Outsourcing inventory management
Any successful retail or manufacturing business needs inventory management. But you don't have to do it all in-house.
Simplifying your inventory
If you run a retail or manufacturing business, you'll know about inventory management. You'll understand that it can be part science and part art, because it's hard to predict future demand based on past sales. Yet the success of your business depends on getting this right. Your sales forecast should be tied to your inventory management to ensure you don’t:
- overstock and get stuck with excess inventory (which you will have to figure out how to get rid of by discounting or giving away)
- run out of inventory (which will lead to lost sales opportunities)
But that's just part of the problem. Storing, moving and delivering inventory can also be complex, time-consuming and expensive. This can be a drain on your time and resources. It can also make it hard to scale up your business.
That's why some businesses choose to outsource some or all of their inventory management. In this guide we'll look at what that involves and see if it might work for you.
What could you outsource?
Inventory management is a big part of doing business as a retailer or manufacturer. Five of the most important steps are:
- predicting which items you'll be selling or using in the short to medium term
- ordering or manufacturing the right amounts at the right time
- organizing storage and rotation of inventory or raw materials, and managing warehouse space
- training staff to manage stock or raw materials
- organizing and fulfilling distribution and delivery
Number one is often best done in-house, since you and your key employees understand your business well. You can decide where your business is going, which products will sell well and which won't.
Good POS software will help you here, and so will analysis of your accounts and receipts. (Read our guides about POS retail software and efficient inventory management systems to learn more). Bear in mind that your knowledge in this area is partly what gives your business an edge.
But it's a different story for the other four steps. Many businesses do outsource some or all of these elements of inventory management. Could that work for you too?
Who can help?
Let's say you manufacture and sell a certain type of widget. Your widgets might all be identical, or you may have just a few different product lines. They are small enough to be sent via parcel mail, and they are non-perishable.
You could store these widgets in your own warehouse. That would mean allocating space, tracking each item, handling orders, and all the other work listed above. Alternatively, you could arrange for another company to do this for you. Then you'd just need to:
- decide what to make, and how many units
- send those units to the outsourcing company whenever they're finished
- let the outsourcing company do the rest: storage, packaging, delivery, order tracking and reporting
This type of outsourcing is sometimes called fulfilment outsourcing. It can eliminate a lot of hassle, leaving you free to concentrate on your core business.
But what if you want to outsource even more of your inventory management? If you're running a retail business, you can do that too.
A drop ship company is a wholesale organization, or sometimes a manufacturer. They can handle the entire inventory management process for you.
Once you make a sale, the drop ship company takes over. They will source the item from their warehouse, package it and deliver it. You will never actually see or touch the item yourself. This means all you have to do is market and sell the products to your customer.
Drop shipping became increasingly popular as auction sites such as eBay grew in popularity. Today it's used in many different market sectors. Usually the retailer is paid a sales commission by the drop ship company. That's instead of the retailer paying for the drop shipping service.
Some drop ship companies will even customize packaging materials. They will add your compliment slips and return addresses, for example. This means your customers will never know that their purchases didn't come directly from you.
Using the economies of scale
This is one of the main reasons why outsourcing inventory management could work for you. Your business might be small on its own, which gives you limited economic power as it’s harder to negotiate. But if you could team up with hundreds or even thousands of other businesses, you would be in a much stronger buying position.
That's what inventory management outsourcing companies do. They can buy or rent vast warehouses and negotiate big shipping discounts. Some of them may even have their own courier companies.
They can do all this because they are acting on behalf of many businesses at once. That gives them serious buying power. So even once they've taken their cut, they can still pass on savings to you.
But you should consider the pros and cons before deciding if outsourcing inventory management is for you.
The pros of outsourcing inventory management
There are several advantages to doing business this way, for both retailers and manufacturers. For example:
- You don't need so much storage space. Warehousing is expensive at smaller scales, so you can cut your overheads significantly by getting rid of some or all of yours. With drop shipping you may not even need an office either.
- The software is advanced. For example, you can integrate drop ship tools into online shopping carts and other sales channels. This makes it easier to automate your inventory management.
- You can keep staff costs low. You don't need a forklift truck driver if you don't have a forklift truck – or even a warehouse in which to drive one.
- Faster order fulfilment. Dedicated inventory management companies can get your stock to your customers fast – often faster than you can. Again, that's due to the economies of scale leading to greater efficiency.
- You can reduce wastage and have less money tied up in stock. Old inventory can spoil if left lying around. It might be rusting raw materials or fading retail goods packaging. Either way, your inventory has a best-before date. Shifting that worry elsewhere can make good economic sense.
- You can scale your business as fast as you like. You don't need to buy a bigger warehouse to sell more stock. Your inventory costs can now be scaled alongside your increased market share. That makes it easier to manage costs and forecast profits.
The cons of outsourcing inventory management
There are some downsides, which you should consider before deciding whether this is the best option for you. For example:
- You will lose control over a fundamental part of your business. If things go wrong in-house, you can fix them personally. If they go wrong with an outsourcing company, you can do little but complain. Since inventory is a vital part of your business, this is a potential risk.
- Your sales data will be available to the inventory management company. They will know what you sold, when and how much. This is useful commercial information, and it's possible someone could use it to compete with you.
- You may end up competing for tight margins. This is particularly true for drop shipping. What happens if the wholesaler finds someone else willing to sell their products for a smaller margin than you? Your business could be seriously damaged.
- You have to pay for the service. This is an obvious point, but you have to make sure the amount you save is more than what you’d spend.
- When your company receives an order, and a second company ships the product, it is still your company that the customer has done the deal with. This means you, and not the delivery company, can email the customer. This isn’t a negative unless you forget to make it clear from the outset – so make sure to negotiate this early on to avoid any confusion.
Dip your toe in the water
It's a good idea to start small, perhaps with one product line. Find a reputable inventory management company to outsource to. Try to choose one with the ability to link their software to yours, so you can keep track of order fulfilment in real time.
Run the trial for a few months and collect all the data you can. Use good accounting software to make financial forecasts, then ask yourself some questions:
- Does it make sense to outsource more?
- What are the risks and rewards?
- How will this affect your position in the market
- How will your competitors respond?
You'll want to think about the short, medium and long term possibilities before making your decision. If you do go ahead, outsourcing inventory management could give you more time and freedom to build your business.
Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.
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