If one of your warehouse employees walks past an item laying in the middle of a warehouse aisle, do they pick it up and put it in its proper location? Do they pretend not to see it? Do they feel they are too busy to deal with it? Do they kick it out of the way?
The answer to these questions provide a good indication of what your employees think about your inventory. For any distributor to be successful, its employees have to see the direct relationship between inventory and their paycheck. Well-known industry consultant Gordon Graham says that inventory is cash in a different form – and it is. Furthermore, inventory must be transformed back into cash (through sales) for the company to have the money to pay its employees. You cannot be successful (or perhaps even survive) unless all of your employees understand this relationship.
You can see if they understand this concept by giving them a little test. Let them consider the following scenario:
Joe works out in your warehouse. He’s never been what you call “neat.” His motto is, “serve the customer quick, and don’t let anything get in your way.” Joe doesn’t think twice about flinging boxes out of the way to get to the item he wants. The path of destruction he leaves in his wake earned Joe the well deserved nickname, “The Tornado.”
It’s probably not surprising that Joe occasionally (once a week or so) breaks something. And, it probably won’t shock you to learn that some of the material that Joe “flings” out of the way is sometimes never seen again. In fact, Joe loses (or breaks) $100 dollars worth of material a month. What does the company have to do to make up for this loss?
Many people would respond that the company would have to sell an additional $100 worth of material. And that the $100 cost may be worth the speedy service Joe provides the customers. This is incorrect. Material losses, whether from theft, breakage, or misplacing warehouse stock, must be paid for with profit dollars. Profits are the company’s source of income; the money left over after it pays all of its expenses. If a distributor’s net profit before taxes is four per cent (a respectable number for most distributors), the company has a four penny profit for every dollar of sales. The replacement material has to be paid for out of this four cents on the dollar.
Therefore, to make up for Joe’s mistakes, the company doesn’t need $100 in new sales, it needs $2,500! Here’s the math to prove it:
| Value of Lost/Broken Material Net Profit before Taxes |
= | Additional Sales Needed To Make Up for Lost/Broken Material |
If you divide the value of the lost material by your company’s net profit before tax, you get the amount of additional sales you need to generate to make up for the loss. Let’s apply this formula to our example:
| $100 .04 |
= | $2,500 |
The following chart shows the additional sales necessary to make up for various amounts of lost or damaged material:
| Net Profit Before Tax: | 4% | 3% | 2% | 1% |
| Value of Lost Material | ||||
| $50 | $1,250 | $1,667 | $2,500 | $5,000 |
| $100 | $2,500 | $3,333 | $5,000 | $10,000 |
| $250 | $6,250 | $8,333 | $12,500 | $25,000 |
| $500 | $12,500 | $16,667 | $25,000 | $50,000 |
| $1,000 | $25,000 | $33,333 | $50,000 | $100,000 |
| $10,000 | $250,000 | $333,333 | $500,000 | $1,000,000 |
This is what we call an “Alka-Seltzer” illustration. After determining the real cost of lost and damaged material, many distributors reach for the bicarbonate of soda to relieve their heartburn. And the figures in this chart don’t take into account the extra labor necessary to clean up after Joe and find the material he misplaces!
How much effort does it take for your sales department to generate additional sales of $2,500 per month ($30,000 per year)? You must make sure that every employee understands the true cost of lost or damaged material. When they kick a box out of the way, they’re kicking the source of funds for their paycheck!