Better Orders, Bigger Profits: The Costs You Can Control

Have you ever seen a tightrope walker perform? It’s an impressive feat of balance, strength, coordination, and showmanship. Like tightrope walkers, wholesale buyers also walk a fine line when buying inventory. Costs, profits, and order quantities are connected, and buyers are under pressure to find the right balance. Why? Because buyers control how much inventory is ordered and how often.

Sales Generate Revenue but Buying Right Creates Profit

Many businesses with regular loyal customers have failed because they didn’t understand the balancing act between inventory, costs, and profits. Consistent sales often equal success on the surface, but sales alone can’t sustain wholesalers or retailers forever. Buyers need to optimize inventory orders so their companies aren’t losing money.

Order quantities have a direct impact on costs. More inventory increases costs, and higher costs lead to smaller profit margins. This fact is well known, but balancing inventory to maximize profits is an age-old challenge for retail and wholesale companies. Here are some better buying practices that will lead to bigger profits.

Some companies believe that to maximize profit, you need to maximize turns. There are some myths in the distribution industry masquerading as best practice. Focusing on inventory turns is one of them. Banks use inventory turns as a metric to determine if companies are safe borrowers. Wholesalers shouldn’t focus on turns alone. Doing so often leads to higher handling costs, not higher profits.

Also, you must forego economic order quantity (EOQ) optimization to maximize turns. EOQ is a cost-balancing equation to decide between buying in bulk or buying smaller, frequent orders. Larger quantities come with reduced handling costs, and vice versa. In addition to ignoring the benefits of EOQs, maximizing turns also causes you to miss out on any potential discounts when buying in pallet quantities.

When buyers control inventory, they control costs that directly increase or decrease profit margins. Sometimes, buying a whole pallet or a full truck is not optimal. Forcing buyers to fill a truck with every order could cause serious negative consequences. One of our customers learned this lesson the hard way.

At first, this client did not buy at a full pallet discount from major suppliers. However, they believed it would make sense to buy this way because they would get the maximum discount possible on everyday purchases. It also enabled them to stay price-competitive in their market. However, the buyers couldn’t place an order to fill up a truck within weeks of this new policy. Here’s why.

A pallet of fast-moving items could last them a day or so. But they ended up with months of inventory for the slower-moving items after only a few order cycles. As a result, inventory quickly piled up and they ended up building an additional warehouse after six months even though their amount of business was the same.

With thousands of SKUs and dozens—and potentially hundreds—of vendors, buyers are often overwhelmed trying to calculate the best time to replenish inventory. To solve this, some companies order from vendors on a fixed schedule. This method is restrictive and makes it difficult to meet service levels.

Years ago, my father, Anders Herlitz, worked with a profitable company that realized they were starting to lose money. Yet, there wasn’t an obvious reason for the loss. Anders eventually realized the company started an aggressive backhauling program. This means they were sending a truck to a customer, and then stopping at a vendor on the way back so the trucks weren’t returning empty.

It sounded efficient, so they put nearly every vendor on fixed schedules based on their customer delivery routes and other variables. This created self-imposed restrictions. Yes, they were maximizing freight efficiencies. However, they were creating suboptimal conditions for just-in-time (JIT) ordering. The result? They were 30% or more overstocked and couldn’t hit customer service levels.

It is best to have a powerful purchasing system, like HIMPACT, that determines when to order based on actual sales. This is the only way for buyers to maintain consistent and high service levels.

Ordering in bulk or by the pallet unlocks a higher discount than ordering by the layer. Sometimes these savings are significant and can help you be price competitive. A costly drawback to bulk ordering is the potential to end up with too much inventory if you forecast incorrectly or apply this buying policy without careful consideration. This ties up capital and increases costs. Buyers should be careful and ensure they know the real costs of buying in bulk.

We’ve seen this happen many times over the years. Clients get excited when a vendor is offering a 4% discount. Their instinct is to take advantage of the discount. The cost of carrying and holding that excess inventory does not always lead to greater profits though. HIMPACT has a built-in function to solve this problem, which we’ll discuss more in the Order Policy Analysis section below.

Safety stock is a buffer against consumers not buying to the forecast and vendors not delivering on the promised lead time. Safety stock varies in any warehouse based on these factors. Many consumers purchase “A items” consistently. As a result, demand becomes more stable. That means you don’t need much safety stock for these faster-moving SKUs.

For slower-moving items, there is a smaller customer set. This often leads to larger swings in demand. If you want to run slower-moving items at the same service level as other items, you must have more safety stock on hand.

There isn’t an exact service level that fits every type of company, though. The safety stock and average outbound fill rates change for each industry we serve. See the general ranges below for each industry:

• Foodservice: 99.1% – 99.4%
• Wholesale Grocery & Pet Supply: 93% – 98%
• Beer, Wine & Spirits: 97% – 99%

What’s important for wholesalers is to understand how their customer service levels impact their business, and what levers they need to pull to maintain those goals or change them if conditions change.

1. Order Policy Analysis

When looking at the seven steps of buying, order cycle analysis is the first area where wholesalers have any control. You can’t control demand or lead time, but you can determine when the most profitable time is to buy based on all the variables and constraints you are up against.

Order Policy Analysis simulates the most profitable number of days of supply you should be ordering when you place a PO. In essence, the OPA simulator drives profitability. It shows that buying a full truckload at a 4% discount might be less profitable than buying half a truck at 2%. In some cases, it could be more profitable to forego all discounts and buy one mixed pallet once per week while paying for freight at the LTL rate.

HIMPACT will always show you the difference between real-world constraints and what is optimal. For example, say it is most profitable to order from a certain vendor every 11 days. Yet, the vendor’s order minimum of 5,000 pounds forces you to order every 15 days instead.

Those extra days may cost you $1,200 per year. That information would be nearly impossible to find for every vendor without a tool like HIMPACT.

You can take these findings back to your vendor and see if they will accept a lower order minimum so you can order when it is most optimal for your business.

2. Service Level Analysis

Another profit-maximizing tool in HIMPACT is Service Level Analysis. SLA recommends the most profitable service level for every item at every warehouse or store location. It also shows the difference in profit between the current service level and the HIMPACT recommendation. Then, with one click, buyers can set the new service level strategy for hundreds or thousands of SKUs.

3. Convenience Packs

When coming in or out of a season, HIMPACT dynamically changes the buying multiple for any seasonal items. Maybe during most of the year, you only need to buy a layer of inventory, but as that product comes into season, you want to start ordering it by the pallet. Convenience packs enable buyers to automatically increase order quantities right before the season hits and then decrease orders at the tail-end of the season so you don’t end up with excess inventory that will spoil or need to be held until next season.

Maximizing profits starts by controlling what can be controlled, avoiding hidden costs, and buying at the right time. Does your current ordering process involve hours of manual labor, fixed vendor schedules, or other constraints? Schedule a call with our team today. We can help evaluate your current process and determine what inventory management tools in HIMPACT are right for your needs.