Edge Retail Academy Blog

What Price is your Inventory Really Costing You?

by David Brown

If there is one question that I am asked more often than any other by my clients, it is “How do I deal with my excess inventory?” It is a little of a ‘glass half empty’ question for some. A better question would be “How do I deal with my lack of sales relative to the inventory I have?”

Inventory is only excessive to the extent that you don’t have the sales to match it, and it is important that you always have capacity to grow your business further. Strangling growth from a shortage of good product can be a bigger issue than being awash with surplus inventory. That said, we deal with clients in several countries and there would be few of our international clients who run with the high level of surplus inventory commonly found in the US. The level of overstocking reaches almost pandemic proportions in some stores, and in reality, I am less concerned by the number of clients who ask the above question than the number who don’t!

Many see their oversupply of aged inventory as a non-issue, being under the assumption that it is still good, saleable product that could be purchased tomorrow, or that somehow this “nest egg” represents a retirement fund when the business is sold. Certainly, given the price of gold, several of these pieces would cost more to purchase from vendors today than they would have originally, but are they really saleable, to either the public or somebody buying your business? The answer is generally “no”.

Sadly, there is more bad news, as the longer the items are sitting on your shelf, the more they are costing you –even if you didn’t use debt to purchase them.

Let’s do an exercise with a pair of gold earrings that have cost $100 to purchase from the vendor. What is the true cost of these earrings if they are sitting on your shelf twelve months later?

Let’s look first at the one-off costs at time of purchase. There is freight to get it in-store, computer processing, time spent selecting the piece and time spent getting it displayed in the store. Let’s allow $5 for freight and another $10 for staff and your time in selecting the piece, processing it in-store and getting it on display.

Vendor cost $100

Staff time $10

Freight   $5

 

Initial costs   $115

 

On top of this we have holding costs for the 12 months. Lets use 5% interest for the year (although in more prosperous trading times this would be closer to 10%). In addition, we have the time spent cleaning and showing the piece during the twelve month period even though it hasn’t sold, plus insurance, a percentage of rent, advertising, boxing, the tax you had to pay on it given that you diverted ‘profit’ to purchase it … and so on.

Interest $5

Staff cleaning and other costs $10

Note: Most financial and industry experts agree that the ‘holding cost’ associated with non-performing inventory is 20% per annum.

So even giving you the benefit of the doubt, we are already up to $130 cost for this item in just twelve months and we have not allocated any packaging yet because it hasn’t sold. If the item needs to be reduced and cleared after this period these costs will further reduce the profit on the item – if there is any.

But the real cost of this item is the opportunity cost that has been missed. Opportunity Cost is a term often discussed in economics. It represents the cost of the opportunity missed by choosing this particular action, as opposed to another. In the case of our jewelry example, the cost is the missed profit that could have been achieved if another faster selling item had been chosen.

So how much is the Opportunity Cost? Who knows for sure, but if another piece had been chosen that had sold, been reordered and sold again once more during the year and the gross profit on each of those sales was $100 then the opportunity cost of not choosing the other piece would be the $200 of profit that has been missed out on. This is best summed up by the phrase “stock-turn”. The more often a good item is sold and reordered the less this opportunity cost becomes. That’s why it is important to keep inventory fresh and turning over, and why not carrying excessive dead inventory is crucial. Suddenly, without stock-turn, these humble gold earrings start to look very expensive indeed!

We can’t all be crystal ball gazers and know with certainty what will sell, but the important thing is to acknowledge when an item has become old and “cut your losses” as soon as possible. Continuing to forget about it will only increase the ‘holding cost’ and the ‘opportunity cost’ of not sourcing another piece that could yield a profit.

So, that aged inventory you have is more expensive than you thought. Realistically, for every $100,000 you are overstocked you will be looking at $5,000 to $20,000 in holding costs – so carrying $400,000 in excess inventory will take $20,000 to $80,000 off your bottom line while contributing nothing to your sales. In fact, it may even reduce your sales, if your percentage of aged inventory is so high your customers can’t see the good product through the bad.

So, think carefully before deciding that surplus or aged inventory isn’t costing you anything. It may be more expensive than you think.

If you would like strategies for your excess inventory or aged inventory, please reach out to The Edge Retail Academy, and we can help!

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