A lot of factors go into placing a purchase order. The biggest factors include forecasted demand, vendor lead time and order frequency. These factors all get mixed together into a probabilistic soup to produce an order quantity. This process can be automated or manual, but the calculation must ultimately consider how much you can control all of these factors when arriving at an order quantity.
Based on what you can and can’t control, here is a tip that is counter-intuitive. You will actually save more money by increasing your inbound cost-per-unit.
Let’s break down what that means:
- Forecasted demand is a prediction of what customers will purchase in a future time period. During a time of uncertainty this input is very difficult to predict. The factors driving customer behavior during this pandemic and holiday season are unprecedented.
- Vendor lead time is a prediction of how long it will take your supplier to deliver your goods. This is also unpredictable because the upstream supply chain has similar volatility with manufacturers and suppliers.
- Order frequency is how often you are cutting purchase orders. When you increase the frequency of ordering, you order for a smaller period of demand because the next order comes in less time. Unlike the other two factors, order frequency is something that you have complete control over and is very predictable.
Like most logistics puzzles, you benefit most by putting energy into what you can control. Given the reality of the world right now, it is very unlikely that demand or lead time will be predictable. That is why right now is the perfect time to look at increasing your order frequency to give yourself more opportunities to change your decision.
A simple example of adjusting order frequency
For example, let’s assume you are doing a normal best practice of monthly procurement to get a volume discount and lower cost-per-unit on shipping. The order is based on a normal projected demand of 100 units per week for this hot product. The vendor lead time is typically four weeks.
Except it turns out that demand has really dropped because of the global pandemic. There is uncertainty everywhere. A couple days after the order is placed, it becomes clear that you are no longer going to sell 100 units a week, but you have already placed the order and 400 are on the way.
Because of this, you will exit next month with 280 extra units of inventory. The type of inventory will determine the severity of the miss (medicine vs. batteries, for example). From a modeling point of view, however, the excess inventory adds risk to the business because you tied up cash in assets that aren’t usable. Throughout the pandemic, cash has proven more valuable than inventory.
Focus on what you can control
Think about de-prioritizing volume discounts and increasing order frequency to something closer to a weekly cadence.
Let's look at what would have happened in this scenario if you were on a weekly order cycle.
In this scenario, you would have ordered only 100 units to cover Week 5 in the first order because you know that you will get a chance to order more next week for Week 6. Just like above, you place your order for 100 units, then immediately realize that demand is dropping. You order 20 additional units in Week 2 instead of 100. Forecast continues to drop, so in Week 3 and 4 you don’t place an order at all.
When the demand is uncertain, it is important to focus on levers that you can pull to give additional flexibility—in particular, the levers that help improve your cash position. The price breaks from placing monthly orders will land a huge amount of overstock. The smaller cost-per-unit amount wasn’t worth the cash flow problems you created.
While reducing the size of the orders will increase your inbound cost-per-unit, it gives you the flexibility to adjust to demand fluctuations which is a great way to improve your cash position.
Cash flow is the ultimate flex
During this holiday season, flexibility will prove to be one of the more important business conditions compared to years past. Between supply volatility, consumers having as many shopping choices as they have ever had, and how fast trends change, it will be critical that e-commerce businesses work on a weekly cadence.
The more flexibility you have on which SKUs you buy and how much you buy of them, the better you can navigate the current industry volatility. A little more of SKU 123 might be needed while a little less of SKU 789 will work.
Without cash in hand, that flexibility will be hard to find. Consider moving your purchasing and procurement habits to put the business in a better position to win this holiday season.