Understanding the Types of Inventory Management

Have you thought about your inventory process lately? If you’re particularly plugged into the day-to-day, it’s likely you know every pain point in the warehouse: overstocks, stockouts, stagnant products, high-demand products on back-order.

If you’re struggling with inventory woes, it’s time to consider how leveraging the different types of inventory management can solve them.

Sorting through the Different Types of Inventory Management

With each type of inventory management comes different workflows, risks, and benefits — which are often dictated by the industry, the size of the business, and the way a supply chain operates. In understanding each way to manage inventory, it’s possible to optimize your business functions and implement the best solution to maximize growth.

Inventory Tracking Methods

ABC Analysis

While the more sales inclined may see ‘ABC’ and think “Always Be Closing,” in the case of inventory management, ABC analysis is all about grouping inventory by their costs and demand. While this serves as a necessary method of inventory management, it’s also helpful for accounting for costs and risks.

• A-Class inventory: This group tends to feature high costs and high demand, requiring tighter controls on how (and when) these items move through the supply chain. A-Class Inventory requires the most detailed tracking and record keeping as well.

• B-Class inventory: This group falls into the moderate cost and demand category. The inventory here is still important, and more costly than C-Class inventory, but generally moves more freely through a supply chain. Tracking and record keeping are still important with these items, but less detailed.

• C-Class inventory: Following the pattern, this inventory group has the lowest cost and has the lowest impact on the business. C-Class items move far more easily through the supply chain with minimal record-keeping and control over when they move. They also make up the bulk of a company’s inventory.

More generally speaking, typical ABC analysis follows the 80/20 rule; in this case, it looks like:

• Up to 20% of your inventory should fall into A-Class
• Up to 30% of your inventory should fall into B-Class
• Up to 50% of your inventory should fall into C-Class

These ratios will fluctuate slightly between industries, but also with the state of the economy. Nonetheless, ABC analysis is particularly useful for businesses that feature a large amount of inventory that also have clear value delineation.

Consignment Inventory

While functionally different than utilizing a consignment shop, the principle is similar:

Consignment inventory is a system where a seller or retailer sells a product owned by a supplier. This allows a seller to have lower overhead by not needing to house the stock they sell, while enabling the supplier to hold onto their goods until they’ve sold.

In this inventory model, consignment also enables relationships between multiple sellers, as the supplier would actively update its available inventory. The benefit of this form of inventory management is that it minimizes the overhead for a business functioning as the seller in the consignment relationship. However, it can cause unintended rigidity in your business, as inventory management is completely dependent on the supplier.

Perpetual and Periodic Inventory Systems

Perpetual and periodic inventory systems embody the divide between “modern and traditional” inventory tracking methods. One is only possible because of the efficiency offered by software tracking solutions, while the other is the time-tested, “back in my day” approach.

With a perpetual inventory system, software and other tech solutions are used to update inventory amounts in real time. Once the purchase is complete, the system is updated to reflect the impact of the sale on available inventory. Perpetual systems are perfect for retailers and other businesses that have large or highly varied inventory. A perpetual inventory system is also encouraged for most businesses — this type of software solution is integral for enabling scalability and growth.

On the other hand, a periodic inventory system is a method that only tracks inventory after a set period (such as monthly or quarterly). This is a low-cost inventory solution that relies on counting by hand and updating inventory numbers in a spreadsheet or basic inventory tracking software. For businesses with small inventories or specialized retailers, this is perfect for keeping a closer eye on which items are moving in and out.

Safety Stock and Specific Identification

Safety stock is extra inventory that acts as a backstop in case of unanticipated demand, delivery delays, or ordering mistakes. While it requires more up-front financial risk, it can pay off in periods of instability where customer demand is unexpectedly high or a business’s supply chain is disrupted. While safety stock can end up resulting in “overstocking” in the event of poor sales trend forecasting, modern tools such as predictive analytics can limit or even eliminate such a result.

A specific identification tracking system is used for unique or low-inventory products with higher prices (such as cars, furniture, art, specialized technology or hardware, etc.). This is particularly helpful with accounting as specific identification systems also granularly track fees associated with the tracked inventory.

Vendor Managed Inventory (VMI)

In contrast to a consignment inventory system, a VMI system functions by selling the retailer goods, in addition to managing the inventory supply chain — allowing the retailer to focus on the sales while the vendor prioritizes managing the inventory.

The VMI approach is a more risk-balanced solution than consignment, as the vendor benefits from having consistent, repeat customers. As long as the seller is able to accurately track sales and provide high-quality customer data, both parties are able to maximize their profits over time.

Inventory Accounting Methods

In addition to the inventory management systems discussed above, there are three inventory accounting methods that businesses use to ensure their businesses remain profitable in the long-run. These methods are put to use in businesses whose inventory is made up of similar products, predictable items, or raw materials.

• First-In, First-Out (FIFO). FIFO is an inventory accounting method that encourages the movement of the oldest items first. This conversely means that new products are moved out last — with the added benefit of giving a more accurate calculation of the Cost of Goods (COGs) a business has since newer products have a tendency to cost more (when accounting for inflation or changes in the supply chain that influence cost). FIFO is utilized in most industries but is most important for businesses working with perishable goods. If you want to learn more about how FIFO is calculated, check out this guide by Investopedia.

• Last-In, First-Out (LIFO). Lifo is an inventory accounting method that encourages the movement of the newest items first. For most industries, using LIFO to calculate COGs would be inaccurate. However, for businesses that deal with rapid depreciation of goods, such as car dealerships, LIFO is the best way to maximize profits — while keeping the COGs low. If you’d like to get a better understanding of the LIFO process, check out this guide from Freshbooks.

• Weighted Average Cost. Calculating the weighted average cost is a fantastic way to figure out, generally, how much your business may be spending on inventory every quarter and year. Since this system is purely for accounting purposes, it can be utilized with ANY of the inventory management systems we’ve discussed so far (including FIFO and LIFO approaches, since they mix management and accounting). Since this isn’t the best place to talk about hard numbers and formulas, you can check out this resource from the Corporate Finance Institute that gets into the details of weighted average cost.

How Software-based Inventory Management Solutions Grow Retail Businesses

As your retail business grows, your inventory management capabilities should too. This means you’ll need a software solution that sets your business up to effortlessly scale, while remaining flexible and adaptable to market conditions.

This is what we think you should look for in your next inventory management solution:

• Streamlined processes and real-time data. Managing your inventory should be a breeze — it ought to have a simple UI that minimizes errors while providing accurate, real-time data. It should also have the tools needed to reduce the amount of time needed to perform daily tasks, translating to higher productivity, which acts as a net benefit for your business.

• Simple integration. An increasing number of inventory management solutions are API-enabled, meaning they can easily slot into your business without having to make drastic changes to the way you operate. Because of the lower overhead with an API-enabled solution, you’ll see the benefits of integrating even faster.

• Direct impact on customer satisfaction. Your new inventory management solution should also enable you to have the products your customers adore available when they need them most. This is accomplished through both predictive analytics (for AI-driven solutions) and automating restocks to help reduce instances of popular items being left off the order sheet.

Top 3 Tips for Addressing Common Inventory Management Challenges

Operating e-commerce and physical storefronts can come with a number of challenges that are difficult to overcome without the right tools. The most common issues come from stocking problems, supply chain interruptions, and correctly identifying customer wants and needs.

If you’re also struggling with these in your business, these tips may be helpful for getting you back on track and successfully growing.

#1 — Utilize both traditional and software inventory management systems to eliminate stockouts and overstocks.

Going fully digital with your inventory management is fantastic for scaling up your business and enabling flexible growth. However, one of the more detrimental effects of scaling up is losing touch on “smaller” issues, such as inventory shrink and stockouts.

When you implement a modern inventory management solution, you’re going to have many tools at your disposal to keep orders coming on time, and lower the possibility of an overstock… but faulty data is faulty data. If shrink (missing or damaged product that isn’t accounted for in the system) happens consistently, you may end up being out of stock on an item your system thinks is in stock — cascading into a series of headaches you don’t want.

This is why it’s important to periodically manually confirm inventory numbers, especially for high-demand products.

#2 — Leverage automation to reduce or eliminate supply chain delays and order processing issues.

Supply chain delays and misprocessed orders can dramatically slow down your business and halt productivity. Most of the time, this comes from complex workflows or human error. When these issues continue to crop up, it may be time for a headless ERP equipped with an inventory management module.

The best solution for tackling these issues is taking some time to refine the old workflows and streamline them into more easily repeatable steps. Once this is done, your inventory management system may be able to automate these tasks to ensure they activate exactly when they need to — freeing up time for high-ROI workflows.

#3 — Integrate predictive analytics to make sense of customer purchasing trends.

AI-powered tools are the future for scalable business solutions, and with them comes unprecedented potential to grow your business. One of the biggest issues plaguing inventory management is determining overarching sales trends and predicting the items your customers may desire next.

By leveraging predictive analytics — enabled by AI integrations within your management software — you can get real-time reporting about your customers’ past and present behaviors, along with detailed reports about trends you might have missed in your sales data. Adding these invaluable insights to the rest of your data analytics can paint a more detailed picture of your business and lay out a path for you to leave your customers satisfied and excited to purchase from you again.

Implementing a Scalable Inventory Management System: What You Need to Know

Deciding which type of inventory management solution is right for your business might feel a bit overwhelming right now: price, accessibility, features, integrations, and scalability are likely top of mind. Thankfully, you’re not alone in figuring out your next steps in this decision process.

• Speed up your process with AI. Consider leveraging tools like ChatGPT or Perplexity to help you search out which inventory management systems might be right for your business. You can include information about your budget and business goals to help refine your search and narrow down a list of contending solutions.

• Refrain from constraint. Some solutions may fit the budget but not fit your long-term needs. Likewise, certain solutions aren’t designed to be scalable, flexible, and seamlessly integrated into your business. With the future in mind, make sure you’re investing in your business — not just checking a box off a list.

Once you’ve settled on a product you think would fit in your business, take a few minutes to make some additional considerations:

• Is the system scalable? Scalability and flexibility should be your number one priority. The system you choose should not only meet your needs in the present, but also open up possibilities for how your business could change in the future. In some cases this may mean choosing a headless ERP system with an inventory management module.

• Does the system include AI functionality? With AI-driven tools leading the charge for both innovation and productivity, having an inventory management system that provides predictive analytics is a must.

• Will it easily integrate with your tech stack? The other major factor you need to consider is whether or not the inventory management solution is designed to work alongside other parts of your tech stack. This is another area where a headless ERP would be an excellent fit — as an API-enabled inventory management solution could easily integrate with your other API-enabled tech solutions.

Making Your Inventory System Work for YOU

With so many products out there to choose from, we’re going to make it easy for you:

Our headless ERP solution is modular, API-enabled, and AI-driven. We can create the perfect ERP solution for your business that not only meets your inventory management needs, but can help with omnichannel order management, light-manufacturing (production management for businesses that have manufacturing elements but specialize in retail), cost accounting, and more.

Because our ERP solution features a decoupled user interface (UI) and backend, integrating your existing API-enabled tech stack is a breeze — meaning you could keep your CRM, POS system, and HR software as well.

Solve your inventory management for good. Schedule a demo today.