Planned Excess: How to Manage It
By Jon and Matt Schreibfeder
Last month, we discussed the advantages of utilizing the economic order quantity (EOQ) when determining how much of a product to buy from a vendor. Properly used, the EOQ will minimize your total cost of inventory and maximize your net profits. This is the best quantity to purchase. But vendors usually want you to buy at least a carton (or even a pallet) quantity of an item. They force you to buy more than you want to. We call the unwanted inventory that you are forced to buy “planned excess.”
Why planned excess? Because you didn’t willingly buy it. There is a big difference between a buyer making a bad buying decision because they “thought the item would sell” and being forced to buy unneeded stock. It is a good idea to calculate the planned excess value for each stocked item whenever your supplier requires you to purchase a certain quantity:
- For items where you want to buy the EOQ, planned excess is calculated as the difference between the EOQ and the EOQ rounded up to the next multiple of the vendor package quantity. For example, if the EOQ for an item is 48 pieces, and the vendor insists you purchase a carton of 100 pieces, planned excess would be 52 pieces (100 piece carton – the EOQ of 48 pieces). We would multiply the 52 pieces by the cost per piece to determine the planned excess value for the item.
- The formula to calculate planned excess for products maintained with minimum and maximum stock levels is:(Minimum + Vendor Package Quantity – Maximum) * Cost per Piece
When the net available quantity (On-Hand – Committed + On Replenishment Order) drops down to the Minimum quantity, you would like to just order enough of the item to get up to the Maximum quantity. But the vendor may insist that you buy a vendor package quantity. Again, the quantity, greater than what you want to buy, is planned excess.
It is “best practice” to sort all products with planned excess in each warehouse in descending order based on the planned excess value. Starting at the top with the item that has the highest planned excess value ask these important questions:
- Does this item really need to be stocked in this warehouse?
- Can the product be special ordered or transferred from another warehouse as needed to fulfill customer requests?
- Can you provide your customers with an equivalent but more popular product and avoid maintaining the product in stock?
- Is it practical for two or more branches split a vendor package quantity when replenishing stock?
- Is there an alternate source of supply that does not require the purchase of a full vendor package? Even if you have to pay more per piece, carrying less stock (with a lower inventory carrying cost) may result in higher overall profits for the item.
One of our clients used to stock common batteries (size “AA”, “AAA”, “C”, “D”, etc.) as a courtesy to their customers. They didn’t sell that many. For years they bought cases of each size from a wholesaler to achieve the lowest actual cost per piece. But the low sales volume resulted in a lot of surplus stock and even some expired quantities of these products. We changed the source of supply to a local department store. Even though we paid more per battery when we bought them in small packs, the excess inventory was eliminated, and profitability was increased.
To achieve effective inventory management, perform an analysis of your planned excess inventory at least twice a year. Make sure your inventory dollars are working to generate profits and not lying dormant in your warehouse!