You want to stock the products that your customers request most often in your warehouse(s). But what about products with sporadic sales, or no sales at all? A recent article (not by this author) suggested that you should discontinue and liquidate the stock of any product that is not sold or used on a regular basis. No exceptions. Clean them all out! Or so the author said.
But do you really want to do this? We don’t think so. Most distributors and manufacturers should maintain a stock of some slow-moving products, and even products that have never been sold, in order to maintain a high level of customer service and enhance their corporate profitability. Why?
A Product May Have “Critical” Qualities
What is a critical product? It is something that is needed to maintain the throughput or output of a manufacturing production line or is necessary to maintain a vital function or process. If this piece broke or was inadvertently removed from a machine or the production process, a company or its customer would suffer significant or even tremendous losses from lost production (or the temperature in someone’s home would drop below freezing in the middle of winter). Even though a product is infrequently taken from stock (or may have never been taken off the shelf), the item must be available for immediate delivery if it is ever needed.
Every business needs to create its list of critical repair products. But as you add each item to this list, consider two questions:
Is the item “critical” or merely “important”? A critical part not only shuts down a machine, it shuts down an entire process or vital service. For example, one of our customers is a food processor. They have one large mixer that is used to combine the ingredients necessary to make any of 25 different products. If the mixer is out of service, none of the 25 products can be produced. The company keeps on-hand in their inventory a spare piece of every component of the mixer. On the other hand, the company has 10 identical wrapping machines. If one wrapping machine breaks down, its workload can be reassigned to the other machines. Production might be delayed for a couple of hours, but the process would not be shut down. The spare parts for the mixer are critical inventory. Those for the wrapping machine are merely important and can be ordered as needed for next-day delivery. Keep in mind that a critical item has the potential, on its own, to shut down a process. When creating your critical item list be sure to note the process that is dependent on each product.
How long can the company do without the process associated with this critical part? Will a stock-out of this item definitely result in a crisis? Another one of our customers is a utility company on a remote island. They have to keep more spare parts on hand than a utility company located in a metropolitan area. Why? Because the second company can get many parts from a number of local suppliers within an hour or two, while the island-based company has a minimum two- to three-day lead time for any product. Most consumers would tolerate (though with some annoyance) an hour-long blackout. But what about a power shortage lasting three days?
The Relative Cost or Profit of the Item
Besides being a critical item, it may be less expensive to stock an inexpensive product than to bring it in to fulfill specific customer orders. Imagine a faucet washer that costs ten cents. Your best customer uses two a year, but your normal vendor sells them in a package of 12. Buying 12 pieces provides you with a six-year supply of the item for $1.20. Maintaining this item in inventory is considerably less expensive than buying one or two pieces whenever they are needed from an alternate source of supply. Keeping several years’ supply of selected inexpensive products on the shelf will not have a great effect on your company’s overall profitability. And by putting a significant amount of these items in inventory, you won’t waste your buyers’ time forcing them to continually deal with these “nuisance” items. Concentrate on ensuring you have the optimal quantities of those items that have the most dollars flowing through your warehouse.
High-profit, slow-moving items may also represent a good inventory investment. The gross profit that results from each sale may be so large that it offsets the cost of carrying the inventory for a prolonged period of time. But how can you be sure?
Use the Adjusted Margin Analysis
To Justify Stocking All Slow-Moving Products
In the article, “Are You Making Money?”, we introduced the concept of adjusted margin analysis. This analysis subtracts the cost of carrying inventory from the gross profits generated from the sale of specific items. Review this article and use its analysis to justify stocking each and every slow-moving product.
- Critical items may not have an adjusted margin that is equal to or greater than the other costs the company incurs in the course of doing business. But they should be associated with other items whose profitability is large enough to compensate for carrying the average investment of these products.
- The adjusted margin analysis will also identify the actual profitability of slow-moving products that experience high gross margins.
Most companies have to maintain slow-moving products in inventory. However, you must be sure that each of these items improves your overall customer service and/or your company’s net profitability.