There are many performance indicators in inventory management, the main ones: inventory, sales, surplus, lost sales, availability percentage, and inventory turnover. If the estimation of sales and turnover is not a problem, with a surplus, it is more complicated. A retailer’s often-heard opinion is, “Surplus is the supplier’s money.” It makes us feel that the overstock indicator can be put on the back burner.
So, we delved into the surplus issue and realized that its effect on the business was profound. How does financial performance depend on surplus, and why is overstock not only the supplier’s problem? Let's figure it out.
Retail Inventory Management Challenges. Why Is Surplus Important?
Among the current inventory management issues, some most common ones emerge. All of them are related to surplus either directly or indirectly. Studying their causes and effects in detail, we find that overstock is not only the supplier’s lookout but also a real problem for retailers, which is often turned a blind eye.
In many companies, it’s store managers who still handle orders instead of the central office.
In such circumstances, inventory management becomes entirely uncontrollable. Orders become dependent on the opinion, expertise, and even the mood of this or that manager. There is often a lack of coherence or a consistent approach to management. The manager tends to form "outsized" orders since the operating staff is better motivated by the sales rate than by turnover.
There used to be a practical case when managers in a retail chain not only formed orders but also negotiated prices with suppliers. As a result, the same goods were delivered to different stores at different prices. Of course, such an organizational set-up option has actually become outdated. However, it reveals the influence of operating personnel on financial performance may lead.
Lack of category A fast-moving products and excess inventory of other, less popular products among buyers.
There is also a race for profit margin due to well-known manufacturers, own imports, and the development of their own brands. In this race, lost sales are unacceptable, although inevitable, and range from 5 to 30 percent for different chains.
High payroll expenses.
This applies to operating personnel in stores and to IT specialists. In some chains, IT departments appear that automate inventory management processes or other areas in the company.
Retailers have to launch new projects and streamline their business experience to solve new problems. The company needs a budget for this, and that's just what working with the surplus wanted. Overstock is a problem holding really great promise. Their reduction always releases the company's money frozen in goods. Here, the initiative and responsibility for minimizing surplus rests entirely on the chain and not with the suppliers. So, the first thing a retailer should do is determine the level of surplus across the chain and compile a list of SKUs that belong to this category.
The surplus is calculated as per the following formula:
It is also important to determine the margin per shelf meter – the indicator reflects several factors at once:
- product mix accuracy and potential
- correct display
- shelf replenishment matrix performance
Surplus increases the cost of inventory, which can cause margins per shelf meter to deteriorate. Next, we will analyze this point in detail.
Having defined overstock in specific numbers is important to understand how painful it is for a business and what exactly it affects.
Effect of Budget Cycle
Few people consider this aspect since there is a belief that the store inventory is the supplier’s stock and money. So, it's not a problem if the turnover is less than the delay period. What is more, we usually consider the entire chain indicators, but what if we look at each separate product? When we analyze our customers’ experience, the “inventory is the suppliers’ concern” assertion is not suitable for most products and does not apply at all to the following categories:
- domestic import;
- domestic production;
- products which turnover is more than the delay period.
If overstock goods turnover is greater than the delay period, this means direct economic loss. In this situation, it will be necessary to attract finance for the development of the network as loans or other sources.
Turnover acceleration is the ability to use your cash to scale and launch new projects faster by releasing funds from inventory.
According to the statistics that we collected using the LEAFIO Inventory Optimization solution, the inventory turnover without a surplus is 2-3 times better.
It is obvious that surplus costs money for the company, not for suppliers, as many believe. If we multiply the theoretically optimized surplus by the % of loans or by the average cost of money for the company, we get the amount of cash released. Sometimes the numbers are quite impressive.
If you want to analyze your business by its key areas, we suggest downloading a handy checklist. With it, you can assess your inventory management, merchandising, and loyalty program and then draw up a plan to optimize business processes.
Effect of Surplus on Logistics and Their Expenses
Hardly anybody considers logistics expenses through the lens of overstock indicator. Although the inventory logistics expenses with and without surplus differ due to three parameters:
- Inventory storage. The longer the product is in a warehouse or on a store shelf, the more it costs the company. Products may become out of code or lose their appearance, which can also have a negative effect.
- Interplant transfer. It also consumes a certain resource, both transport and human.
- Returns. We mean physical transport logistics, which also requires financial investments in the chain.
Imagine logistics as inventory following down the tunnel from point A to point B. While the inventory is within, the retailer incurs logistics expenses. That is why, in a perfect picture of the world, inventory should arrive quickly and sell out immediately so that there are no logistics expenses. However, this is not actually possible, and we have to understand the logistics expenses and how they affect the final margin.
How does surplus affect the cost of logistics? Let's perform some hypothetical calculations.
An average inventory indicator across the chain is 100. Of these, category A product accounts for 20, and category B - for 80. Let's say they sell the same per day – 1 unit per day. From here, we can calculate the turnover: category A has 20 days, and category B - has 80.
Now let's imagine that the total logistics expenses across the chain are 5% of the cost (remember that the average inventory indicator is 100). Then for category A products, this indicator will be 2%, and for category B - 8%. Let's remember these numbers.
Now let's see the difference in terms of marginality. Let's say that the mark-up for category A and B products is the same and amounts to 25%. We can subtract 5% (average chain logistical costs) and get the same figure – 20%. But if you differentiate the products, these indicators will be noticeably different:
category А: 25% — 2% = 23%
category B: 25% — 8% = 17%
As you can see, the margin of goods without surplus will be higher. Therefore, this factor should be taken into account, even if everything is on consignment or with a delay of payment.
Effect of Surplus on Sales
We have already found out that the company's cash flow depends on how quickly the products turn over. Surplus is tied up the chains’ money that may not be enough for something important.
For example, sometimes, the chain experiences cash gaps, and the company cannot purchase the fast-moving products on time. What is more, this often happens out of the retailer’s sight. It may happen so that the chain pays for delivery not within the specified period but a little later. One would think, what the big deal? But if this happens regularly, the agreement with the supplier is violated. Psychologically, an “equitable distribution” situation arises: if the chain fails to fulfill its payment obligations, the supplier may not meet its delivery obligations.
Let's assume, for a second, being the supplier. They have orders for a certain product from several retail chains. Currently, the supplier has this product in limited quantity that should be distributed among several retailers. Who will the supplier prefer? Certainly not the company that delays payments.
When a chain receives an orderless than due, lost sales appear, and few people can see the root cause of these consequences.
Conclusion: surpluses affect the availability of the goods due to the limited purchase budget.
A retail product is essentially a shelf. If a product occupies too much space, the company loses profit from the products that could be laid out there and sold.
It is important to understand and track the following overstock indicators:
- cost to the company;
- which SKUs and locations contribute to surplus the most.
Only by having access to complete and relevant information, you can build a system for working with overstock. LEAFIO Inventory Optimization makes it easy to manage surplus by providing all the reports you need.
OPTIMIZE AND AUTOMATIZE SURPLUS STOCK MANAGEMENT
Sometimes, the best way to solve a problem is to prevent it. Effective excess stock management can be achieved by implementing modern technologies into your business. Using Leafio software, you can gain control of product margins by increasing sales, turnover, and decreasing investment, automating routine operational tasks, and continuously controlling and optimizing your inventory, avoiding the problem of surplus stock altogether. Leafio automatically calculates target stock levels and replenishes the inventory whenever necessary, thus optimizing your product range.
Leafio is a next-generation digital supply chain for optimizing and automating surplus stock management. It can make highly accurate demand forecasts and conduct insightful analytics that helps optimize business inventory. For businesses that deal with food products, a special fresh algorithm is designed specifically for perishable goods order management. Orders are generated based on demand, residual shelf life, order execution time, and current balances. This will help you always to keep your inventory fresh and avoid stock surplus.
Thanks to Leafio, you will be able to reduce overstocks significantly and control and optimize your inventory without having to do all the work yourself.
Returns to the supplier
A growing number of chains are moving away from this practice because it is expensive and unprofitable in terms of operational processes. Although if there is a regulation on the return and it is not too costly, you can use it.
Redistribution of goods within your own supply chain
This is a fairly rational approach, but logistical expenses costs are increasing, decreasing the margin.
Sales and discounts
This is actually true for FRESH category products when the expiration date is coming to an end, and it is wiser to sell them as quickly as possible. Of course, this practice has a negative impact on the final financial results due to the loss of margin.
To do nothing
That would surely be easier. However, this is a road to nowhere, especially in today's competitive environment.
Surplus and its impact on business are often underestimated. Many retailers are more focused on lost sales indicators and reducing payroll fund costs. However, the surplus is really important for the business's health since it gradually affects the retailer's internal business processes, ultimately affecting the entire chain's profitability. By shifting this problem to suppliers, you can lose huge amounts of money without even noticing it. Therefore, to begin with, the surplus should be counted, and its impact should be analyzed, and then figure out what to do with it.