Owners of e-commerce businesses are probably asking themselves: is it possible to reduce inventory without affecting sales? Can you set up a virtual store without its own inventory? The simple answer is: yes!
When we analyze an e-commerce business that already has a volume of sales, inventory costs can be one of the culprits for margin and profit. This happens because, in the case of some segments, inventory coverage costs can be very expensive.
What is inventory coverage?
Inventory coverage is an indicator that shows us the number of days during which the availability of products meets future demands from sales. In other words, given current inventories, it will take X days for inventories to run out.
Calculating inventory coverage
Inventory coverage is quite simple and is represented by:
Coverage = Inventory / Average Sales
Let us suppose the following data:
Available inventory = 1,000 units
Average daily sales = 10 units
Coverage = 100 days
As we can see from above, an inventory of 1,000 units will last 100 days. In this case, this inventory will generate various costs for the e-commerce business over this period, such as storage, depreciation and insurance, among others.
The greater the inventory coverage, the greater the total cost for an e-commerce business to hold those inventories for sale.
The importance of inventory coverage
Inventory coverage and sales are intimately linked when we talk about e-commerce. There are two main factors behind this:
a) An e-commerce business has no physical location for displaying its products, since everything takes place on the e-commerce platform. Display capacity is almost unlimited. That is why it is common for store owners to opt for a huge product mix. And this is something clients demand. After all, who has never accessed a virtual store only to be frustrated because a certain product was not for sale or was no longer in stock?
b) One of the main factors for increasing e-commerce sales is to increase the flow of visitors to the store, and one of the strategies is paid advertising. In other words, investing in online advertising (to generate traffic, not to have the product, or similar products, available) can directly impact ROI and the conversion rate.
On evaluating these two points, we can see that, on the one hand, the higher the inventories of the virtual store, the higher the sales, the ROI and the conversion rate, and the better the client’s experience. But, from an operational perspective, higher inventories can mean higher costs, which can adversely affect profitability.
On the other hand, the lower the inventory, the lower the operating costs, even though this will probably mean lower sales, ROI and conversion rate, as well as a worse experience for the client.
The actual impact of inventory costs
Striking a balance between inventory coverage and sales is fundamental to increasing the profitability of e-commerce. However, in some segments this evaluation can be a decisive factor between closing down the business or being profitable.
According to the Brazilian magazine PEGN, of the 3 departments that most sell over the internet, two of them have high costs of goods sold (CGS): household appliances and mobile telephones.
In these two segments, well-managed stores reduce inventory coverage to between 25 and 40 days. Nevertheless, since the cost of the goods (CGS) is very high, so are total costs. Gaining one or two days can represent huge savings.
In other segments like fashion, where sales were greatest even with lower CGS than the others, the product is graded by size and color. This forces the storeowner to hold large inventories of around 180 to 200 days in the case of well-managed stores.
So, we can conclude that proper inventory management, in addition to reducing costs, can strike an ideal point of equilibrium that will increase the store’s profitability.
Later, we will look at some of the strategies that have arisen with the evolution of e-commerce.
How to set up a virtual store without its own inventory
Bearing in mind that the objective is to put together a virtual store with the lowest possible inventory coverage, since this leads to lower costs, or even with no inventory whatsoever, we need to be aware of several issues. Here are some of them:
Choose a favorable niche with fast production and resupply of goods, as well as simple logistics;
Try to develop a strong relationship with suppliers; after all, you depend exclusively on them to grow the business;
Do a full investigation into how those suppliers work: whether they meet deadlines, whether they have quality products, their pricing policies and, primarily, whether their staff work to organized routines;
Do a correct assessment of the cost of the goods to validate inventory coverage as one of the main costs;
Research within the store segment the ideal inventory coverage in days, so that the e-commerce business does not experience a loss of sales.
### Alternatives to setting up a virtual store without its own inventories will present several strategies that have arisen over time with e-commerce, and which are essential items for helping to reduce inventory costs, or to reach the point where we no longer need inventories to sell.
1. Cross docking
The simplest manner of working with inventory-free e-commerce is cross docking. Under this system, the store must work closely with the supplier, and whenever an order is placed, the supplier must be contacted to send the products.
In practice, consumers will make the purchase at the virtual store, which will request the goods from the supplier who, in turn, will dispatch it. When the goods are received, they should be checked and packaged for subsequent dispatch to the addressee. The advantages of this model include not running the risk of having products sitting around in inventory, as well as the fact that they will transit through the stores before being sent to the client. Many furniture stores employ this strategy.
However, when adopting this strategy, a couple of points need to be borne in mind:
- a) The delivery deadline could be long in comparison with other stores. So, assess the impact on sales if the deadline exceeds that of your competitors;
- b) Since the store will now purchase whenever it makes a sale, negotiation power and CGS could increase substantially.
Attention: since the product will be purchased from the supplier and sold on to the end-client, care is required so as not to overinflate the purchase price, resulting in a price that the market finds relatively unattractive.
2. Drop shipping
In the case of drop shipping, the supplier will be responsible for preparing and delivering the orders placed with the virtual store.
In practice, the supplier’s products are displayed on the store site, the client makes a normal purchase, and, after payment, the supplier is notified with details of the order so as to deliver it.
In this case, responsibilities are shared, and there is no need to worry either about inventories or the logistics of delivering the product. Another benefit is that the possibility exists of offering a good variety of products on the site; after all, they will not be purchased in advance.
This logic appears quite simple, doesn’t it? But, here are a few details for avoiding problems in the future.
Firstly, one needs to be aware that, although the supplier sends the product directly to the client, the store is responsible for that purchase, in addition to issuing the tax receipt and paying the taxes.
The recommendation is to work with suppliers you can trust, with whom you have good communications.
3. Combining the physical stores
The third strategy is for virtual stores that also have a chain of around 5 or 10 physical stores. This strategy consists of combining all the inventories of the physical stores into a single perspective for the e-commerce business, and it is one of the key omnichannel strategies.
When an order is placed, the e-commerce platform immediately identifies which store will be responsible for delivering that item to the end-client. If an order has more than one item for different stores, the system should be intelligent enough to discern this scenario.
In this model we need to draw attention to two points:
- a) The e-commerce platform must be sufficiently intelligent to deal with the scenario described above, while also having the flexibility to have invoices issued for each of the stores responsible for sending the product;
- b) When this strategy is implemented, there must also be an arrangement with the sellers. If the virtual store is selling the only product available in the physical store, and it has been sold, the seller cannot show that product to a client. It is very important to implement clear rules for the sellers, or even in cases involving different commissions.
Another, somewhat more daring possibility, is to expand the operation of the virtual store to a marketplace.
A marketplace functions almost with the same logic as a traditional e-commerce business. In other words, one can find a variety of products, make comparisons, check out categories and conclude the purchase.
The difference is that responsibility for the inventory and the product does not lie with the marketplace, but with the base virtual stores, usually smaller ones, which registered their products for sale on that site.
The reality is that, nowadays, there is a series of technologies available for transforming a virtual store into a marketplace. So, if this idea is chosen, you just have to plan it thoroughly and find technological assistance for this task.
Therefore, as we have seen, it is possible to set up an inventory-free virtual store!