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Overstock and Understock: Inventory Harmony

striking the right balance between overstock and understock is essential

  • Written by Tess Holman
  • Published on August 24, 2023
  • Time to read 9 minutes

Introduction

Maintaining the right balance of inventory is an age-old question in any business. Even though managing inventory on paper seems simple, it can be far more complicated than people expect. Two essential terms to understand when managing inventory are “overstock” and “understock.”  

In this blog post, we will define what overstock and understock are, what challenges they pose to a business, and practical solutions and strategies that businesses can adopt into their operations to find balance in their inventory.

Main Points:

  1. Overstock is having too much of a product. Understock is not having enough products to meet demand. 
  2. Overstocking’s main issue is that it can lead to cash flow problems.
  3. Understockins main issue is that businesses won’t have enough products to fill the demand.
  4. Many programs can be purchased and used to help with this problem.

Overstock and Understock Defined

A graphic illustration shows two rows of shelves, juxtaposed, one filled to overflowing, one almost completely bare.

Overstock means an excess of inventory beyond the demand. Understock means a shortage of products to meet customer needs. Both these scenarios can significantly impact a company’s profitability, customer satisfaction, and overall brand reputation.

Understanding the Dilemma of Overstock

Overstock occurs when businesses hold more inventory than needed to meet customer demands. This situation can arise due to various factors.  These factors include forecasting errors, inaccurate demand predictions, bulk purchasing, or overzealous stocking practices. Having some buffer stock is necessary to cater to unexpected surges in demand. However, excessive overstock can lead to several adverse consequences, including:

  1. Capital Tie-up: Overstocking ties up cash that could have been invested elsewhere. In turn, this can hinder business growth.
  2. Increased Holding Costs: Storing excessive inventory incurs additional holding costs, such as warehousing expenses, insurance, and depreciation. Consequently, this further dents the company financially.
  3. Risk of Obsolescence: Over time, unsold excess inventory can become outdated or obsolete. This results in potential write-offs and losses.
  4. Reduced Cash Flow: Overstocking can lead to cash flow constraints, as money remains tied up in inventory. Consequently, this leaves little room for other business expenses.

Reducing Overstock Challenges

To avoid the pitfalls of overstock, businesses should adopt measures and focus on optimizing inventory management. Here are some effective strategies:

  1. Accurate Demand Forecasting: Investing in advanced demand forecasting tools and techniques helps businesses predict future demand patterns more accurately. In turn, this helps them to adjust inventory levels accordingly. Some selling platforms, like Shopify, have tools that are included in their basic plans that can be used. They also have add-on apps that offer very robust predictive analytics.
  2. Real-time Data Analysis: Utilizing data analytics and business intelligence tools allows companies to monitor sales trends, track inventory levels, and make data-driven decisions in real-time.
  3. Implementing Just-in-Time (JIT) Inventory: Embracing JIT inventory practices reduces the need for excessive stock.  Products are ordered and delivered precisely when needed, minimizing holding costs.
  4. Adopting Vendor Managed Inventory (VMI): Collaborating with suppliers to manage inventory levels can improve coordination and reduce overstock situations.

Understanding the Challenge of Understock

On the other hand, understock arises when businesses fail to meet customer demand due to insufficient inventory levels. This situation can occur due to conservative stocking practices, unforeseen demand surges, supply chain disruptions, or delays in procurement. Understocking can have equally severe effects on businesses:

  1. Lost Sales Opportunities: Insufficient inventory may lead to customers seeking alternatives from competitors. Consequently, this results in lost sales opportunities and potential long-term brand disloyalty.
  2. Damaged Customer Relationships: Failing to fulfill customer orders promptly can lead to frustrated customers, weak reputations, and negative word-of-mouth.
  3. Missed Revenue Targets: Understocking can prevent businesses from capitalizing on potential revenue. In turn, this impacts their financial performance.
  4. Increased Expedited Shipping Costs: Businesses may resort to costly expedited shipping options to fulfill orders quickly during understock situations. Additionally, this can further erode profit margins.

Strategies to Overcome Understock Challenges

Understocking situations are best avoided by using the following strategies:

  1. Safety Stock Planning: Establishing a safety stock buffer can help businesses bridge the gap between forecasted and actual demand. This practice can safeguard against unplanned changes.
  2. Collaboration with Suppliers: Building solid relationships with suppliers and ensuring transparent communication can lead to quicker buying of goods and reduced lead times. Ultimately, this minimizes understock occurrences.
  3. Inventory Automation: Implementing inventory management software with automation features enables businesses to track inventory levels in real-time and set up automatic reordering triggers.
  4. Adopting Omnichannel Fulfillment: Embracing omnichannel fulfillment strategies allows businesses to leverage their entire distribution centers and stores network to fulfill customer orders. Consequently, this reduces the risk of understocking at any specific location.

Finding the Balance: Inventory Optimization

A graphic illustration depicts vital aspects of balancing inventory

Businesses must strike a balance between overstock and understock. This is known as inventory optimization and involves using technology and data analytics to maintain the right inventory level for each product.

  1. ABC Analysis: Adopting the ABC analysis method divides products into different categories based on their contribution to revenue. This categorization helps businesses allocate inventory resources more efficiently.
  2. Economic Order Quantity (EOQ): Calculating the EOQ helps businesses identify the ideal order quantity that minimizes holding and ordering costs.
  3. Seasonal and Promotional Planning: Understanding seasonal demand and planning for promotional events allows businesses to optimize inventory levels during peak periods.
  4. Continuous Improvement: Inventory optimization is an ongoing process. Businesses should regularly review and refine their inventory management strategies to adapt to market changes and customer demands.

Conclusion

In conclusion, striking the right balance between overstock and understock is integral to successful inventory management. Both scenarios can have consequences for businesses. They can affect profitability, customer satisfaction, and overall brand image. By embracing data-driven demand forecasting, real-time analytics, JIT inventory practices, and strategic safety stock planning, businesses can optimize their inventory levels. 

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