This article was taken from an interview with former Amazonian Todd VanderStelt and Amazon Agency specialist Andy Thompson.
Todd led the Headphones and Textbooks categories at Amazon, implementing the Hands-off-the-wheel supply chain automation program that is responsible for determining how much inventory Amazon orders from its vendors. As you might guess, he’s well qualified to chat on the topic and dishes some insider info – if you’re an Amazon Agency or vendor, let us know what you think! More to come soon.
Vendor Central still seems like a black box. Why does Amazon order the inventory they do and how can we influence the purchase orders now that the bots are in control? Behind the scenes, the process of ordering inventory from vendors is a complex operation. In this blog post, we delve into the intricacies of how Amazon orders inventory from vendors and discuss how agencies working with vendors can help their clients secure more purchase orders from Amazon.
Part 1: How Does Amazon Order Inventory from Vendors?
At its core, Amazon aims to maintain sufficient inventory to meet customer demand. This is most easily thought of as “weeks of cover” or “days of supply”. Staying in stock and staying ahead of lead times are key objectives for Amazon and its ordering systems. They can’t sell what they don’t have, so they try to maintain an ample amount of inventory throughout the distribution network (or ‘distribution nodes’) based on current and projected sales pacing. That seems pretty obvious. But what’s not obvious is what goes into Amazon’s determination of the ‘optimal’ amount of inventory to order and hold.
Forecasting and Trailing Sales History:
How much inventory Amazon thinks it needs and therefore orders is in part determined by a forecast and trailing sales history. In essence, Amazon needs to predict how much of a product will sell in the future to maintain an efficient inventory level (emphasis on ‘efficient’ as it doesn’t always mean completely in stock throughout the year).
Amazon generates different forecasts representing different confidence levels, or ‘P’ values. Typically, a ‘Mean’ forecast best represents what is projected to be sold in a given week. This is the best forecast for monitoring sales projections, but generally doesn’t serve the needs of the inventory models because there other factors to consider. Inventory models and managers are seeking to achieve a target service level, which is why the most conservative forecast doesn’t always apply and the P70, P80, and P90 forecasts, come into play.
The ‘P’ values (or confidence intervals) that come with the forecasts seen in Vendor Central represent the probability that Amazon estimates demand will be at or below the forecasted units per ASIN. As an example, the P80 forecast seeks to determine the point where there is an 80% probability that customer demand will be at or below the forecasted amount, leaving a 20% probability that demand will be higher than the projections.
In order to determine the amount of inventory required to support the forecasted amount, Amazon will use a target service level or critical ratio, set for each ASIN that balances a number of factors to achieve an optimal inventory amount. No retailer can afford to buy enough inventory to guarantee being in stock 100% of the time…the amount of inventory required would be exorbitant to achieve that level of confidence. Thus, a lower threshold is used. Achieving a ‘good’ target service level ends up requiring more inventory than will likely be needed to cover next week’s sales based on the mean forecast, but it’s a necessary evil if Amazon wants to be 90% confident that they’ll have the inventory to support the possible demand. This fact favors the vendor and its purchase orders.
As Todd puts it, “The complexity is that the forecast distribution is always changing, especially if Amazon doesn’t have good signals. If there’s a lot of volatility, such as if you’re losing the buy box, you can get vastly different forecasts so expect the forecasts in Vendor Central to change week to week.” (Hint that this is one of those things the vendor or agency can influence)
In the past before automation, in-stock managers were evaluated based on three primary metrics of inventory turns, working capital available to order inventory, and Fast Track In-Stock Rate. There was much more of a human element influencing ordering, so you could tug on the sleeve of your vendor manager to influence Purchase Orders. That is not so much the case anymore per the next point.
Automation Takes Over:
Automation has transformed Amazon’s inventory ordering process. Amazon’s Supply Chain Optimization Technology team (aka the ‘SCOT’ team) is now responsible for these decisions, using a whole lot of math to support ordering decisions. In addition to ongoing forecasting improvements, their work also encompasses determining the ‘economically optimal’ target service level of inventory, while considering other factors that determine how much inventory to buy. The primary factors the SCOT team takes into account are:
- Economic Ordering Modeling (EOM): Think of this as a pure profitability measure at the ASIN level. To be clear, we’re talking about Amazon’s profitability on the end sale to the customer. Amazon buys the items from the vendor at wholesale pricing and then calculates their own profitability after deducting additional costs Amazon incurs such as fulfillment and trade spend (in some cases). The more profitable an ASIN is, the higher the cost of out-of-stocks and the more willing Amazon is to buy inventory above and beyond the target service level.
- Customer In-Stock Value (CIV): This determines the value of having a product in stock, which includes an item’s profitability, but also considers its halo effect on sales of other products to Amazon. Customers don’t purchase items in a vacuum, so Amazon looks to quantify and incorporate customer behavior beyond the single ASIN purchase. As an example, Todd makes the case for keeping Televisions in stock even though they are costly to store and ship: “There’s a value to Amazon having TVs in stock because those customers are signing up for Prime to get free shipping. Those customers are coming back and buying accessories like cables and remotes that provide great margin. So Amazon looks at the full purchase behavior of any individual SKU when determining whether or not to stock (purchase) and to stock at what level (how much they buy).”
- Cost of Overstock: This analyzes factors like return terms, price elasticity, and likelihood of selling overstocked items. Here, Amazon is trying to determine how painful it will be for them if they are stuck with inventory they can’t sell. Can Amazon simply ship it back to you, the vendor? Or do they have to mark it down to sell it? Will customers buy it at a discount? What’s the price elasticity? Is it a highly seasonal product with limited demand post-holiday? These are all things Amazon is taking into account for their purchase order quantities.
Vendor Lead Time & Fulfillment Rates:
Lastly, Amazon factors in inbound performance metrics such as order frequency (how often they can order from you), lead times (how long they have to wait), fulfillment rates (how consistently you fulfill their order), and lead time volatility (how often the wait time changes) when determining how much inventory to purchase to hit that target service level. The consistency in vendor lead times and fulfillment rates can significantly influence Amazon’s purchasing decisions, and is something agencies and vendors can influence by having solid operational processes that deliver when Amazon comes calling.
If you’re tracking how the math works here, you may have recognized that if you have high lead time volatility, Amazon will need to buy more inventory to achieve their target service level. So hey, a lack of operational excellence means Amazon will hold more of my inventory right? Not so fast as it also increases Amazon’s risk of overstock, which drives down their target service level, and it won’t be long before your vendor manager comes knocking asking for better terms.
Best not try to game the system, it won’t work out well in the end for either party. If you’re looking for the best possible outcome and consistent PO’s that you’re able to support, operational excellence plays a critical role in delivering the clean signals Amazon needs to plan your inventory levels.
Part 2: Strategies for Agencies Working with Vendors to Secure More Purchase Orders
Now that we’ve discussed Amazon’s inventory ordering process and the factors it considers, let’s explore how agencies can help their vendor clients get more orders from Amazon:
Ensure Consistency in Buy Box Ownership:
Agencies can play a crucial role in helping vendors maintain consistency in the Buy Box ownership. There are several ways in which Amazon can lose (or pull) the Buy Box, each of which introduces noise in the demand signals leading to issues in inventory planning. This is something agencies should monitor relentlessly because not only does it affect longer term ordering from Amazon, but also impacts an agency’s ability to advertise the vendor’s items on Amazon and grow the brand over a period time. If an agency is unable to consistently promote the vendor’s products and growth stagnates, it’s unlikely the agency will be retained by the vendor for long.
As Todd puts it, “If Amazon is not winning the buy box 100% of the time or there’s massive price volatility, the demand signal is going to be disrupted when they’re not winning the buy box. A lower price point may drive additional sales, but it’s at the cost of volatility in order signals that perhaps they weren’t prepared for. And if they’re losing profitability in the process, that is going to feed back into their target service level targets. Then it’s a domino effect that is going to reduce the amount of inventory that they’re going to buy to the point where they may discontinue the ASIN altogether”
Implement Strict Pricing Policies:
Agencies should encourage their clients to establish and maintain strict pricing policies. Stable pricing across authorized sellers and distributors, along with no resellers selling on Amazon will support price consistency that goes a long way in supporting Amazon’s inventory ordering decisions. If Amazon is having to compete on price to stay competitive in the market (since they always attempt to have the lowest price), or keep the Buy Box internally vs. resellers of the same ASIN, they lose margin which impacts the target service level for the affected ASINS.
If a distributor is pricing a vendor’s items below what Amazon is selling the item at, and what Amazon can afford to sell at and remain profitable, Amazon removes the Buy Box and may actually stop selling the ASIN once it reaches its ‘Can’t Realize a Profit’ selling price (i.e. the CRAP price, or scrap price you might say). This is the downward spiral strict pricing policies can help avoid. As an agency, you can help monitor pricing across the web and distribution channels to ensure there are no instances of MAP pricing being violated.
Control Distribution Channels:
It’s essential to know who a vendor’s distributors are and track the inventory’s path to prevent rogue inventory from showing up in unauthorized places. If you hope to enforce your strict pricing policies, controlling distribution is the only way you’ll have a chance of success.
It’s critical that the vendor knows who is selling their inventory and where. This helps prevent inventory leaking out and being sold at steep discounts, further disrupting the Buy Box and Amazon’s ordering signals. The vendor should be able to pick up the phone and call each of its distributors. If that relationship doesn’t exist, there is always a risk of a vendor’s Amazon sales being impacted by a shadow seller that can’t be tracked down.
Obvious strategies to help clean up distribution channels include creating a list of authorized sellers and distributors, standardizing contracts with the selling partners for pricing and deal restrictions, and creating an Amazon carveout (i.e. ‘no selling on Amazon’). And one step further, serialize the vendor’s products so each item has a unique identifying number. This way, if a rogue seller pops up with the vendor’s inventory somewhere off-Amazon, a test buy can be done to check the item’s serial number against an inventory record showing who the original distributor/purchaser of the inventor was, allowing for identification of the leak and a means of shutting it off quickly. This is less effective for resellers operating on Amazon alongside the vendor as inventory is often commingled, but can helpful to identify where the inventory came from in the first place all the same.
Educate Clients on Global Impact:
If your clients are global companies, emphasize the importance of controlling inventory and distribution in all regions. Inventory leaks anywhere in the world can impact your Amazon performance.
Todd has experienced this before from the Amazon side, commenting, “I’ve seen it so extreme that you’ll get your US market under control, your average selling prices rise to your MSRP, and then all of a sudden the same SKU that’s being sold in Europe at a lower price is coming across the water because someone sees an arbitrage opportunity. So you’ve got to think of this holistically because anytime there’s an inventory leak, no matter where it is in the world, if the opportunity is large enough it’s going to end up on Amazon and disrupt your performance. If you don’t control it because of how automated it is, you’re going to find yourself in a death spiral both in terms of what Amazon is going to order and predictability in your supply chain. Not to mention, it can degrade your brand overall.”
Grow Amazon’s Sales for Them:
This one seems obvious but the more an agency can help increase demand for a vendor’s items, the more Amazon is going to sell and subsequently order. The primary means of doing this is to advertise the products on behalf of the vendor. An agency that does not know how to effectively promote their client’s products on Amazon has one (or two) hands tied behind their back in terms of being able to produce growth results for the vendor and will likely not be retained.
For vendors, the economics of advertising on Amazon are a bit more difficult than for sellers on the platform (or third party sellers as a first party vendor would call them). In particular, the vendor has slimmer margins based on the wholesale cost or Shipped COGS amount the vendor actually receives in cash from Amazon after selling the products directly to Amazon at wholesale prices.
Vendors get paid when Amazon drops a purchase order with the cash coming after the obligatory payment terms. On one hand, this means that Vendors can get paid earlier as they don’t have to wait for the product to sell through. But on the other hand, this can result in a very spikey cash flow cycle where the vendor is spending advertising dollars without a corresponding payment from Amazon in quite some time. This is a common reality for Vendors, especially coming out of Q4, and agencies should do their part to forecast the required advertising spend so the Vendor can plan their cash outlays accordingly. Further, the agency needs to understand the unit economics and profitability of each ASIN, including the brand’s customer dynamics which account for repeat purchase rates and lifetime value of a customer. A one-time purchase doesn’t consider the bigger picture of building a brand on Amazon so a longer lens should be used to set appropriate ACOS and TACOS targets… alas, a topic for another day.
And of course, growing a vendor’s traffic and conversions on Amazon isn’t limited to advertising. There are other things you probably already know the agency can assist with such as content optimization for better Amazon search ranking, promotions such as deal days and coupons, nurture programs via email campaigns in Vendor Central, review growth through Vine, brand storefronts and posts, along with a whole host of strategies off-platform that can boost eyeballs on a vendor’s product detail pages.
Build Better Vendor Processes for Better Bargaining Power:
These last two points go hand-in-hand and represent a perpetual challenge of the agency-client relationship. You’re an outside party and you can’t rightly reach into your client’s company to fix broken processes or inefficient systems. Yet sometimes, that’s exactly what you have to do to help your client succeed on Amazon.
It’s clear from Amazon’s ordering systems that consistent lead times, fulfillment rates, and purchase order confirmations give Amazon the best signals to order more inventory. This is something you can audit right away in a new Vendor Central client’s account. What’s their PO Confirmation Rate? Fulfillment Rate percentage? Average lead time for each item? You can see these values directly in Vendor Central. If the PO Confirmation Rates and Fulfillment Rate percentages are less than 95%, start asking questions of your client. What’s causing less than optimal rates? Are there certain items that give more trouble than others? It’s important you know these things ahead of time as they will make your job easier or harder down the road.
If the fulfillment processes are less than consistent, you should advise your clients about how they can put different systems in place to better prepare for Amazon’s ordering. Forecast not sufficing for the client? Build them a new, more conservative one. Purchase Orders getting missed? Get on the Amazon distribution list for new POs and make sure the client’s fulfillment person acknowledges and confirms new POs within a reasonable amount of time. Track the shipments being created by the client and confirmed by Amazon. Make sure the shipment goes out to Amazon on time. Know that the job is getting done.
This in turn leads to better conversations with Amazon come annual agreement time. If a client consistently hits the mark, Amazon will reward them with better terms, which can result in saving thousands of dollars for the client. You can pay for yourself if the job is done right and the client will come to think of you as part of the team, indispensable for your tribal knowledge of the brand and expertise of how it operates on the Amazon channel.
Todd talks about this idea and dynamic as an agency:
“I’ve sat in those conversations both internally at Amazon and working with the vendors and brands directly. They’ll come to see Amazon as a huge channel opportunity and will then engage with an agency, thinking the agency should know enough about the operational aspect of the problem to be able to set expectations accordingly. If the agency’s counterpart on the vendor’s team is a marketing manager, that marketing manager isn’t going to have the authority to make channel decisions, distribution decisions, production decisions, or whether or not to serialize product, etc.. And so if you as an agency do end up in one of those situations where the brand does not have its operations in order, you’ve really got to work hard within the brand to talk to the right stakeholders, to lay out the scale of the problem before you can even get to the fun stuff about what you are going to go do to advertise or target new customers or use this channel to build your business.”
Be a Strategic Partner:
Todd says, “Engage in strategic discussions with your clients. Be prepared to address larger issues, including channel management and distribution control. Develop strong relationships with brands and assist them in identifying the right stakeholders. Help them understand the scale of the problem and work together to tackle operational challenges.”
Agencies should aim to be more than just service providers; they should be business partners. To build long term relationships with clients, agencies have to earn trust and inspire confidence. This often means having subject matter experts that can talk to the initiatives mentioned above. Amazon is a complicated system, and the complexity is the opportunity for an agency. Agencies are well suited to be the experts that help vendors have peace of mind that their account is in good hands amidst a rapidly shifting ecosystem that they don’t feel comfortable managing themselves.
A large driver of complexity is the ever expanding implementation of automation and AI in ecommerce operations. As the shift occurs, the opportunity for an agency will evolve to being the overseer and interpreter of the complex systems, steering the ship in the direction the vendor wants to go and navigating the unknown waters. Put simply, agencies should be well versed in analyzing performance and identifying how different strategies and systems are causing changes in a vendor’s numbers…if an agency can do this, they will forever be valuable to the client.
When thinking about how to engage with vendors and be successful as an agency in the years to come, Todd has a comment to think about:
“If you’re a traditional digital marketing company that is extended into Amazon, you don’t necessarily have the full channel and operational expertise on staff and that can be a blocker for agencies to drive the full results. It’s a full channel management problem on Amazon. It’s not just an advertising opportunity so you need to consider adding that depth to your team.”
Amazon’s inventory ordering process is a complex, automated system that depends on a bunch of factors we wouldn’t normally think about. As an agency working with vendors, your role is critical in making sure your client knows what matters when it comes to Amazon’s ordering and how they (and you) can positively impact the purchase orders Amazon submits to the brand. By becoming a strategic partner and addressing operational challenges, you can make your team indispensable to the client and provide real value that turns into real dollars for them. In an increasingly automated world, agencies that offer comprehensive support across the number of areas we described will be the most valuable partners for brands seeking success on Amazon. Hopefully this article helped shed a little light on how the big machine works and gives you and your agency the edge you need to make a difference for your clients.