Each business is unique, with its own strategies, KPIs, metrics and inventory management approaches. However, the challenges and problems businesses face when dealing with inventory are often the same and can affect any business of any size.
What is excess inventory?
Excess inventory is the number of items per stock-keeping unit (SKU) that exceeds the rationally calculated and cost-effective inventory level.
A rational cost-effective inventory level is calculated using the following metrics:
- Replenishment cycle. The number of days between current order placement and the next delivery. This indicator includes time needed to complete, process and deliver the order.
- Average sales (the number of items per SKU)
- Minimum order quantity. This includes packaging as some items are supplied per item and some are sold in boxes or packages.
To calculate the optimal level of inventory for a particular SKU you have to multiply the average replenishment cycle time by average sales, adding a minimum order quantity.
Retailers have to maintain an optimal inventory level for each product. Exceeding this optimal level leads to excess inventory.
What are the causes of excess inventory?
We have analyzed a number of client case studies and came to some conclusions. The main reasons retailers hold too much stock are:
1) Intuitive order forecasting and poor order calculation. Procurement managers often tend to order more inventory than is required or they base their orders on intuition and professional work experience rather than on real business needs and demand levels. The cases we analyzed showed that 80% of intuition-based orders result in overstocking.
2) Ordering in bulk. Suppliers often give discounts for larger orders. Sometimes, unethical suppliers can offer you discounts to get rid of their slow-moving goods. As a result, you end up carrying too much inventory that you cannot sell. If goods are not sold, they become dead stock. Some retailers we worked with complained that 3/4 of goods bought in bulk merely gather dust for more than a year, with only 1/4 of the batch getting sold.
3) Sometimes suppliers pay retailers extra money to secure a place for their products during a promotion season. This measure may seem a win-win situation for both retailer and the supplier, as the retailer gets guaranteed money and stock. However, if the promotion figures are not successful, or if the sales level is lower than expected, the retailer ends up with overstocked shelves and the money received from the supplier is not enough to cover losses.
4) Unfair practices and deals between procurement managers and suppliers. Unfortunately, sometimes managers can create dishonest relationships with suppliers. These orders have nothing to do with real business needs. Suppliers get rid of their dead stock by moving it to retailers’ warehouses.
5) Rarely, national or international suppliers set special order thresholds or minimal order quantities influencing the orders made by retailers.
6) Sudden drop in demand levels. If this happens, you have to quickly recalculate and reconsider your optimal inventory levels. Your current stock level will be higher than the optimal one. The more often you compare, the better.
What happens if you ignore your excess inventory?
Excess inventory is a tricky thing and you won’t find any magic formulae that will help you to alleviate stock issues. Therefore, many retailers pay little or no attention to overstocking and prefer to ignore the problem rather than deal with it. This is what can happen if you do this:
- Excess inventory eats up storage space and ties up your capital.
- Perishable goods can spoil. Other items can become outdated.
- Having too much stock for a particular category of goods limits your ability to order new goods and enlarge your product range.
A step-by-step guide to shedding excess stock
First, analyze your inventory, both in terms of quantity and money. We strongly recommend that you consider both terms and integrate them into your analysis. This will take a bit more time and effort, but is also more comprehensive.
If you compare both quantities and money spent on inventory you will see how much excess stock you have and which extra items are the most expensive. Sometimes retailers get rid of expensive excess inventory and it leads to nothing, the shelves remain stocked.
Accurate and complete analysis allows you to take further effective steps on dealing with excess stock.
Then, divide your excess stock into two groups:
- Excess items with regular sales and low demand.
- Inventory which is not expected to be sold quickly.
Inventory management solution can help you to group your stock by making a report on sales levels (inventory dynamics) for each product category/subcategory/SKU.
Low level goods sales need to be closely monitored. You have to understand the causes of extra inventory and mitigate them. Then you can concentrate on selling the existing extra items, balancing the inventory levels, or starting a promotion campaign to sell your overstock faster.
Dead inventory that is not likely to be sold should be taken off the shelves. Do not focus on the causes of deadstock, instead, find proactive and creative ways to manage it.
How should you manage deadstock?
- Return it to your supplier.
- Use obsolete inventory for your internal business needs (domestic production etc).
- Analyze inventory levels across all your sales locations. Transfer excess inventory to another sales location which may have better demand or a product shortage.
How do you transfer goods between sales locations?
If you have a distribution centre (DC), you can move your excess inventory there and redistribute it between other locations, or return it to the supplier.
If you do not have a DC, or transferring goods there may be a costly/logistically ineffective procedure, you can turn the closest or most suitable store into a temporary DC.
You can move goods between stores if they are closely located (in the same city/area/district/province), and if you are sure that your profits margins will not be affected. Sometimes logistics costs and transfer expenses are higher than the profit you may get.
After you eliminate your dead stock you must immediately take it out of the assortment range (or product matrix). If you still do not have an assortment matrix, we strongly recommend that you create one and regularly analyze it. Your assortment range should be up-to-date and filled with top-selling fast-moving and profitable goods.
Managing excess inventory is a complex process that requires long-term efforts by your company's management, procurement team and category managers. The risk of having excess stock is high, there are no risk-less periods or secrets. All you have to do to mitigate the risk of having too much stock is to carefully and accurately manage your inventory, deploying systematic, strategic and well-grounded methodologies of stock inventory control.