Defining the product mix of an online store can make a lot of difference if the goal is to achieve positive bottom-line performance.
However, finding a balance in the inventory can be tricky as stocking up on just the best-selling items can expose the business to sharp downturns in case the demand for those particular products unexpectedly declines.
In this article, we share some useful tips that different types of e-commerce businesses can implement to optimize their product mix so they can increase profitability and inventory turnover.
Understanding the Pareto Principle
Pareto’s principle is a statistical theory that states that 80% of the outcome of a situation is driven by 20% of the variables that have an influence on it.
This principle is applicable to many areas of life and business and it is particularly relevant in inventory management as 80% of a company’s sales are believed to come from 20% of its products.
With this in mind, online entrepreneurs can start by focusing most of their resources on their best-selling products to make the most out of them.
That said, the Pareto principle also allows for a small percentage of products that have a lower turnover rate as those may be used for other purposes such as diversifying the firm’s exposure to a handful of items to mitigate the impact of single-product demand downturns.
What is the ABC inventory system?
The ABC inventory management system consists of categorizing a store’s inventory based on how important each SKU is to the performance of the business.
Products categorized under the letter “A” are typically considered either the most valuable or the ones with the highest turnover rate.
Store owners should focus most of their effort and resources on marketing these products as they will likely yield the best results for the business from a financial standpoint.
“A” products may not be the most profitable but, since the demand for them is particularly high, they are considered the “bread and butter” of the business. “A” products account for 50% to 60% of the store’s inventory.
Meanwhile, “B” products are those that have a steady and predictable demand and their profit margins are decent and usually higher than those of items categorized as “A”.
They are also important for the business as they can cushion any temporary downturn that the “A” products experience. Some examples of these products are accessories, spare parts, and other similar items.
Finally, products categorized as “C” are those that have the lowest demand but their profit margins are particularly high compared to the other two categories. These could be niche products that can be hard to find at other places and, therefore, the store is able to sell them at a higher price.
“C” products can be a great “hook” as customers will be happy to find them and may return to the store in the future as a result of that first purchase.
Profit Margins & Their Importance
Profit margins are quite relevant to determining the optimal product mix. As a rule of thumb, if a product has a high-profit margin and high demand, it should make up for most of the store’s inventory. The same goes for average-margin/high-demand products.
Meanwhile, average-margin/average-demand products can be categorized under the “B” letter and, therefore, they may not exceed 30% of the store’s inventory.
Finally, high-margin products with low demand should make up for the lowest percentage of their inventory.
Using “Hook” Products for Cross-Selling
Upselling and cross-selling are two common practices that aim to increase the average order size of a store. Upselling involves influencing the customer to opt for the “premium” version of the product.
Cross-selling, on the other hand, is an approach that seeks to entice the customer to purchase complementary products in addition to the item they originally intended to buy.
“Hook” products are those in high demand and they typically drive the most traffic to the store. One interesting practice is to work on developing as many accessories and related products that can be matched to the store’s best-selling items to increase sales.
Since the sale of these products is largely driven by the performance of the “hook” item, their selling volumes should be particularly high as well.
Bottom line
Defining a product mix can be tricky at first but, by focusing on objective variables such as the items’ profit margins and demand, entrepreneurs can quickly and easily determine what is the best approach for their particular businesses.
