The Inventory Actuarial Table
Most distributors carefully consider each new purchase of capital equipment. Every truck, desk, and computer purchased must have the potential for increasing profitability of the company. After all, money doesn’t grow on trees, and management knows that the limited funds available for new capital equipment must contribute to the company’s profits. Unfortunately, new inventory items don’t always receive the same careful consideration.
Why? Because introducing new inventory items is often an emotional decision. You have a “hunch” that something will sell, and you act on that hunch by investing in some of the product for stock. Unfortunately, often these hunches are wrong, and the result is dead inventory. Is there a better way than simply relying on hunches? We think so.
After working with many distributors, we’ve found there are some common characteristics of those new products that usually meet or exceed sales projections. There are also common attributes of new items that often become dead inventory. We call the result of our research the “Inventory Actuarial Table.” In the insurance industry, actuarial tables assess the risk involved in insuring a car, a person’s life, or something else for which an insurance policy is issued. Our actuarial table looks at the risk of a new stock item becoming dead inventory. Our inventory actuarial table is divided into three sections:
- Items presenting the least risk of becoming dead inventory.
- Items presenting a moderate risk of becoming dead inventory.
- Items presenting a substantial risk of becoming dead inventory.
Let’s look at some common characteristics of the products in each category, as well as looking at some things you can do to minimize your risk of each type of product “dying” in your warehouse without being sold.
Least Risk
These items are almost sure to sell. For example:
New Items with a Firm Customer Commitment – that is, a signed customer purchase order to buy the entire quantity that you must bring into inventory. Yes, there is a chance that the customer will go out of business, cancel the order, or return the material for credit, but most customers who are willing to sign a purchase order are intent on using the product.
Non-Stock Products with Recurring Sales. These are non-stock products that are continually sold to one or more customers. After you’ve ordered them several times in one year to fill existing customer orders, you may decide that it would be more economical for you, and more convenient for your customer, to keep several pieces in stock.
To reduce the chance of these items becoming dead inventory, sales should be analyzed at least twice a year to ensure that your customers are continuing to buy these products. If you notice a drop in usage one month, immediately contact the customer to determine the reason for the decrease in demand. Perhaps they are experiencing a temporary drop in usage – or, for some reason they’ve determined that your service is unsatisfactory, or their needs have changed. Quickly identifying the reason for the decrease in sales allows you to fix the problem or to liquidate your remaining inventory before it becomes dead stock.
Moderate Risk
There is a greater chance that these new stock items will eventually become dead inventory. Salesperson and customer “suggestions” represent the most common type of moderate risk item. Has a salesperson ever burst into your office and exclaimed, “these would sell like hotcakes if we only had them on the shelf”? This salesperson’s excitement is reflected in a common sales pattern for new stock items:
Notice that sales spike shortly after the item is introduced to inventory. This is probably due to the fact that salespeople are featuring this product in their sales calls. As time goes on, salespeople don’t talk about this product as often. In fact, their attention may be centered on more recent additions to inventory! They forget to remind the customers who asked that the product be stocked why they aren’t buying more of the item.
To reduce the chance of these items becoming dead inventory, you must continually remind the salespeople of the sales and current stock position of all new stock items. Print and distribute a report containing the following new product information to each salesperson each week, or at a minimum each month, until the product has been in inventory for five to six months:
- Product number and description.
- Current month sales (in units).
- Sales projection for the current month (provided by the salesperson before the item was added to inventory).
- Total sales (in units) of the item to date.
- Total sales projection to date (provided by the salesperson before the item was added to inventory).
- Current on-hand quantity.
- Manually set minimum stock level of the item.
- Manually set maximum stock level of the item.
- Name of salesperson who requested that the item be stocked.
- Reason why the item was added to stock.
Note that because we don’t have enough usage history to accurately forecast future demand of new products, they are normally maintained with manually set minimum and maximum stock quantities. By continually reminding salespeople of the existence (as well as the sales volume) of new stock items, we hope that they will continue to enthusiastically promote the product.
Substantial Risk
What type of new stock item is often at the greatest risk of becoming dead inventory? Products that your vendor suggests you carry! Your vendor’s salesperson arrives at your office carrying an armload of glossy brochures. He shows you sales projections showing that a new item will take off and provide you with a wonderful opportunity to increase your profits or market share. Unfortunately, the new inventory may not be the panacea portrayed in the fancy graphs.
Recent surveys have shown that only a small fraction of customers who have said in a survey that they would buy a new item eventually purchase any of the item. This means that the vendor’s survey (which was probably biased towards purchasing the product) probably does not accurately reflect the eventual actual sales of the item.
The best way to reduce the chance of vendor-recommended items becoming dead inventory is to negotiate the return, at no charge, of any unsold portion of the initial stock shipment of the product six or nine months after the date of receipt. If the vendor is unwilling to take back this unsold material, carefully reconsider stocking the product. Can you obtain a small quantity of the item from another source, even if you have to buy it at a higher cost? This “test quantity” will help you determine whether or not the new item will be a profitable addition to your inventory. Sure, the high cost will mean that you won’t make a lot of money from the item during the test period. But losing money for a month or two on sales of an item is usually preferable to writing off a large unsold portion of the initial shipment.
When you add new items to inventory, you’re investing part of your company’s limited assets in the hope of gaining new sales and increasing profitability. Each new product addition should be made only after careful analysis, and the performance of every item should be reviewed on a regular basis.