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Surplus inventory: Avoid it, identify it, sell it

by Gerry Aubert

A customer cancels a large order. A vendor offers a moderate discount to double an order for products you might sell over the next 12 months. This month's sales forecast is inaccurate. All of these scenarios can result in something industrial distributors dread: surplus inventory.

As much as distributors may like to tuck away the problem as easily as they can tuck away the surplus inventory in the dusty, back corner of their warehouse, they can't. The bottom line is that surplus inventory is one of the largest costs that today's industrial distributor faces. The cost of the products themselves, the loss of working cash and the ongoing holding costs are just a few ways that surplus inventory can eat away at bottom-line profits.

According to an article published in Barter News in January 2000, manufacturers, wholesalers, direct marketers and retailers have used corporate barter companies to move a portion of their surpluses, which in 1999 reached a staggering $350 billion. It's estimated that product overstock and surplus inventory will total $445 billion by 2002.

The magnitude of the problem warrants immediate and dedicated attention. In a soft, yet highly competitive economy, industrial distributors must find ways to avoid, identify and sell surplus inventory.

Avoid it
Obviously, the best way to eliminate the cost of surplus inventory is to avoid it all together. Industrial distributors know that's often easier said than done. By reacting quickly to accurate customer and vendor intelligence, improving the procurement and inventory processes, and changing ineffective processes and procedures, you can succeed in avoiding some level of surplus inventory.

One Midwest industrial fastener distributor succeeded in doing just that. The distributor planned inventory requirements and stocking levels using customer-supplied forecasts. Customers provide their estimated annual usage and a normal replenishment quantity. By combining these estimates with actual demand history, the distributor determined a stocking level and passed that information onto its manufacturers. Manufacturers then used this data to ensure on-hand quantities reflected forecasted needs and produced only what was required. The distributor improved service levels and could now order just in time. In this case, inventory managers cut inventory stocking levels by up to 50 percent while service levels remained stable.

As with any improvement project, distributors must begin by determining where within their organization lies the largest opportunity to avoid surplus inventory. Companies may want to consider improvements in the following areas.

Collect accurate customer and vendor intelligence-and react quickly. Industrial distributors must find ways to understand customer requirements and current trends or promotions in order to generate accurate sales forecasts. The more quickly you know about an order change, a quality or cost issue or a service concern, the more quickly you can react. An online, fully integrated Web site that allows customers to access product information, review and update demand requirements, enter orders or change existing orders gives you immediate, real-time access to customer decisions. A well-trained sales force tuned into customer needs can also be a valuable source of intelligence.

On the vendor side, you must maintain constant communication with suppliers to ensure timely knowledge about discontinued products, product recalls, planned obsolescence and warranty issues. Ideally, you and your suppliers should have visibility into one another's pipelines so that all parties have real-time information to make the best business decisions. Exchanging production and requirements information through daily reports or e-mail file transfers may improve communication. Establishing a vendor rating program based on suppliers' responsiveness, accuracy of information and other criteria may also help.

Get demand and inventory information under control. Managing the tremendous amount of information that revolves around demand, products and inventory is probably the single most difficult-yet most critical-task to accomplish in order to avoid surplus inventory.

Industrial distributors must maintain accurate demand statistics by item, product, period, location and customer. It's critical to implement a business system that allows tracking of promotional, internal transfer, component, special order and direct demand. Order cancellations and substitution demand can erroneously boost demand data.

Classify items based on product life cycle such as "new," "rising," or "declining."  Also classify items by customer agreement and demand pattern as well as by criticality, which refers to slow-moving service items required to retain business.

Paint an accurate "big picture."  Once you have your demand and inventory information under control, get the details of the "big picture" in order. Understand each combination of stocking location, buyer, product category, supplier and functional classifications.

For example, anticipate demand surges or droughts or take advantage of current costs to avoid anticipated price increases. Balance consumption rates against efficient production and fulfillment rates, and transportation inventories need to cover all stops along a product's journey.

Manage stocking inventory by days of supply, lot control for shelf life and aging analysis. Non-stocking inventory (or items that should have zero on-hand balances) should include only direct ship, special order, obsolete or de-listed items.

Review and change company policies to minimize surplus inventory. Review existing company policies, which should provide safeguards against surplus inventory-not encourage additional purchasing and stocking.

Policies dictating purchasing and replenishment decisions should keep the "days of supply" requirement low and adjust forecasting to reflect different product life cycle stages. Avoid vendor super sales unless there is significant ROI. Take the time to find flexible vendors that accept forecasting requirements and will ship based on demanded quantities instead of pre-determined minimum quantities. Be sure that supplier backorders can be cancelled within a generous time frame.

Stocking policies should include "no returns after" and "no returns before" deadlines. Create incentives to encourage customers to accept a total quantity of special items. Implement customer end-of-life and final sales agreements, which require customers to purchase all on-hand quantities at a set time. Enforce strict write-off policies to ensure timely stock elimination and then immediately scrap the products.

Identify it
Every industrial distributor knows that surplus inventory exists; finding that surplus can sometimes be a challenge. Some likely causes for surplus inventory include a loss of a customer or supplier, a new competitor, the end of a season or product lifecycle, or an internal consolidation or branch closure. Distributors need to prioritize their surplus inventory by shelf life, aging, investment value and turnover. Closely examine trends. For example, management issues might cause problems with inventory location while training issues might contribute to buyer-related surplus inventory.

A large paper distributor pinpointed its surplus inventory by using simple quarterly reports. The organization used an ABC analysis, which is a popularity ranking of products based on items such as volume, profit and turnover, to create a quarterly list of products that did not meet minimum Gross Margin Return on Investment (GMROI) objectives. Buyers and merchandising staff were then responsible for either eliminating the product or raising the GMROI of the product above required minimum levels within the next quarter. Depending on the product and situation, the distributor successfully improved the GMROI through better forecasts, more frequent ordering, lower minimums, better billing terms and improved margins. The distributor successfully improved inventory turnover from six to eight turns while at the same time increasing service levels.

Remember the following when identifying and attempting to control surplus inventory.

Once you identify surplus inventory, determine what quantity you need. Use product forecasts to determine quantities needed to support sales and adjust for just-in-time items. Take into account short-term supply needed to fulfill expected orders.

Maintain inventory control through returns, monitoring and policies. Mistakes in vendor shipments, late or cancelled backorders and customer returns should be returned to the vendor. Establish policies that do not allow customer bulk returns of items not purchased, obsolete, recalled, or non-returnable final sale items, and repackaged items.

Eliminate it
Jon Schreibfeder, president of Effective Inventory Management Inc., reminds industrial distributors that purchased inventory is a "sunk" cost. It's paid for, and no matter what it's worth now, the money's still gone. Once surplus inventory exists, distributors must find ways to recoup as much of the cost as possible.

One North America industrial distributor found a successful way to redirect some of its surplus inventory within its own organization. The distributor launched an internal surplus removal program, which used surplus inventory at key locations to replenish the normal requirements of other internal locations. When buyers reviewed their suggested orders, they provided information about surplus quantities first so that stock was transferred rather than purchased. Although some freight costs were incurred, interest charge reductions and restocking charge avoidance successfully offset these costs.

To effectively eliminate surplus inventory, industrial distributors should appoint a "surplus czar" to coordinate the surplus management process. The czar must work with both sales and purchasing departments to eliminate obsolete, de-listed and slow moving inventory items. Here's how:

Return products for cash or credit. Where possible, industrial distributors should return products to suppliers. Flexible return agreements with key suppliers must be negotiated at the beginning of the relationship. It's also helpful to develop a system that allows you to track and flag products that are nearing return date limits.

Explore any and all avenues for selling the surplus. By keeping accurate records of customer needs, you may be able to generate a list of customers who have purchased the products in the past or a list of strong cross-sell and up-sell candidates. Incentives such as freight allowances or lowest cost guarantees may move product more quickly. Promote surplus products in mailings, targeted e-mail campaigns or on the company Web site at clearance prices.

If existing products do not sell to existing customers, consider re-packaging products with complimentary items, reworking products to make them saleable or finding new customers either domestically or overseas.

As a last resort, surplus items can be sold to an auction or a clearance vendor, donated to a charitable cause or sold for recovery.

With the right strategy, software and systems, industrial distributors can successfully avoid, identify and eliminate surplus inventory. Depending on the industry and the organization, such an effort can save thousands to hundreds of thousands of dollars annually. The worldwide market continues to raise the competitive bar, and today's economy remains soft. Tackling challenges such as surplus inventory can mean big savings across the board.

Gerry Aubert is senior business consultant for Frontstep Inc. Based in Columbus, Ohio, Frontstep is a provider of software and services for growing, midsize manufacturers, distributors and subsidiaries of Fortune 500 companies. Visit www.frontstep.com for more information.

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