Have you ever heard a wholesaler, importer or distributor say, “We’re committed to inventory” or, “We can’t sell it if we don’t have it”? But inventory is one of those things where more is not necessarily better.
Have you ever heard a wholesaler, importer or distributor say, “We’re committed to inventory?”
How about, “We can’t sell it if we don’t have it?”
Or perhaps, “We’re not going to just give it away?”
It’s not really surprising, in fact, that each comment seems to be followed over time by the next. There seems to be a direct, linear connection from the pledge of being committed to having (lots of) inventory in stock to the idea that you must have it in stock in order to sell it, to, to the assertion that the excess, leftover, dead stock retains its value and cannot be sold for below cost.
Let’s take a closer look at these statements.
“Our inventory is our most important asset. We’re committed to inventory” Inventory may be the largest asset on your balance sheet, which makes it very important, but it’s not your 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 wholesaler, importer 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 a distributor or wholesaler 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 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 can’t sell it if we don’t” I call this the “Field of Dreams” argument; if we stock it they will come. I hear this most frequently from salespeople. It 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, his company is.
But underlying this statement is an important truth about inventory and 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. A carefully constructed demand forecast, based on factual history and your customer’s own projections of their needs, is the best basis for making a stocking decision. An accurate demand forecast is the basis of a sound inventory plan, which will tell you what you need, when you need it, where you need it and how much of it you need. And building demand comes back to marketing; if you aggressively market it, they will come.
“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 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.
If a potential customer felt the inventory was fairly valued and desirable at $12.50 (a 20% margin on a $10.00 cost), 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!
Dead inventory is a problem for most every wholesaler, importer or 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. Learn from the experience and move forward. 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. Turn it into cash. Now.
Conclusion
Don’t fall in love with your inventory. It’s amazing how the investment in inventory can take on an emotional, almost passionate quality. If you think about it, however, it is perfectly understandable. For many wholesalers and distributors with an entrepreneurial investment in their business, their inventory is made up of products which represent a life’s passion.
For those of us whose focus is on managing inventory, however, we look at inventory, and 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 wholesalers, importers 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.
© Ted Hurlbut 2004
