In our personal lives we often get offers for free samples, free trials, and free products. If we had to pay, it’s highly likely we would not purchase such an item. Unless the free item proved useful to you, would you keep it if your living space was tight? The solution is apparent because you have no personal investment in the item. What would you do if you paid for it? Does the “no-cost” product have any real value to you? Would you recognize that keeping it could actually cost you?
Many companies, particularly those that are either in financial distress or facing rapid growth, address a similar question with respect to purchased inventory that they don’t need. Companies keep numerous products that haven’t sold in a long time and have no reasonable prospect of being sold, without understanding the true costs and consequences. In addition, company managements know but don’t adhere to proper inventory stocking levels they themselves have established; they therefore also invest in and carry excess quantities of inventory (in addition to non-saleable products).
Often dead items and overstock account for 40% to 50% or more of total inventory and of storage space as well. Management may believe there is little or no cost, especially if the surplus or dated inventory has been written off the books. In fact, there are major hidden costs being incurred, an internal tax, if you will, on keeping such inventory.
Those higher costs can be either hard or soft, such as:
- Opportunity costs related to using valuable storage space as well as equipment needed to move or relocate excess inventory, resources that could be redeployed to productive use or even reduce the outlays for leasing equipment and space
- Staff costs to track, handle and secure such products
- The penalties of lower customer service because active inventory is less easily accessed
- Freeing up working capital that is tied up in such inventory, even if it’s only salvage value, and avoiding the interest cost thereon
- Reducing the cost of insurance and security associated with protecting investment in excess inventory.
Management can calculate how much space such product occupies and how much longer is required to store and/or pick orders from active stock because wasted space has to be traversed. In turn, we can compute the incremental requirements for staff and equipment. The additional time to store and pick product also diminishes customer service on product that is selling. By determining the true, full costs of excess and inactive inventory, management can decide which of these non-saleable products, if any, should be kept and which can be economically disposed of. A review of this type will also uncover the reasons for accumulation of such inventory in the first place and how to prevent a recurrence.
Costs will be reduced dramatically, and the time to perform all operational functions will also decrease. How can one argue against having improved customer service while reducing costs? The real advantages will be realized in increased profits, cash flow and competitive edge. This is a “tax cut” that everyone in business can get behind.