Excess inventory – competitive advantage or margin killer?
- Last update: 20.11.2022
- Published: 23.05.2022
If you are running an e-commerce business, you are certainly well aware that keeping inventory levels at an appropriate, safe level tends to be a demanding job.
Neither the situation, in which you face a shortage of goods nor the one when the stock is ample enough to last for the next two years, are desired by you. Nevertheless, in recent years, the latter has become an increasingly common problem, and receiving an unexpectedly high invoice for product warehousing is the straw that breaks the camel’s back.
In the following article, you will find out where excess inventory in your warehouse is coming from, and how it significantly affects your bottom line. We will also tell you how to reduce the chances of their occurrence and describe some of the best practices that will allow you to deal with this unpleasant nuisance if it does occur.
When is a stock excessive?
It is definitely more difficult to define which inventory level is too high than vice versa. The lack of inventory is crystal clear. If I don’t have the goods available and a customer wants to order them, I have a shortage. However, how do I determine when I have overstocked an item?
According to some retailers, even a week’s level of stock is considered too high. In other businesses, only a stockpile that covers monthly or even semi-annual needs will be considered excessive.
Each company must find its own answer, sticking to the generally accepted principle: “the level of inventory is considered good when the cost of having it is less than the cost of not having it” . While doing so, note that only that part of the inventory that exceeds our limit should be referred to as surplus. Everything else is our normal inventory, which is used to handle ongoing customer orders.
What is the root of this problem?
There are many reasons behind the situation of excess inventory. Quite often we can come across a very vague answer to this question, pointing towards poor planning and inadequate communication as the cause.
Although this statement is true, presented in such a general way it does not help to understand the root causes of problems, and thus does not help to eliminate them.
The most common causes are listed below:
- The minimum order quantity (MOQ), which guarantees you very attractive purchase prices, is significantly higher than your realistic needs. With the smallest possible order, lack of inventory will be the last thing on your mind for many months.
- Treating goods shortages with over-ordering. When shortages do occur, you try to avoid their recurrence at all costs, knowing that this is the worst possible thing for your business. In order to avoid a repeat of the above, you often order more than necessary, against reason and as a result of a bad experience.
- Overestimated customer demand. Most common situation when developing new products, or when colliding with short-term trends. Seeing how sales are booming, you assume that this pace will continue. This, however, is not the case. The planned promotion failed to bring the expected results, the market trend has passed, and you are left with excess inventory.
- Inadequate inventory control. When deciding whether to place another order, you rely on the information available to you. However, if inventory records are not kept accurately and up-to-date, it is easy to make a mistake, such as ordering the same item twice because the previous one has not yet been recorded in the statement.
- Disruption of the supply chain. Based on the assumption that the holiday season brings the highest sales, you arrange a delivery for the beginning of the month. However, it turns out that for unknown reasons the market has run out of drivers and the shipping time has been stretched to the point that your super-needed supplies arrived on 28.12, which is precisely when no one actually needs them anymore.
- Lack of established inventory management rules. Since there is no set limit at which to maintain stocks, there is nothing stopping you from ordering a little more goods, disregarding the threat of surplus. Especially since the extra quantities can help you fill your shipment and reduce the unit cost for transportation. After all, it would be a shame to let half the truck go empty.
Consequences of excess inventory
It may seem better to have more inventory than less. After all, a dissatisfied customer due to the lack of available goods is a customer that is easy to permanently lose. So, why take the risk of shortages?
There is much truth in this mindset. However, are you aware of how much excess inventory in fact costs you? While there are actually large lost revenue costs behind the unavailability of goods, the fact is that the cost of excess inventory can be much higher than that.
Listed below are some of the most damaging consequences of excess inventory.
- Storage costs – especially noticeable when you are renting space from an external company and have to pay for each occupied pallet or shelf location. It’s impossible to argue with the bill you are required to pay. Even if the only purpose of the goods stored there is to catch dust, they take up space and generate costs.
- Damage and non-conformance costs – no matter how careful you are about the quality of your warehouse operations and ensuring safety in moving around, damage is bound to happen. The more goods you store, the more damage and costs related to it will occur.
- Costs of terminating products – this category applies primarily to fast-moving consumer goods. Once the designated expiration date has passed, we can no longer sell them, and their disposal is a serious financial burden due to the cost of the operation itself, as well as their production or purchase. We still face this challenge with other categories, however, in such cases we are more concerned with, for example, going out of fashion or the introduction of newer and better models to the market, so that sales of the ones we have decrease and they also face disposal or are sold at a negative margin.
- The cost of frozen money – if the acquisition of inventory was covered by funds loaned from the bank, you can consider that your cost is all the interest and commissions that you have to pay to the bank. With better inventory management, you might be able to avoid taking a loan and the costs that go with altogether. The situation is no different when the capital comes from your pocket. Remember, you make money when you turn those funds around. Instead of too much of one commodity tying up your cash, it would be better to invest in another assortment of products that happen to be in high demand right now, and you don’t have enough inventory available to meet demand.
- Administration cost – whether your stock is rotating or not, you have to spend time monitoring its level. This time is a cost incurred by you, a cost that is better spent, for example, on conquering new markets.
- Transportation cost – this is one that we typically can only talk about when our surplus has already been disposed of, such as through disposal or by giving away freebies to employees. It is an unnecessary cost and an excessive burden on your bottom line, and completely avoidable.
Inventory management as the remedy to an inventory tsunami
When thinking about a solution to the oversupply problem, it is useful to use a metaphorical example to better understand the complexity of the problem.
Now imagine that in the bathroom we have closed the drain in the sink and turned on the tap, from which the water is running in a constant stream. Slowly but steadily, the sink fills up, until at some point the water begins to overflow, flowing onto the floor and inevitably flooding us. The same is true of excessive supplies. They accrue slowly, but at some point they begin to bother us, and eventually flood us. The same goes for excessive inventory. They grow slowly, but at some point, they begin to bother us, and ultimately flood us.
Upon observing such a situation, we should carry out two main actions. The first is to turn off the tap, that is, to cut off the possibility of new excess water. Only the second is to get down on our knees and start cleaning the floor and wiping up the puddle.
Defining a clear method for handling both is what inventory management is all about. This involves defining rules on how to take care of inventory so that we won’t suffer from shortages or surpluses, as well as how to deal with them once they occur. For this purpose, we can turn to methodologies such as MRP (Material Requirements Planning) or DDMRP (Demand Driven Material Requirements Planning), or simply work out our own way, based on the following guidelines.
Turn off the tap - prevent overstocking
Preventing the problem from arising is the best way to deal with the issue of surpluses. It is definitely easier and cheaper to prevent the situation than to battle its negative consequences later. Since the root cause is making poor purchasing decisions, prioritising on improving their quality should bring you closer to satisfying results.
- Invest in a software that will record information about your inventory – both what you already have in stock and what items are on their way. The first step toward making good decisions must be knowing what place you are at today and how much inventory you actually have available.
- Establish clear inventory management policies. Regardless of whether they are created by yourself, or whether you use existing ones such as DDMRP or MRP, you need to clearly define what inventory levels are desirable for you, and when to start referring to it as excess inventory. Another necessary step will also be to define rules for when and in what quantities you will place further orders. These will be your main decision-making guidelines.
- Monitor current sales. Systematically monitor the level of new orders you receive, in order to understand changes in customer behavior and trends.
- Define KPIs (Key Performance Indicators) that will allow you to easily monitor your inventory situation.
- Prioritise your work. By using the ABC classification, based on the Paretto principle, you can identify which inventory items are most important to you and focus most of your attention on them, while those with a small contribution to inventory and sales can be inspected somewhat less frequently.
- Analyse trends. Before adding a new product to your assortment, conduct a market analysis. Check what trends are currently dominating the market. Compare your assumptions with similar products in your product range. Be prepared prior to placing an order, which may block your inventory and resources for the next 2 years.
Clean up your floor - cleaning actions for excessive inventory
Even when you have all the preventive measures mastered to perfection, it is inevitable that sooner or later you will have to face surpluses. There are instances that cannot be predicted or prevented in any way, and then it is useful to have a thought-out action plan.
This category primarily includes sudden events arising in the external environment It could be the introduction of a more interesting or cheaper product by your competitors, a sudden change in a market trend, or simply human error when doing calculations and placing an order with a supplier. Whatever the reason, you should know exactly how to handle such a situation.
- Draw conclusions. Ok, I agree this point may not necessarly reduce the inventory of a problematic product, nevertheless it is your mandatory action point. First, you need to understand what is causing this situation to prevent it from happening again in the future. Remember that making mistakes is not the problem, the problem is when you repeat them.
- Resell the surplus of goods to your supplier or another company. Keep in mind that while you are facing a surplus of a particular commodity, others may still need it. It is possible that with your order you have cleared out the supplier’s warehouse and there are a few takers on the market who will even pay extra for the availability.
- Run a contest. Use some of the surplus to promote your business. You are able to engage existing and new customers with an interesting contest format, featuring a surplus product as the prize.
- Make a promotion. A strong price cut off the bat is an effective way to boost purchasing interest. Customers tend to like discounts ranging from 50%, 60%, 70%. Your goal is to recover as much of your frozen funds as possible and reduce costs, so don’t be scared by this measure.
- Prioritise, perform a surplus analysis. For each one, determine what real costs it constitutes for you. Start solving problems starting with the most cost-consuming items. These are the ones your attention should be focused on.
What can we do to regain control?
In the e-commerce industry, the most effective and also the simplest solution is to take advantage of the DDMRP methodology. Its fundamental premise is to set accurate inventory buffers, derived from your sales and supplier terms. Not only do these buffers serve to protect you from shortages, but they also set a maximum inventory level for each product. produktu.
The second fundamental premise of this methodology is determining when to place your next order to a supplier or production order. We don’t go about this based on our forecasts or assumptions, but rather according to realistic customer demand, so we minimise the risk of excess inventory. Each time a product’s inventory reaches a certain level, we receive alerts that prompt us to place an order.
When these two foundations are combined with a daily review of the inventory situation, you receive a readymade recipe for regaining control of your inventory. Instead of focusing on constantly putting out fires, DDMRP will enable you to spend your valuable time growing your business.
Will this solution work in my case?
The answer to this question is very simple. It will work! The answer to this question is very simple. It will work! Any business that requires inventory, whether for the production of finished goods or commercial goods, will operate more efficiently when we define for ourselves the principles of inventory management. This first step already works wonders. However, once we add the use of simple applications that do most of the work for us and reduce the risk of human error to a minimum, we receive the perfect solution.