How to Improve Inventory Planning with a Bottom-Up Approach
Recently the eCommerce industry saw five years of growth in less than five months. And as a result, many direct-to-consumer brands have had the opportunity to seriously grow their brands and increase profits.
It's exciting. But to actually make this growth happen, you need to have the right amount of inventory on hand. That's where demand forecasting and inventory planning come in.
Many online retail merchants use a top-down forecasting method. But admittedly, the results are wildly inaccurate, tying up working capital (or financial resources) and stunting growth.
So, how should you be planning your inventory instead? From the bottom up.
Before we dive into how to plan inventory from the bottom-up, let’s quickly walk through:
- What is demand forecasting?
- What is inventory planning?
- The difference between forecasting and planning
- How to plan from the top-down and the bottom-up
- Why bottom-up methods are so much better
What Is Demand Forecasting?
Demand forecasting uses inventory levels and historical sales data to predict future customer demand for a specific product line. With this information, eCommerce brands can make more informed supply chain and inventory ordering decisions, allowing them to cut costs and increase profits.
Perfectly forecasting demand is impossible. However, you can increase accuracy by leveraging real-time inventory trends, such as inventory turnover rate and stock-to-sales ratio.
Traditional forecasting methods rely on spreadsheets, but this method uses outdated data that's stuck in a single moment in time. This means that the final forecast is more of a shot in the dark than a bullseye.
Luckily, you can promote these forecasts' accuracy by using a bottom-up approach (more on this in a bit). The final prediction will still be slightly off, but where other brands could be off by some 300 units, you can ensure your brand is only off by three.
With all that said, the best option is to ditch spreadsheets altogether and use an ops optimization tool like Cogsy to track these sales trends in real-time.
The platform uses that data to update the forecast each time new information is introduced. With every new tidbit that’s added, the final forecast becomes more and more accurate. As a result, your inventory planning will get smarter.
What Is Inventory Planning?
Inventory planning determines the optimal amount of stock needed to fulfill demand and reach your brand's revenue goals. This process starts with demand forecasting and ends with replenishing stock.
When done right, inventory planning ensures that your retail brand only purchases inventory that will sell. Doing so reduces costly mistakes like deadstock (extra inventory that won't sell) and stockouts (where you don't have any product to sell).
As a result, inventory planning:
- Reduces unnecessary holding costs and expenses
- Unties working capital that could better support other initiatives
- Keeps customers happy by having what they want in stock
To be blunt, your inventory plan is only as accurate as the demand forecast it's built off. Accurate demand forecasts consider past sales history, current stock levels, and real-time inventory trends to calculate how much stock people will want to buy (typically, in the next 3–12 months).
DTC brands can then use demand forecasts to calculate how much stock they'll need in order to fulfill demand. In other words, they can create their inventory plan, so they only order what they need.
Demand Forecasting vs. Inventory Planning
Many retailers wrongly assume that demand forecasting and inventory planning are the same.
They are not. Forecasting and planning are closely related business practices for commerce brands, where the prior informs the latter.
The purpose of inventory is to fulfill demand. But before you can calculate how much stock you'll need to do this, you need to first know what that demand looks like. That's where your demand forecast comes in.
Once you have a projection of how much customers will potentially want to buy from you, you can start building your inventory plan. This plan answers this question: How much inventory will my brand need to capture and fulfill all the potential demand?
Without first creating a forecast, inventory plans are often just guesses – and not educated ones. They also leave brands grossly over- or underestimating how much stock they'll need to order and when.
However, in most cases, you can just say “inventory planning,” and it’s understood that creating a demand forecast was involved somewhere in the process.
What retailers need to understand is that not all demand forecasts (and consequently, inventory plans) are created equal.
For instance, top-down methods are not as reliable as bottom-up methods.
What Is Top-Down Inventory Planning?
Top-down inventory planning assumes that your inventory and revenue have a linear relationship. Meaning it tries to match inventory plans to revenue growth rather than the other way around.
For example: Say you have an online furniture shop that made $1M last November selling 500 designer couches. This year, your goal is to make $3M in that same month.
The top-down approach assumes that if you want to triple your revenue, you need to triple your inventory. Based on this method, you'd order 1,500 couches.
The Problem with Top-Down Inventory Planning
The top-down inventory planning strategy fails to optimize your inventory for unit economics (or the revenue and costs of selling a single unit).
For instance, let's say the couch in the above example quickly becomes "last season," and sales only marginally increase. In other words, they seriously underperform compared to your predicted 300% year-over-year growth.
Because of this, you only sell 600 of these couches, and the other 900 units become deadstock.
In an ideal world, it wouldn't matter because you could take your time selling through this excess inventory.
But, in reality, the longer you hold onto these items, the more expenses you accrue. Deadstock costs 30% more than the inventory's value on average between administration, storage, insurance, and other costs.
So, when you finally do sell through this inventory, your margins are wrecked. As a result, your profits are much lower than anticipated, and you don't meet your $3M revenue goal.
What Is Bottom-Up Inventory Planning?
Unlike top-down inventory planning, the bottom-up method uses your demand forecast to determine the baseline stock levels your brand needs. Then, it cautiously layers key growth assumptions onto that solid foundation.
Brands that use the bottom-up inventory planning successfully carry less deadstock inventory, lower holding costs, and increase their net revenue.
Why Bottom-Up Inventory Planning Is Better
Bottom-up inventory planning relies on a few small assumptions that are statistically more likely to be true (like month-over-month growth and seasonality). Top-down inventory planning gambles with one big assumption that's rarely true: that inventory and revenue share a linear relationship.
As a result, bottom-up inventory planning is far more accurate. While a bottom-up forecast might be off by a few units, a top-down forecast might be off by a few hundred units (a much more expensive mistake).
Let's go back to the online furniture store example to prove this, but this time, let's plan from the bottom-up:
Based on your current inventory levels and current turnover rate, you determine that you need 503 couches to match last year's demand. The team confirms that the supplier can deliver the required units.
- The furniture brand has recently experienced a month-over-month growth rate of 8.78%. You adjust your forecast accordingly, from 503 units to 518.
- With your scheduled Black Friday and Cyber Monday marketing promotions, you expect this November to be a massive month for you. You layer in a multiplier of three, and adjust the forecasted units from 518 to 606 couches total.
As a result, the bottom-up plan is off by six units, whereas the top-down strategy is off by 900 (the latter is a much more expensive mistake). The furniture brand has almost precisely the number of couches it needs to meet customer demand.
With all that said, we realize this more accurate bottom-up approach to inventory planning can seem intimidating. But with the right ops tools (like Kimonix and Cogsy), it doesn't have to be.
Effortlessly Plan Inventory from the Bottom-Up
Kimonix is a holistic, AI-powered merchandising solution that automates how you sort, recommend, price, and promote products. With it, you get tons of data on what SKUs are fueling conversions and keeping customers coming back.
When you pair this with an ops optimization tool like Cogsy, you can plan inventory from the bottom up to ensure you always have these bestsellers in stock. Best of all, you can do it without needing to touch a spreadsheet.
With Cogsy, you can automatically turn your Kimonix data into:
- Accurate demand forecasts that factor in your stock levels, inventory trends, and historical sales data.
- Sustainable operational plans (calculated from the bottom-up) that hit your most aggressive revenue goals.
- Optimized purchase orders with automatic replenish alerts (so you always order at the perfect time to avoid a stockout).
Best part? Cogsy tracks all this in real-time.
All this means that if demand unexpectedly shifts, you'll know immediately and can quickly pivot your inventory plan accordingly.
Final Thoughts: Use Bottom-Up Inventory Planning to Grow Your Retail Brand
Keeping a pulse on your brand’s inventory levels and forecasted demand positions your brand for long-term, sustainable growth. It ensures you’re not accidentally tying up working capital in ways that could hurt your overall margins.
For really fast-growing brands, top-down inventory planning might be the best option. This is especially true if historical sales data doesn’t offer a real precedent for your brand’s performance this year. However, for most brands, bottom-up inventory is the way to go.
When choosing which methodology is best for you, remember:
- Growth often isn’t linear, so more inventory does not inherently mean more revenue.
- The SKUs driving growth will likely change over time.
- You only want to invest capital into inventory that will sell (and sell quickly).
By keeping all this in mind, you can ensure you’re investing working capital in opportunities (inventory or otherwise) that will help your brand grow better, faster.