How to Manage Nonproductive Inventory, Part 1

An inherent fact in retailing is nonproductive inventory — i.e., inventory that's sitting idle in stores or distribution centers with no immediate sales plan for moving it. Nonproductive inventory can be overstocks (inventory you own that exceeds projected future sales, primarily for discontinued and soon-to-be-discontinued items) and too-much-too-soon inventory, for which you have a future sales plan but your weeks-of-inventory ownership is far greater than needed. Both can have a substantial negative impact on your company's bottom line.

Nonproductive inventory is both a problem and an opportunity. It's a problem in that your cash is tied up, which increases overhead and operating expenses for every day the inventory remains unsold. It also directly reduces gross margin when you mark down the inventory to sell it. But nonproductive inventory can also represent a great opportunity. Better management of this inventory can drive up sales, reduce expenses and increase profits.

It's common for 20 percent or more of total units to be sold off-price. That can equate to 12 percent or more of total sales revenue. The impact on gross margin is dramatic. The table shown below gives an example of a $100 million business with all sales at full price, and that same business with 12 percent of its sales off-price.

The end result? A difference of more than $4 million in gross margin for the business. The example is admittedly silly because you'll always have off-price sales, but it does convey the real impact of off-price selling.

Off-price selling is a significant issue for any business. But before you can begin the process of converting that problem into an opportunity, you need to closely evaluate your nonproductive inventory. Here's what you're likely to find:

• Large overstocks on a relative few items. It's the old 80/20 rule, where 10 percent to 20 percent of your items account for 80 percent or more of your overstocks. From a purely financial, return-on-investment perspective, these are your first priority.
• Small overstocks on many items. This is the other end, where 80 percent of items comprise 20 percent of overstocks. While any one item can appear insignificant dollarwise, many unmanaged items together will impose a major financial drag on the business.
• Too much too soon. This is "good" inventory with a future sales plan, but more than you actually need. Every day that issue goes unaddressed reduces your profits. While you may be tempted to pass it over and focus on overstocks, it could be in your best interest to sell off some of this inventory in the near term.

Each of these situations presents a real problem for retailers and require a different approach to correct them. In part two of this blog post coming in two weeks, I'll provide some best practices for dealing with nonproductive inventory that you can use in your business.