ten products. If all ten items are delivered, the item fill rate is 100%. In case only nine products are provided, the fill rate is 90%
As a business owner, tracking the item fill rate is vital to prevent lost sales through customer complaints and maintain excellent customer relationships.
What is the correct item fill rate? Most businesses keep their rate at 85-95%, and the best-performing companies reach 98-99%.
Why should you care about the fill rate?
- It tells you about the relationship between you and your consumer. For example, do you meet customers’ demands or make them wait, eventually making them go to competitors? Or are you reliable for them to keep coming back?
- It tells you how well your Inventory is being managed. The stock is kept up to date with the most relevant information and can predict customers’ demands by checking the item fill rate.
- Avoid losing sales and money due to understock.
Some of the biggest eCommerce platforms lead the industry because they have the right metrics to check where they are constantly heading. Your eCommerce store is no different.
With the proper inventory management tools and systems in place, you can track all the crucial metrics and keep your eCommerce business’s health in check.