It's the start of a new year, and time to run reports on the business and do some planning for the coming year. One of the tools I use is a simple Open-to-Buy (OTB) system to plan my inventory purchasing throughout the year.

When I look at the inventory in my store I see stacks of $20 bills which could be in my bank account. When inventory is to high it means my bank account is too low. But, conversely, if inventory is too low I could be hurting my sales - which affects my bank account as well. Finding a balance is what inventory planning is all about.

The OTB system uses a formula to tell you what your budget should be for inventory received on a monthly basis. The system is very logical:

OTB = ENDING INVENTORY TARGET - BEGINNING INVENTORY - SALES

In English, this formula states that in my budget for purchasing to hit my target inventory at the end of the month is dependant on my starting inventory and my sales for the month. In other words, my budget for inventory received in the month is basically replacing my sales volume and modifying that amount depending on whether I want to see my inventory increase or decrease during that month.

The ENDING INVENTORY target is based on a forward looking projection of sales and a target for inventory turns. For example, if I want to have 3 inventory turns a year this means that at the beginning of each month I should have inventory in stock to support sales for that month plus the next 3 months (4 months in total). 

Simple, in theory. 

In practice, there are some challenges if you have a seasonal business, as I do. Our biggest selling period during the year, not surprisingly, is OCTOBER-NOVEMBER-DECEMBER. Our slowest selling period of the year is JANUARY-FEBRUARY-MARCH. The problem is that the Peak is followed directly by the Trough. In fact, the biggest selling month, December, is immediately preceding the Trough - which creates a cliff-like drop off in targeted Inventory amount.

The OTB system works quite well in building for the peak season. The forward looking budget allows me to build inventory for the peak season across a number of months, thus smoothing the cash flow requirements. But there is a problem in the December to January transition.

There seems to be no way to make this transition smooth. In order to support the sales projections for December we must have inventory in the store. And even with a good sales month that leaves us with significantly more inventory in January than the forward looking OTB would demand. And if we managed the December inventory to make the January inventory amount closer to the OTB projection then it feels like we would not have enough inventory in December to do the sales we expect.

I am not sure how to solve this riddle. The traditional retailer approach to this is the ubiquitous January Clearance Sale. While we do run a store-wide sale in January, the customer traffic is so much lower than December that it just does not burn off a significant amount of inventory (but it does cut into the Margin).

We did much better this year than last year in managing the inventory. Our Beginning Inventory in January was 33% less than the year before. Yay for the home team. But even that is almost 2x what the OTB model would like to see.

I am not sure what other retailers do with Inventory Management in a seasonal business, but I would very much like to hear some best practices to compare with. In any event, we had a very good year so this conundrum falls into the realm of How-do-I-improve - which is the constant mode of every business owner.