March 27, 2007
When to Get Rid of Stock
As I cover in many of my posts, the number one problem I experience with inventory management is "what difference does it make if I have too much inventory, I'm going to sell it eventually anyway, right?"
Typically, this question comes into play in terms of over ordering stock that really does sell, but not fast enough to warrant such large orders. Many posts on this site cover this the issue of how much to order and the true cost of carrying excess stock.
Another problem I haven't really addressed is what happens when inventory sells so slowly and costs so much to carry that it's not only not worth it to order more, but it's actually worth it to destroy that which you do have.
I recently came across this example while studying the inventory at a book publisher that noticed they were spending thousands a month on excess inventory charges. While my example uses the book industry, these principles can be applied to other goods.
The typical storage cost per book is generally right round a penny per year. While this doesn't seem like much, it adds up pretty quickly to $5000/mo when you have 500,000 books in stock.
The question quickly becomes, is the $5000/month worth it to store all the goods. In order to adequately determine this, what needs to be examined is the lifetime cost of storing the goods until they're sold and comparing this to how much it costs to store relative to destroying and then reproducing.
Start with the monthly sales/inventory. This will help you to get a feel for how fast the book is selling. Once this is determined, you can determine how long until the book will sell out.
The next thing to look at is the cost of the book. This will help determine how how long you should keep the book.
Once you have this information, here is how you can apply it:
Taking the monthly sales to inventory ratio, you can determine how long it will take to sell the book out completely. Let's assume we discover that based on historical evidence, we believe the title will sell out in 6 months. This means that if sales remain steady, it will cost an a maximum of six cents (a penny per month) for storage. Assuming the cost of the book is roughly $1, you're better off storing the books than destroying now and reprinting later.
This is a fairly typical example of a good that is still selling well and certainly shouldn't be destroyed.
But let's take a look at an example that should be destroyed.
The monthly sales to inventory ratio shows that it will take 400 months to sell the remaining 8,000 copies of a certain title that is sitting in the warehouse (assuming it ever sells). While this sounds excessive, I can assure you, I've seen it.
At 400 months, it will cost the last of those books that is sold $4 in storage over the next 400 months. Assuming the cost to print the book is $1, a $3 loss is incurred by storing the book as opposed to printing again in the future. At $1 to reprint, the recommendation for this title would be to keep 100 months of inventory. 100 is chosen because this is the point at which it becomes no longer worth it to store rather than to reprint.
That is, you should keep the amount of inventory that is cheaper to store than to reproduce.
While this model is very simple, it serves as a useful starting point for determining how much inventory to hold. There truly is a point at which destroying now and reproducing later becomes a worthwhile investment. However, the goal is to avoid this altogether. To properly order in the first place and to not hold excess inventory is a much more desirable achievement.
This should serve as a starting point, although there are certainly other things to look at, including the funds that can be acquired through remaindering goods, and the likelihood that sales will increase, rather than remain steady or decrease.
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