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Inventory myths

Belief in these four myths may be costing you money

by Joan Adams

Inventory is the lifeblood of any distributor. Without it what would we do? What would we sell? Still, far too many folks in our business think of inventory as wealth, therefore, the more inventory the better. On warehouse tours, I have had company presidents show me the warehouse, and while admiring the racks upon racks of inventory, tell me while beaming with great pride, “We have over X million dollars in inventory!” They think they are showing off this apparent abundance of wealth. Meanwhile, I am quietly cringing – thinking to myself – “That’s a whole lot of money to be tied up in something that is not readily convertible into cold, hard cash.”

There are arguments for carrying lots of inventory. I believe I have heard them all over the years. Let’s take a quick look to see how valid some of the arguments are.

1) We can’t have stock outs
I completely agree. No distribution manager wants to find himself saying, “Gee, I am sorry, we don’t seem to have that part, and the order lead time is six weeks.” Instead, he wants to be able to have the goods on hand so he can ship to his customers in a timely manner. Meaning, there are certain items that a distributor must buy in advance and keep stocked. This doesn’t mean a distributor has to buy everything it carries ahead of time and in quantity. If an item can be replenished in a week then there’s no reason to buy more than a week’s worth. Obscure items (these typically have very long lead times) are a dodgier proposition. You want them in stock but they don’t sell with any regularity. When you buy a bunch of these, it could be a very long time before a customer orders one. In the meantime, you are stuck with them, maybe all the way into obsolescence.

2) If we buy more – we get a much better price
Hold on, wait a minute. If we get out the sharp pencil and do the calculations, is the price really so much better? When a distributor buys a large quantity, they take on the risk and the handling of these items; they tie up their cash hoping to make a good return some time in the future. These items all need to be stored, under a roof, so essentially they are getting free rent. The outlay of cash was up front. For every month that goes by and the distributor has not sold all that high-volume inventory, it loses interest. By which I mean – had the distributor put the money in the bank – each month it would earn interest. That hardware isn’t making you any money, it’s tying it up. In short, the risk of obsolescence, damage or simple lack of demand is completely borne by the distributor. The manufacturer is in dandy shape. He/she made the items, shipped them and got paid. Now, instead of having boatloads of inventory filling his warehouse, his cash is in the bank, earning interest, and on hand if the need for cash arises.

3) Inventory is an asset (like money in the bank)
Except for it’s not. Let’s say that sales are $10,000 a day on average (I am picking an easy number for the math). In this case the “money in the bank” or cash on hand comes out to exactly $50,000 a week, not that $2.5 million tied up in inventory. Stop and think about it. If you needed to lay your hands on a cool million for some projects (new trucks, new racking system in the warehouse and new ERP system), you can’t just reach into the inventory bank and pay people with MRO supplies, you would need to sell more than $1 million worth of inventory (there are carrying costs, overhead, people, warehouse, etc., to pay for) in order to get your hands on that cool million.

4) A wide variety of inventory enables us to sell to a wide variety of customers
Maybe. Mostly a wide variety of inventory means lots and lots of stuff. The more different items you carry the more complicated managing inventory becomes. You are now stocking more items, buying from more vendors, taking more deliveries into the warehouse . . . and so on. To my mind, More stuff = More work. I also am a big believer in specialization. When I had a ’65 Mustang convertible I took it to a place that specialized in Mustang service. I would never have taken it to a place that advertised “We service all cars, foreign and domestic.” I think a wide spectrum of inventory distracts the distributor from its specialty, its particular focus. Many of your customers feel the same way.

Don’t get me wrong. Inventory is necessary, good and valuable. It’s what makes our business tick. The distributor that manages its inventory well will have the right inventory in the correct amounts on hand at all times to offer their customers. And that’s a huge competitive advantage.

Joan S. Adams has consulted for industrial clients for more than 20 years. She operates Pierian, a consultancy that brings sustained and measurable success through operational excellence, customer focus and competitive market strategy. She has engineering degrees from the UW-Madison and MIT. E-mail her at adams@pierian.net.

This article originally appeared in the May/June 2012 issue of Industrial Supply magazine. Copyright 2012, Direct Business Media.

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