5 Steps to Reduce Excess and Obsolete Inventory
- 1 Identify your excess and obsolete inventory
- 2 Evaluate whether the excess inventory is ‘risky’ (could become obsolete
- 3 Understand the causes of your excess and obsolete inventory
- 4 Find proactive ways to reduce excess and prevent obsolete inventory
If you type ‘excess stock’ into any search engine you’ll find a wealth of companies offering to buy your surplus inventory so you can instantly get a cash injection and free-up space in your warehouse – but at what cost? Excess inventory has many disadvantages, including the risk of it becoming obsolete. Selling excess inventory items is a quick way to reduce your stock levels and alleviate cash problems, but it’s certainly not the smartest! Often this results in a hefty dent to your profit margins!
In this post we look at proactive measures you can take to reduce excess inventory levels in your business. Our approach is to prevent the problem occurring in the first place by following a number of simple steps.
1. Identify your excess and obsolete inventory
Try to categorise your stock into three categories:
Healthy inventory: Also called cycle stock. This is the inventory you plan to sell, based on demand forecasts.
Excess inventory: When stock levels for a product plus buffer stock exceed forecasted demand.
Obsolete inventory: When stock remains in the warehouse and there is no demand for it over a prolonged period of time (typically for at least 12 months).
This information is a great starting point to understand if you have a problem with excess and obsolete inventory.
2. Evaluate whether the excess inventory is ‘risky’ (could become obsolete)
Sometimes it’s OK to have higher levels of stock than demand requires. For example, if you have high volumes of fast-moving items that continuously sell well, no problem! You can easily lower current stock levels by reordering less and using up the surplus.
However, excess stock becomes a risk when you have high volumes of items sat in your warehouse that are slow moving or have volatile demand e.g periods of low or no sales, or have declining demand i.e they are coming to the end of their product lifecycle. You therefore need to identify these items and put a plan together to reduce their stock levels and prevent obsolescence.
3. Understand the causes of your excess and obsolete inventory
There can be many reasons why you have excess inventory. Most often it’s down to:
1. Poor demand forecasting capabilities
2. Needing to mitigate supply risks e.g the consequences of a no-deal Brexit or regularly inconsistent supplier lead times
3. A desire to ensure 100% stock availability (service levels)
4. A complex supply chain (this could be multi-tier (echelon) or multi-site)
5. Purely bad decisions
4. Find proactive ways to reduce excess and prevent obsolete inventory
Prevent excess inventory with better demand forecasting
If your demand forecasting regularly leads to over or under stocking, it’s time to look at ways to improve it. For starters, forecasting based on number of stock days is an over-simplistic and inadequate method for predicting demand. Instead you need to consider moving to statistical demand forecasting techniques that will take into account demand trends, seasonality and promotional activity.
Statistical forecasting carried out by inventory optimisation software, such as EazyStock, will analyse every product in your portfolio and assign a demand type according to its position in the product life cycle. This means that as a product moves through the growth, maturity and decline stages, and its demand patterns change as a consequence, the algorithms used to calculate demand will also dynamically update to make forecasts as accurate as possible.
Don’t use excess stock to mitigate supply risks
Carrying excess stock is not the answer to alleviating issues with your supplier lead times. Instead you need to address this problem by:
Planning for supplier holidays in advance: If you know when your suppliers shut down e.g for annual holidays, Chinese New Year etc, add these periods of closure to your lead times and adjust reordering points accordingly.
Monitoring supplier lead times: Keep track of your suppliers’ lead times – are they sticking to their service level agreements, or are they often late? If it’s the latter, get the issue sorted at source. In the meantime, add adequate safety stock, (buffer stock) to your inventory to cover delays.
Read our post on effective inventory replenishment for more information on managing supply and demand variables to reduce excess inventory.
Carrying excess inventory is no way to reduce stockouts
It’s a massive misconception to think that holding lots of stock is the only way to ensure product availability – this is simply not the case!!! Of all the tips in this post, this is the biggest takeaway. It’s possible to have high service levels and achieve excellent stock availability without carrying high volumes of every item in your warehouse. The key is to use inventory optimisation techniques when setting your stocking policies.
This means going beyond simple ABC analysis. Instead you need to prioritise which inventory items to carry based on multi-dimensional criteria, such as demand types, pick frequency, demand volatility and cost to sell (or profitability). This allows you to set the stock levels of every item in your warehouse according to how well it sells and how much it costs the business. A typical inventory policy matrix may look something like this:
Here, the items in the light orange, bottom right categories are picked most frequently and are cheap the sell, so are usually stocked in greater quantities than those dark orange, that are picked less and are more expensive to the business.
Every company’s inventory matrix will look different (and you can have more than one for different product categories), for example, a catalogue business may wish to stock all items and would therefore have all boxes shaded in to some degree.
For each category, you should set a service level (stock availability) target. Typically, these would be higher for products that are picked more frequently and have a lower cost to sell. The aim is to find a balance between the capital you invest in stock, versus your ideal availability targets.
With stocking policies in place for every SKU that define individual stock levels and associated fulfilment targets, the risk of excess and obsolete inventory is dramatically reduced.
Obviously, creating an inventory matrix with this much detail could be very challenging without inventory optimisation software. A tool such as EazyStock will undertake all the hard work for you and, as demand, pick frequency and costs change, will automatically move inventory from box to box, dynamically adjusting recommended stocking levels.
Optimise inventory levels throughout your supply chain
If you have a multi-tier (echelon) supply chain or carry stock across multiple locations it can be difficult to prevent excess inventory from building up. For example, if you have decentralised ordering its very common for inventory planners to order ‘a little extra’ and inflate their forecasts to cover the risk of run-out. But do this across each stock location and these ‘little extras’ will amount to high levels of surplus stock.
The answer is to plan and manage inventory with one centralised view. Systems, such as EazyStock, allow forecasting and reordering to be based on point of sale demand data, not demand at each stage of the supply chain. In addition, with a view of stock levels across all locations, inventory can be balanced out. This means excess stock at one location can be redistributed to other sites, where levels of the same item are low, before needing to order more from the supplier.
By managing your inventory across all echelons, or locations you’ll quickly remove surplus stock from your supply chain and the risk of obsolete items appearing on warehouse shelves.
It’s easy to be tempted to buy in bulk to get the best price on an order. And, if the items will move quickly off the shelves, it may not be a bad idea. But, if it the goods are slower-moving with erratic or declining demand, you should think again. It’s no good getting a cheap price for inventory that’s going to tie up capital and even worse, be at risk of becoming obsolete and sold at a discounted rate.
Excess inventory may also be a result of setting your minimum order quantities too high. If this is the case, renegotiate! Do the maths: it may be better to pay a higher unit rate for smaller order quantities, than have cash tied up in stock that isn’t moving fast enough through the warehouse.
Excess and obsolete inventory can be very problematic to businesses, and finding proactive ways to prevent stock build up can bring major benefits. Improved cash flow, more working capital, a better inventory turnover ratio and lower storage costs will all help ensure a healthy profit margin.