One of our clients is continually overstocked. Management is frustrated that they are not achieving their return on investment goals. They couldn’t understand why, after working hard to establish replenishment parameters that would optimize their inventory investment, the company was still far from achieving effective inventory management.
I looked at their inventory and found that more than 66% of their stocked items had an on-hand quantity greater than our recommended maximum stock level rounded up to the next multiple of the vendor package quantity. Over 72% of their inventory dollars were invested in this excess inventory.
We asked the company’s buyers about this situation. They stated that they always bought to obtain prepaid freight from a vendor with no exceptions. This policy caused them to buy many products before their net available quantity dropped down to the calculated minimum stock quantity. It also caused many products to have a stock level above the calculated maximum stock quantity.
One buyer showed me a purchase order she just issued for a special order item worth $25. But in order to meet the vendor’s free freight requirement of $900 worth of material she added $875 of the most popular items in the line to the order. Her reasoning was that “these products always sell”, so there is no harm in bringing in excess inventory. Every day all of the company’s buyers issued multiple replenishment orders following this logic.
Unfortunately, the cost of financing and maintaining this extra inventory far exceeded the cost of paying freight for special order items. It would have cost $10.75 in freight to bring in this item. The company will incur a total of $26.25 in additional inventory carrying costs during the four months it will take to sell this material. It is no wonder that the warehouse was bulging with excess stock and the company was failing to achieve its inventory turnover and return on investment goals. It is even more surprising that no one suggested that salespeople charge “non-preferred” customers the freight cost for acquiring these non-stock products.
State of the art inventory management systems include comprehensive tools for calculating replenishment parameters that will maximize net profits, while achieving your company’s customer service goals. However, it is imperative that buyers utilize these parameters when issuing replenishment orders. Beware of the “Free Freight” offer. Do the math… “Free Freight” offers may not always provide the lowest total cost to your company.