Obsolete inventory is one of the largest components of inventory cost and often is larger and more costly than executives are willing to admit. Many suggest optimistically (and often sheepishly) that there is no such thing as obsolete inventory because it will sell someday. I have developed a new three-letter acronym for this to go along with JIT, RAW, WIP and FGI. It is "GSM" for "Glacially Slow Moving"! Studies related to inventory cost and inventory reduction prove that obsolete inventory does in fact exist, along with the warehouses, containers and trailers to hold it. Warehouse personnel will express how frustrated they are because the inventory takes up prime bin locations and gets counted, recounted and moved many times during its life. Most companies are busy searching for ways to return, sell, give or throw away obsolete inventory, but the important question isnt how to get rid of it, but how to avoid it in the first place.
Why does obsolete inventory build up? The root cause is uncertainty in both supply and demand. Reduce the uncertainty and you diminish your exposure to obsolescence. Three tools can accomplish this: 1) sales and operations planning; 2) auto-replenishment systems; and 3) "ramp-up/ramp-down" discipline.
Sales and Operations Planning
If you are experiencing growth in obsolete inventory, missed forecasts, reduced earnings and increased backlogs, consider taking major action through sales and operations planning (S&OP). S&OP strategies closely integrate the supply and demand planning processes that allow the business to provide the right products/services at the right time in the right quantity at the lowest possible cost. A tight connection between operations capabilities and sales demand planning enhances profitability, performance, customer satisfaction and return on investment, all while lessening exposure to potential obsolete inventory. Recent studies by the Aberdeen Group show that S&OP can boost profitability, delivery and cash flow, regardless of company size, by as much as 40%.
One of the key traps associated with demand planning is the optimistic view that new products or promotions will generate high sales. Many a company executive has been stranded with major amounts of excess inventory after ordering surplus materials/parts in anticipation of demand. Inflexible operations and supply chains require a gamble of sorts to ensure that the demand can be met. For example, many companies have ordered container loads of parts from China only to see the anticipated demand fail to materialize, leaving them holding mountains of inventory. Some companies make it worse by renting warehouse facilities to store it all, increasing costs in an already bad situation. Flexible operations, supplier partnerships and agile supply chains help prevent this catastrophe.
Auto-replenishment Systems
Auto-replenishment systems, which help reduce supply uncertainty, are another valuable means of preventing obsolete inventory. As the name suggests, they automatically replenish inventory without using systems such as MRP. The two most widely used are vendor-managed inventory (VMI) and kanban. Recently I helped a client almost double its inventory turns (from six to 11) in about six months using these methods. During the same period, the client trimmed its average order lead-time from more than 90 days to about 30 days, and the numbers are still improving.
The VMI approach asks suppliers to come on site to determine needed inventory, order it, receive it and often even put it away in point-of-use locations. While such systems must be managed correctly, VMI has the power to reduce not only stock-outs and excess inventory but also handling and transaction costs. Kanban, a Japanese technique that uses a card or other visual trigger to replenish inventory, is usually implemented as a two-bin system. When one bin is empty, the in-house or out-of-house supplier receives a signal to replenish in a fixed quantity. Both approaches can improve overall inventory turns and accuracy, while reducing stock-outs.
VMI is not without traps. If the programs are not carefully designed and monitored, suppliers will over-fill the bins, potentially resulting in excess stock. Many a salesperson, needing to make month-end or quarter-end numbers, has aggressively replenished customer stock. While VMI can be a strong tool for inventory management, bin sizes and vendor activity must be monitored to ensure that the system is preventing, not encouraging, obsolete inventory.
