Guest blogger and trusted business associate, Bill Boyer is the President of Tidewater CEO, a consulting/coaching organization for small company CEO’s. He can be reached at firstname.lastname@example.org or 757-233-2577.
Unfortunately, most businesses got caught with too much inventory at the beginning of this major economic downturn. Were you in love with your inventory? What have you learned from this? What will you do to keep this from happening again?
This is definitely a problem for most smaller businesses. Larger corporations normally use formalized inventory controls systems that tend to force inventory down. Less sophisticated systems may be based solely on prior activity, which can result in too much or too little inventory because the systems don’t factor in current sales volume changes. In times of rapid change, it is very important to be able to override your purchasing systems based on current activity or informed judgment.
What can cause you to have excess inventory? Obviously, a precipitous fall in sales can cause problems for even the best-run companies. When you are able to buy your inventory at a reduced price, you may decide that the deal is too good to pass up. You may anticipate that your customer is going to increase their purchases, so you stock up so you will be able to ship on a timely basis. You may not be watching the sales activity of each of your products, and fail to decrease the order quantity for items that are decreasing in sales volume. Even when you are aware of the reduction, the salesperson for this inventory may convince you that the market will swing back. Or even worse, you don’t want to say no to the salesperson.
You must remember that inventory value usually decreases the longer you own it. If you are unable to use it, you may have to sell it in its original state to a discounter. Or you may decide to reduce the price of your product to get it sold. This may work, but if demand for this product increases again, you may find it difficult to get your pricing back up to the original price level.
While pricing reductions are at times necessary, you must always be aware of the impact on your bottom line. For example, if your margins are 25% and pricing is reduced 6%, sales volume will have to increase 32% to maintain the same profitability. Of course, it is better to sell at a reduced price than to throw it away or continue to pay the costs to finance it.
Up until now, we have discussed companies with physical inventory. Service companies do not have inventory as currently defined. But what about their labor force? Could this be considered inventory? Labor is probably the most expensive inventory in existence. Service “inventory” mistakes are far most costly than manufacturing ones, because labor is a very perishable commodity. Manufacturers can sell their excess inventory, but a service company can not. Cutting back on labor during a downturn must be done judiciously to avoid losing intellectual capital, and staffing up during an upturn requires similar care.
A true story:
Von was a used computer equipment dealer. The bulk of Von’s profits were made buying used equipment for pennies on the dollar, warehousing it, and finding a client who still used the items. Von felt that having too much inventory could not be an issue because he was buying it so inexpensively. Von’s inventory consistently outgrew his ability to fund its growth through profits, so he turned to his line of credit. The line grew…$100k…$200k…$500k. Because Von acquired the inventory so cheaply, controlling it seemed to be a waste of time. He did not ever take a physical inventory. When his bank forced him to take an inventory, he discovered that the newer items (valuable) were far outnumbered by the older items (no longer valuable). He had let obsolescence and overstocked go out of control. Of the total $650K inventory, only $250K was salable. $400K had to be written off. Von was forced into a workout with his bank. Fortunately, he recovered in three years. He now says, “I was not collecting baseball cards. Inventory is only worthwhile if you can quickly turn it into cash.”
Be cautious about adding inventory or staff. Find methods to run the company while staff and inventory are lean. Never have the “just in case” mentality. And no matter what the economic situation, clean up that inventory at least once a year. Your bias should be always to have too little. This is a great time to learn these techniques.