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Excess, Slow Moving and Obsolete Inventory

Managing Retail Inventory and Maximizing Return on Inventory Investment in Small Business (submitted 2009-07-10)  by Ted Hurlbut

“Our inventory is our most important asset.” Inventory may be the largest asset on your balance sheet, which makes it very important, but it’s not the most important asset. Your most important asset is the customer relationships which enable you to turn that inventory into cash, day after day, day in and day out. Inventory is one of those things where more is not necessarily better. When it comes to inventory, “more” generally leads directly to “too much”, which is usually the first step on the road to trouble. Ask yourself this; “If I could figure out a way to do the same sales volume with less inventory, would I?” You bet. Inventory is, in fact, an unfortunate necessity of doing business for a retailer, wholesaler or distributor.

So if inventory is an asset which may not always be an asset, how do you determine what is what? There are two key inventory productivity metrics which are widely known, but not always fully utilized. The first is inventory turnover. Ask somebody how many times their company turns its inventory and they’ll probably know the number right off the top of their head. What they may not be able to tell you as quickly, however, is how that turnover compares to other companies in their industry. Or, how many times they turn the inventory of their key categories or key items. Or, quite revealingly, how many times they turn the inventory of those items which makes up the last 20% of their sales (the 80/20 rule, but turned upside down, into the 20/80 rule).

The second key metric is gross margin return on investment, or GMROI. GMROI merely factors gross margin percentages into inventory turnover data to generate a financial measure of inventory productivity, the return on inventory investment. Which takes us directly back to the question we asked above, slightly re-stated; if you could generate the same gross profit dollars with fewer dollars invested in inventory, would you?

“I can sell it if we have it in stock.” I like to call this the Field of Dreams argument; if we stock it they will come. This is actually the inverse of “We can’t sell it if we don’t have it.” This is, of course, easy for a salesman to say because he doesn’t have to own the inventory personally, his company does, and if for some reason he can’t sell it, he’s not on the hook, the company is. But underlying these statements is an important truth about marketing: inventory doesn’t generate sales, marketing does. Granted, building a reputation for having an item in stock when the customer wants it is not an unimportant marketing message, but it is clearly secondary to communicating to customers the features, benefits and value of an item. That’s what truly builds customer demand. If you aggressively market it, if you aggressively sell it, they will come.

In fact, the marketing consideration that goes into the decision whether or not to stock an item is directly related to the customer’s expectations. If the item is a tube of toothpaste, or a pair of running shoes, or the latest compact disc, the customer clearly expects it to be in stock, and if it’s not, the sale won’t be made. On the other hand, if the item is a leather sofa, or a refrigerator, or custom draperies, the customer would rarely expect to be able to take the item with them.

Depending on the use and the value of the item, as well as whether the item requires professional installation, the customer’s expectations regarding delivery could range from several days to several weeks. Do you need to stock those items at the point of sale? Do the lead times within the supply chain allow for the stocking location to be centralized, back in the supply chain? Why own it at the point of sale if you do not have to?

By the same token, why own more of it than is needed to cover sales (plus an appropriate level of safety stock) until the next vendor shipment. While there are a number of formulas that will generate the appropriate replenishment parameters for any given item, the logic is pretty straight forward; every purchase for stock must be made with the informed expectation that you will be able to sell it within a reasonable period of time.

If an item is purchased from a vendor who maintains minimum purchase quantities, renegotiate those quantities or find another vendor. And if those quantities are being purchased to nail down specific purchase or freight discounts, run the numbers. You’ll quickly realize that in almost every case the discounts that are leading you to purchase more than you need at any given time are very quickly offset by the carrying costs associated with the excess inventory.

“Our customer says that if we stock it for them they will buy it from us.” Really? Do you have a signed purchase order from the customer? No? Not surprising. These types of opportunities should be viewed by understanding that the “if” part of the bargain is the driver, not the “then” part. It’s easy to get hooked in to a large, regularly recurring sale. It’s like finding cash on the sidewalk. Or is it?

In fact, the key to understanding and evaluating these deals is the requirement to maintain inventories for the customer. The customer is very astutely managing the inventory they need to support their business back up the supply chain, and with it the risks and expenses associated with carrying that inventory. They want to be able to count on you having what they need, when they need it. How much additional inventory will you need to stock? What is the incremental carrying cost of that additional inventory? What happens if the customer suddenly decides to switch items? Factor those costs in. How profitable does the business look now?

“We’ve built up a lot of dead inventory, but we’re not going to just give it away.” “We may have had it for several years”, (with no activity but the accumulating layers of dust), “but we paid $10.00 dollars a piece for it when we bought it” (three years ago), “and it’s still in very saleable. There’s no reason to let it go for less than a 20% margin. Besides, somebody might come in and need it tomorrow.”

Where to start with thinking like this?

First, the $10.00 spent three years ago is sunk and not relevant to any analysis today. The value of the inventory today is related to what potential customers might be willing to pay for it, which bears no relationship to what it originally cost. In fact, if you were to continue to try to market it at a price that would recover the costs associated with it, you would need to include in the cost basis the carrying costs that have been incurred since it was purchased, typically around 25% annually of the average inventory value. If these carrying costs were fully accrued, the cost value of our $10.00 item after three years would be $19.53. It would have to be sold at $24.41 to yield the desired 20% margin (compared to a selling price of 12.50 with a $10.00 cost base).

This is clearly absurd. Almost all inventory depreciates in value over time, anywhere from 20% to 50% a year. We understand this inherently; if a potential customer felt the inventory was fairly valued and desirable at a price of $12.50, they would have bought it long ago. The fact that it has still not sold clearly establishes that the market does not value at $12.50! There’ve already been plenty of tomorrows for customers to have bought it!

This may seem long-winded, but you can’t put too fine a point on it. Dead inventory is a problem for most every retailer, wholesaler and distributor at one time or another. It happens. When it does the key to maximizing your recovery is to act quickly, be clear headed and sober in your assessment of what it will take to liquidate the inventory, and take your medicine. Just the opportunity cost alone associated with management’s attention being diverted from constructive activities, like growing the business, argues persuasively that dead inventory cannot be allowed to build up until it’s like a lead weight the company is dragging around. I’ll say it again; take your medicine, learn from it, and move on. Don’t worry about what you once paid for it, or how much you’re carrying it on your books for. It’s not relevant.

Conclusion Don’t fall in love with your inventory. It’s not likely to love you back. It’s amazing how the investment in inventory can take on an emotional, almost passionate quality. But, if you think about it, it is understandable. For many owners and executives, especially those with an entrepreneurial investment in the business, their inventory is made up of products which represent a life’s passion.

For those of us whose focus is on managing retail inventory and maximizing the return on inventory investment, however, inventory is a dispassionate means to an end. We look at inventory, and we see a surrogate for cash. It’s either going to be sold and converted to cash, or it’s sitting there tying up cash, costing us more cash each and every additional day it’s not sold. Our challenge as inventory managers is to help retailers, wholesalers and distributors recognize and adopt sound inventory management practices, in order to maximize their return on inventory investment, without sacrificing the passion that is the lifeblood of any growing business.

About the Author

Ted Hurlbut is the Principal of Hurlbut & Associates, a retail consulting and business advisory firm based in Foxboro, Massachusetts. He is focused on helping his clients increase sales, margins, profitability, and cash flow, and is particularly attuned to the challenges facing smaller, independent, entrepreneurial retailers. You can learn more about Ted, and Hurlbut & Associates, at http://www.hurlbutassociates.com.

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Description: #2GYINZ-LATEX PWD.EXAM LRG. 2 CASES 37.45/cs#2GYPF-3,LATEX PF LRG. 8 CASES 35.66/cs#2GYPF-2,LATEX PF MED. 1 CASE 35.66/cs#2GV-3, VINYL PWD LRG. 5 CASES 25.18/cs#2GV-2, VINYL PWD MED. 6 CASES 25.18/cs#2GVPF-3, VINYL PF LRG. 1 CASE 28.75/cs#2GVPF-4, VINYL PF X-LRG. 5 CASES 28.75/cs#2GYIN-2, LATEX PWD MED. 1 CASE 30.78/cs#2GNPFZ-3, NITRIL PF LRG. 4 CASES 58.53/csSold as a lot of 33 cases

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Product: Sta-Dri gloves
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Description: #2GYINZ-LATEX PWD.EXAM LRG. 2 CASES 37.45/cs#2GYPF-3,LATEX PF LRG. 8 CASES 35.66/cs#2GYPF-2,LATEX PF MED. 1 CASE 35.66/cs#2GV-3, VINYL PWD LRG. 5 CASES 25.18/cs#2GV-2, VINYL PWD MED. 6 CASES 25.18/cs#2GVPF-3, VINYL PF LRG. 1 CASE 28.75/cs#2GVPF-4, VINYL PF X-LRG. 5 CASES 28.75/cs#2GYIN-2, LATEX PWD MED. 1 CASE 30.78/cs#2GNPFZ-3, NITRIL PF LRG. 4 CASES 58.53/csSold as a lot of 33 cases

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• Distress sales of goods
  • Use Deadstock Network or other means to discount the items and get them sold
• Donate the items to charity and get the tax break
• Destroy the items and get the tax break

In any event you should be proactive in your management of this on going issue.

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Slow Moving & Obsolete Inventory Marketplace

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Volume 1, Issue 1, Date

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Keys to moving items

Jason Bader from The Distribution Team list the most successful methods of selling excess and slow moving inventory:

1. Critical to assign responsibility to one individual in the company.  Someone other than purchasing.

2. Return to manufacturer or make them refer you to another company buying that item

3. Develop a close network of your competitors that you can exchange the items

4. Use Deadstock Network to promote you items

BE PATIENT!! Ebay was not built overnight neither will Deadstock network.

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Inventory management blog and information center

I tell distributors all the time that there are not stages of deadness.  In other words, inventory does not go through stages like dying, dead, really dead and then stinky dead!  If it is dead then it is dead.  Make something happen.  Many distributors believe in the stages of deadness.  They think it might be dead with a heartbeat so maybe we can revive it.  We often believe that if we hit our dead stock with some electronic charge (like a sales promotion), it will pop up off the table and start living again.  This is not true.

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I recently spent some time with a large distributor in Florida. The original reason for my visit was to assess the company’s purchasing procedures and look for ways to improve the procurement process. After spending some time with the purchasing director, I happened to notice a report on his desk outlining the inventory turns for the last two years. Just like a good salesman, consultants learn to read upside down just in case there might be some important information residing on someone’s desk. I asked about the report and indeed confirmed that it was a monthly turns history. Over the last 6 months, the turns had been dropping at an alarming rate. To give you a context of alarming, the turns had dropped from around 3.6 to 3.1 turns. Although I had not been originally hired to look at this trend specifically, it was apparent that this decline was causing more than its fair share of anxiety. This anxiety was compounded by the fact that my client, the purchasing manager, had just taken over the team 8 months ago. What had started out as a broad based task had now revealed a very specific goal: arrest the declining turns and reverse the trend. Like many other indicators in our businesses, turns is simply a comparative ratio. In the numerator, we look at the cost of goods sold from stock sales for the past 12 months. We are diligent to make sure that we exclude any sales that may not be from our local stock inventory: direct ships, transfers to fill a back order, etc. Some software makes it difficult to filter out certain transactions, so we might have a little inflation in our numerator. But hey, we are benchmarking against ourselves. As long as we keep measuring it the same way, progress can be measured. While we are talking about benchmarking here, be sure to always measure against your own numbers. Be skeptical of the validity of “industry standards”. I just mentioned a couple of ways that the ratio can be skewed. Besides, some of us tend to paint a slightly rosy picture when we respond to industry surveys. But I digress. The denominator of our turns ratio is the average inventory value. This is a far more stable value; but it can be slightly misleading due to the way our software calculates the average. By the way, the most pure way to find the average is to take 12 months of inventory values and divide by 12. Did I mention that consultants have a flare for stating the obvious; and then try to pass it off as something really profound? In our situation, it was important to look at where we could make the most impact if the trend of declining turns was going to be corrected. Although the purchasing team does have some impact on our cost of goods sold number, through buying at a lower unit cost, the most logical area of focus was on the average inventory value side of our ratio. What are the factors that inflate our inventory? Overbuying is probably the largest contributor. When we don’t set our ordering controls properly, or base our purchases on gut feel, inventory inflation can often occur. Correcting the ordering controls will give us the greatest overall impact on our inventory value; but it takes a long time to realize significant gains. Sometimes, we will not achieve our inventory goals for 2 years. Since I have the patience of an average 4 year old taking a car trip, and most financial partners are not enthusiastic about waiting for a 2 year correction in a plummeting turn ratio, we need to find at a more immediate solution to our problem. If you want to make a quick correction in the average inventory value, attack the dead and slow moving inventory. In the remainder of this article, I will focus my attention on one aspect of dead stock management: vendor returns. In order to set the context, I will explain a couple of steps that are required prior to liquidation of dead inventory. The most important thing to agree on is a time of death. As a company, we must have an agreed upon standard as to when something becomes dead in our system. The most common answer is no sales in 12 months. Some industries need to set their date at 3 months. But, for most hard goods distributors, 12 months is a good first start. Now this definition may produce a fairly significant number; but I challenge you to go one step further. Seek out those items that are nearly dead and add them to your list. Nearly dead items can be identified by using a hits report. A hits report simply tells us how many times a specific item appears on a sales order, regardless of quantity ordered, in a calendar year. If you need help creating a hits report, give me a call. You can eliminate most items with fewer than 4 annual hits and have virtually no adverse reactions with your customers. When you run this report for the first time, you will be amazed at the number of items that fall below 4 hits. Again, I recommend that you change these items to a non-stock status. There may be a couple of exceptions; but try to keep these to a minimum. Now that we have identified this large lump of dollars, it’s time to convert this inventory back into its original form: cash. Dead stock is still money; it’s just old money. There are several ways to convert dead stock to cash; but, I would like to focus on the vendor return solution. Pre-negotiated vendor returns can put a large dent in our dead stock pile. In a previous article, I mentioned that it was important to establish return policies prior to taking on any vendor line. A little footwork up front can make our dead stock liquidation easier. Without prior agreements, sometimes vendors can be rather reluctant to accept a return of goods. As distributors, we seem to be reluctant to process returns to our vendor partners. We are great at taking returns from customers; but for some reason, we don’t follow through with pushing the materials back up the supply chain. One of the problems I run into most often is that we do not actually know what the return policies are. A great homework assignment is to have your buyers research and clarify the manufacturer’s stated return policies. You will be amazed at the opportunities we do not utilize. Many distributors tend to get derailed by vendor return policies that require a restocking fee. Is a 20% restocking fee too much to surrender? Let me ask you this. How much have we lost by holding on to this inventory for a full calendar year? The average carrying cost for a distributor is about 25% annually. Each additional day that we hold on to an item adds to that carrying cost tally. Would I rather have 80 cents in my hand versus a diminishing dollar cluttering up my shelves? Every day and twice on Sunday. With cash, I have the ability to invest in something that turns multiple times a year. I can recover my 20 cents in a few months. In some cases, vendors give us a return allowance based on previous the year’s purchases. Take advantage of this. Convert dead and nearly dead cash into turning inventory. At times this percentage can seem painfully low. This is where distributors have an opportunity to negotiate. Asking for a larger percentage will not always work. Sometimes we need to become creative. Offering a “one for one” return is a good way to start. This offer means that we are willing to cut a purchase order to the vendor for the same dollar value we wish to return. Consider offering a “1.5 for 1” return. Even a 2 for 1 return is acceptable. Remember, we are getting rid of inventory that occupies shelf space and ties up cash. By bringing in good saleable merchandise, we will recover our investment in a few months. There is a tendency for buyers to load up on their A items when putting together their offsetting orders. Be careful of this practice. You will wind up making it very difficult to make future target level purchases and find yourself running out of your B and C items. Spread the investment evenly over the entire line. During the negotiation, try asking for special dating. An extra 30 days is not uncommon. In the case of my client, we determined that approximately 10% of his inventory was eligible for return using the manufacturer’s stated policies. By simply processing these returns, we would not only arrest the fall, but his turn ratio would jump ½ a point. If he was able to go the extra mile and negotiate returns on the items with less than 4 hits, he could actually move up another ½ point once he bled through any additional offsetting order surpluses. It is very rare to see turns jump by a whole point in 12 months. The important thing to remember is that dead stock management needs to become a continual process. You will find the many manufacturers are more willing to process 4 smaller returns spread out over the year rather than one large return at year end. Here is another little trick. Put together your returns during the first month of the quarter, rather than the last. Let’s review the action steps: Determine a company dead stock definition Go the extra mile and identify the items close to death Research and review the stated return policies of all vendor partners Maximize your ability to return product under these rules Negotiate offsetting orders for additional return privileges Continually cycle out dead products on a quarterly basis

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