You know that area in the back corner of the warehouse where nobody ever goes?
Where dusty and faded stock that may have been top sellers years ago is now ungracefully aging until one day when its value is fully depreciated it will finally move from the racks to the waste bin. Sound familiar? Every distributor carries what I call ‘legacy inventory’ or more commonly referred to as obsolete inventory.
This is inventory that the distributor previously bought, that he is insuring and sheltering, that is taking up valuable space, but which is going nowhere. It hasn’t sold in months, possibly years. It just keeps growing and growing.
Few, distributors are immune to this phenomenon. In fact, the value of excess and obsolete inventory in most distributor’s inventories is likely greater than 35% of the total value, often much more.
Two questions emerge:
Obsolete inventory – what can be done to prevent it from occurring?
Let’s first address ‘why’ it happens. The answer most likely lies within the company’s purchasing practices. Within the purchasing department people are charged with purchasing stock from the company’s suppliers. They spend large amounts every day.
Their responsibility is to ensure that product continues to flow from the supplier through to the company’s distribution facilities. It is in the interests of this group to ensure that product is always available when the customer needs it. In fact, there is an inherent bias (It’s called customer service) to err on the side of too much.
For this key group, the ramifications of not providing enough stock are great and quite unpleasant. Furthermore, buying more than is necessary rarely raises management’s collective eyebrows. Over time, the business realizes that overall inventory turnover is very low, that there is a wealth of excess and obsolete inventory and the challenge to improve the situation suddenly becomes a mighty task.
In the absence of effective tools to support the buying task, the experience and judgement of the buyer becomes the primary basis for determining what to buy, when to buy it and how much to buy. Every purchase potentially adds a small bit to the growing legacy stash. For most, there is no offsetting process to identify excesses and obsolete inventory and remove it while it still has value.
Periodically, often once a year, someone will be charged with identifying “everything that hasn’t sold in the last 12 – 18 – 24 months or more”. Based on that, the company may take a write-down. This is not a full recovery of all the monies erroneously spent. It is only partial compensation. Also, the amount of the annual write-off is limited by the Tax man. It is certainly not a solution to the problem.
What can be done to prevent or at least minimize obsolete inventory ‘creep’?
The answer lies in the tools the company does (or does not) provide its purchasing group. Foremost is the company’s ERP, the heart of the company’s digital foundation, the primary source of the procurement staff’s information. There are many excellent ERP’s out there.
They track everything about inventories; location, cost, quantity, on order etc., but they usually aren’t the best at ‘managing’ or ‘optimizing’ what is carried in stock. To do the job effectively, the buyer needs sound ‘Order Points’ or what many will recognize as Min Max levels. These Order Points ‘trigger’ procurement response. When stock levels drop to or below the Min setting, it’s time to order. The quantity to order is dictated by the Max.
The good news is that most ERP’s provide the facility to store hundreds of thousands of Min Max values – a set for every SKU in inventory at every location where it is stocked. The bad news is that most ERP’s have no facility to determine what the Min and Max values should be, let alone keep them current. Somebody or some other system must provide and maintain these values.
Min Max values are anything but static. They change with the seasons; they are influenced by changing markets; and they change as new products are introduced and old products become obsolete. When accurate Min Max values are provided to the ERP, the ERP can determine when a SKU has reached its re-order point (Min) and alert the buyer.
Many ERP’s will actually create a draft or suggested P.O. for the buyer, but only if Min and Max values are present. These suggested P.O.’s are based on fact rather than ‘human judgement’. The human judgement can be best utilized in vetting the ERP’s suggested order.
How often should you refresh min/max
What if the company only updates Min Max values infrequently, say once or twice a year? Not using order points has already been shown as the key reason for inventory creep. Updating them infrequently would be fine if nothing ever changed. But conditions do change. Constantly. For example, a Min value of 150 units for snow shovels may make perfect sense in December, but it should likely be zero in June. That is a very obvious example. What about the hundreds of SKU’s whose variability throughout the year is far less obvious?
If your company’s ERP can accommodate Min Max values, there are effective, inexpensive solutions available, solutions that – forecast demands, calculate Min and Max values, and upload to your ERP. Consider the value of ‘better buying’ if a solution could refresh and re-populate your order points in your ERP, every day, automatically?
Consider also the impact on obsolete inventory creep if that same solution could present to you at any time, details of what is excessive or non-performing. For a more effective and more efficient process, let the ERP determine the buying decisions for the majority of your SKU’s. Let your procurement staff focus their attention on those that may be more questionable.