Understanding Excess and Obsolete Inventory

Before we can address how to handle excess and obsolete inventory, it’s important to understand what these terms mean.

• Excess Inventory refers to products that are overstocked or have more units in inventory than are required to meet demand over a reasonable period of time. This often happens due to inaccurate forecasting, changes in market demand, or production overestimation. Excess inventory can create problems such as increased storage costs, reduced cash flow, and the risk of the items becoming obsolete.  Excess inventory is typically viewed in terms of days of sales or supply on hand (DOS or DOH) which can be calculated using either historical or future usage or a combination of the two.  Many businesses will have clear definitions for Excess inventory so they can reserve for this to account for potential losses due to inventory obsolescence.  The threshold for classifying something as Excess will vary by industry but a good general rule of thumb is greater than 12 months of inventory on hand.

• Obsolete Inventory, on the other hand, refers to goods that are no longer in demand, either because they’ve reached the end of their product life cycle or have been replaced by newer versions. This could be due to technological advancements, market changes, or shifting customer preferences. Obsolete inventory doesn’t just take up space; it’s also a liability as it’s unlikely to be sold or used in the future.

Together, excess and obsolete inventory can have a significant negative impact on a company’s bottom line. However, with the right strategies, businesses can reduce the risk of carrying these burdensome items.

The Impact of Excess and Obsolete Inventory

1. Tied-up Cash Flow: Excess inventory represents money that could be used elsewhere in the business. For many businesses, particularly small and mid-sized enterprises, liquidity is critical. Cash that’s stuck in inventory cannot be reinvested into growth initiatives or paying operational costs.

2. Increased Storage and Handling Costs: The more inventory you carry, the more warehouse space you need. This leads to higher storage costs, which could include rent, utilities, and labor. Furthermore, managing large quantities of slow-moving or obsolete inventory increases the labor needed to track, store, and move these goods.

3. Risk of Inventory Shrinkage: When items sit idle for long periods, the likelihood of them becoming damaged, lost, or obsolete increases. This is especially true for perishable goods or products with a limited shelf life.

4. Decreased Profit Margins: If obsolete items are eventually sold, they may have to be heavily discounted or even written off entirely, leading to reduced profit margins or potential losses.

5. Operational Inefficiency: Carrying large amounts of excess inventory can lead to inefficiencies in other areas of the business. With more products on hand, employees may spend time managing and organizing goods that are unlikely to sell, instead of focusing on inventory that’s more likely to move.

Causes of Excess and Obsolete Inventory

To effectively manage excess and obsolete inventory, it’s important to understand the root causes of these problems. Below are some common reasons why businesses find themselves with excess and obsolete inventory:

1. Inaccurate Demand Forecasting: Companies often face issues with overordering or underordering due to inaccurate demand forecasting. Without a solid understanding of customer needs and market conditions, businesses may produce or stock products in excess, leading to overstocking.

2. Promotional Strategies Gone Wrong: Excess inventory can also arise from promotional efforts that don’t pan out as expected. A product that is over-promoted but doesn’t resonate with the market can lead to unsold stock that quickly becomes obsolete.

3. Changes in Technology or Consumer Preferences: Technology and customer preferences can shift rapidly in many industries. A product that was in high demand last year may be obsolete today due to new innovations, trends, or changing customer needs.

4. Poor Inventory Management Practices: Excessive safety stocks, high minimum order quantities, and poor replenishment strategies can all contribute to excessive inventory.  And without regular review of inventory planning parameters and overstocked inventory it becomes difficult to effectively manage excess and obsolescence.

5. Limited Inventory Forecasting: Without the ability to project future inventory positions most businesses are flying blind and will have limited success in managing inventory to their targets let alone Excess and Obsolete.  Visibility to future sales and consumption patterns is key to mitigating Excess and Obsolete inventory.

6. Product Lifecycle Management: Poor management of the product lifecycle can lead to excess or obsolete stock of items that are nearing the end of their usefulness. Companies may continue to produce products or buy raw materials and components that no longer have demand or are being replaced by newer versions.

Strategies for Managing Excess and Obsolete Inventory

1. Implement Effective Inventory Forecasting: One of the first steps to preventing excess and obsolete inventory is improving demand forecasting and having robust inventory reporting of current and future inventory levels along with regular inventory reviews in order to facilitate action.  This includes producing or buying less of items where Days of Inventory on hand exceeds defined targets.

2. Establish Clear Definitions and Policies for Excess & Obsolete: Establishing a clear definitions and policies for identifying and dispositioning excess and obsolete inventory is essential. This should also include regular reviews of inventory to identify slow-moving or outdated items, and clear guidelines for how to handle them (e.g., markdowns, donations, recycling, or write-offs). Establishing this process helps prevent inventory from piling up and becoming a liability. 

3. Optimize Inventory Planning Parameters: Minimize Excess & Obsolete risk by optimizing planning parameters such as Safety Stock, Replenishment Frequency, Lot Sizes, and Minimum Order Quantity.  It is critical that the planning parameters that drive production and purchasing activities do not create unnecessary risk for generating Excess and Obsolete inventory.  Use of ABC-XYZ classification can be a great strategy to help align planning parameters to the value and variability of each item.  

4. Improve Inventory Management Systems: Investing in modern inventory management software can help greatly improve visibility into inventory levels, product movement, and inventory forecasting and analysis. Real-time tracking, automated reordering, and alerts for low stock or slow-moving products can help businesses stay on top of their inventory. Additionally, inventory optimization software can analyze trends and make recommendations to help optimize inventory planning parameters. 

5. Use Inventory Metrics: Inventory turns and Days of Inventory are key metrics for identifying excess or obsolete stock. By tracking how often inventory is sold and replaced over a specific period, companies can determine which products are underperforming. Low inventory turns may signal that certain products are not selling well and could soon become obsolete. Businesses should regularly assess this metric to prevent overstocking.

6. Negotiate with Suppliers: Work closely with suppliers to build flexibility into contracts and agreements, allowing for changes in order quantities or delivery schedules if demand shifts. Suppliers may also be willing to take back unsold goods or offer discounts on overstocked items, reducing the risk of carrying excess inventory.

7. Offer Promotions or Discounts: For excess inventory that is not yet obsolete but is unlikely to sell at regular prices, offering promotions or discounts can help clear stock quickly. Flash sales, bundle offers, or discounts for bulk purchases can entice customers to buy products that may otherwise sit idle.

8. Sell Off Obsolete Inventory: While some obsolete inventory may need to be written off, other items can still be sold—albeit at a loss. Consider selling obsolete items through liquidators, online marketplaces, or through a specialized secondary market. This can help recover some of the sunk costs.

9. Continuous Improvement and Training: Lastly, a culture of continuous improvement in inventory management can help ensure that excess and obsolete inventory problems are kept to a minimum. Regular training on best practices for inventory management, as well as conducting post-mortem analyses of inventory issues, can help identify areas for future improvement.

Conclusion

Excess and obsolete inventory pose significant challenges for businesses, but with the right strategies, these issues can be managed effectively. By improving forecasting, utilizing automated systems, optimizing planning parameters, and fostering a culture of continuous improvement, businesses can reduce the negative impact of excess stock on their bottom line. Addressing these problems proactively can lead to greater profitability, more efficient operations, and ultimately, a healthier bottom line.