Over the past 12 months, I’ve seen numerous articles on liquidating unwanted dead stock and excess inventory. In fact, we published an article several months ago exploring the advantages of using Internet websites (such as www.tradeout.com, www.surplusbin.com, and www.industrymart.com) to assist in the liquidation of unwanted stock. But liquidating unwanted stock using the Internet (or any other method) is not always successful. Why? For the simple reason that in order to sell something, a potential buyer must exist.
Can’t everything be sold at some price? Unfortunately, no. Last week, a distributor gave me an example of material that cannot be sold, at any reasonable price. He has an assortment of repair parts for obsolete equipment. This equipment is not in service anywhere! No one could use any of these items except maybe as a rather ugly door stop. Because the parts are made of a combination of glass, plastic, and steel, they cannot even be sold as scrap. The only practical thing he can do with this stuff is to throw it out in order to free up the warehouse space for other items. That is, bury it! His company will be out what they paid for this inventory as well as the expense incurred in buying, receiving, and maintaining the material in stock.
Please avoid having to throw out inventory. Whenever you buy a new product, consider its “burial risk.” Look at the following diagram:
Products in the bottom left quadrant (“High Risk”) have a very specific use and are just sold to one or two customers. You are taking a great risk stocking these products unless your customer has given you a firm commitment (e.g., a purchase order signed in blood) that he or she will buy whatever quantity of the item you must purchase from the vendor. If you don’t have this commitment and the customer goes out of business, stops using the part, or begins buying it from your competitor, you will be forced to plan the burial ceremony for the remaining inventory.
Items located in the upper left quadrant (“Moderate Chance”) are less likely to need burial. Even though these items are only sold to a limited number of customers, they have multiple uses or applications. A good salesperson can monitor your customers’ demand for these items so that you can adjust stock levels as usage increases or decreases over time.
The bottom right quadrant also contains items with a moderate chance of needing burial. Even though these products are sold to many customers, they have a limited number of uses or applications. But even if one of these products was replaced by a new and improved model, at least some of your customers probably would be candidates to purchase your remaining inventory (though at a substantial discount). And, because of the wide appeal of these products, you also might find success liquidating them through an Internet site. This type of “remnant” inventory usually doesn’t require burial.
Finally, the products in the upper right quadrant have the least risk of needing burial. These items are commonly used, in many applications, by a large number of customers. Excess inventory of these products usually can be sold by reducing the price, offering salespeople an incentive to move the product, utilizing an Internet liquidation site, substituting the product for a less expensive model, or some other means.
Whenever you analyze whether to stock a product or determine customer prices, consider the burial risk factor. Keep track of the percentage of products falling into each quadrant of the chart displayed above that cannot be sold at any price, and must be thrown out. This equation represents the percentage of inventory that must be buried:
|Quantity That Is Eventually Thrown Out
Original Purchase Quantity
For example, you might normally have to throw out 10% of the purchased stock of items that fall into the bottom left “high risk” quadrant. This “scrap” factor should be included in gross margin and pricing decisions. Say you purchase one of these items for $10 and want to receive a 30% margin on sales of the item. Typically you would set the price at $14.29:
|Gross Margin =||Sales$ – Cost$
|=||$14.29 – $10.00
But the 10% of the original purchase quantity that, on average, will be thrown out must be paid for out of the amount of the item that actually sells. So, we’ll calculate a gross margin based on a cost of $11.00 ($10.00 + 10%). We’ll have to set a selling price of $15.72 to maintain the same 30% gross margin:
|Gross Margin =||Sales$ – Cost$
|=||$15.72 – $11.00
Always consider a new item’s burial risk factor when setting customer prices. Fortunately, most products whose remnant stock will need to be thrown out tend to be less competitive and price-sensitive. Why? Because they are sold to a limited number of customers and have few uses. There isn’t much of a market for them.
You are much better off planning for the inevitable burial of inventory that cannot be sold than letting it take you by surprise. If competition does not allow you to include a burial risk factor in your pricing:
- Consider whether or not you need to really stock the product. After all, you are taking a significant chance on absorbing a loss.
- If you must stock the product, be sure that other profitable sales will compensate you for your probable losses.
After all, isn’t our primary goal to be profitable?