Recent events have placed a renewed importance on managing inventory levels proactively. Even the slightest of disruptions in the supply chain can affect a brand's ability to carry enough inventory and get its products into the hands of consumers when and how they want them.
It's a puzzle that CPG companies must routinely solve: How much inventory should we carry to fulfill sales, and how much safety stock should we have in storage in order to mitigate stockouts and be prepared for unforeseen spikes in demand? While it's vital to CPG businesses to maintain the right balance between inventory levels and costs, it's also easier said than done.
In this article we'll review:
- Common causes of excess inventory
- Pros and cons of excess inventory, including the high cost of holding inventory
- How an accurate demand planning process can solve inventory issues caused by under-predictions and over-predictions, which can result in overstock
Excess Inventory and Its Root Causes
Excess inventory refers to products, raw materials, and components that have yet to be sold or used, and therefore remain in storage, awaiting their future, tying up working capital.
Also known as overstock, excessive stock, excess inventory can be the result of a poorly executed demand forecast and/or inventory management strategy. Generally speaking, excess inventory occurs when supply outpaces demand (or, put another way, when demand far outpaces predicted supply), resulting in slower-than-anticipated inventory turnover.
Often, a CPG company's ability to accurately demand can have outsized effect on its inventory levels. Consider, for instance, what happens when a company predicts sales way above actuals. Under-predictions means that a company might have to deplete its safety stock or pay a high price to vendors in order to fulfill orders it didn't plan for.
On the other hand, if a CPG company over-predicts demand, it will have inventory tying up working capital, which can lower COGS
manage overstock, which comes with its own set pros and cons, including extra storage costs or product that must be sold at a discount, or liquidated.
It's no secret that properly managing inventory is a tough nut to crack. And an expensive one at that.
There are multiple factors that play into this equation, including product shelf life, lead times, velocity and various aspects of brand distribution. Another vital factor is an organization's overall demand planning capabilities or S&OP process: How accurately can you forecasts sales and inventory, and can you accomplish this with consistency (low deviation)?
Though it's rarely quite this simple, the example serves to show the continuous push and pull of supply and demand. Below, we dig deeper into the pros and cons of excess inventory and explain in focus why accurate demand forecasts are essential to optimizing inventory across your warehouses; how to reduce inventory costs associate with excess inventory; how accuracy inventory forecasts can help your company hit important KPIs, and much more.
Excess Inventory: Benefits & Risks
When excess inventory occurs, CPG companies must strategize, often on the fly, in order to recoup potential losses that may occur as the the carrying costs associated with excess inventory can be quite significant. Typically, excess inventory is sold (likely at a discount, thrown away as waste, or remain in storage (again, timing on this depends on factors like shelf life, demand levels, distribution, sales performance, and other variables.) Often, excess inventory can cause serious issues, so it's important to be able to identify its causes and have plans in place to mitigate risks across the supply chain and business.
But it's not always bad: There are instances in which it’s an integral and planned portion of a larger inventory strategy. Let's explore.
Pros of Excess Inventory
- Avoid out-of-stocks. Holding excess inventory is an important insurance policy for unforeseen spikes in demand. Overstock can be used to fulfill order at levels that were not planned for.
- Financial strategy. Excess inventory may also be a part of a larger tax or accounting strategy.
However, when companies are forced to store products beyond their estimations, their bottom line can take a major hit: profits reduce while working capital increases. Excess inventory can have many negative impacts across supply chain, which are often interconnected, and can be a suck on cash flow. Here are some of the ways excess inventory can throw a wrench in your CPG supply chain:
Cons of Overstock
- Products are likely to be sold at deep discounts. In the absence of strong demand, slow-moving (or inert) products must be priced to sell. That is, they must be sold at a discount in order to be unloaded, sometimes to liquidator resellers. Discounts can harm the marketplace. They can also hurt a brand name’s and associated price points that are often built on reputation, quality, and price. Lower prices means higher COGs (cost of goods sold) which means lower profits. Relationship managers must adapt. Markdowns need to be funded as well. (Retailers may also participate in giveaways in order to clear room for new inventory.)
- Additional investments. The ability to unload excess inventory requires the re-deployment of sales resources, such a sales reps who may already be stretched thin. Markdowns must also be funded.
- Obsolescence / End-of-Life (EOL). Products that are facing obsolescence may be sold in bulk to discount retailers that can move them into the hands of consumers quickly. Running conversely with product (or component) obsolescence is the pace of innovation and speed to market for many CPG products and product categories. Here’s how one electronics components director described the push and pull of obsolescence:
As manufacturers reduce the lifespan of many parts, and innovations in technology are occurring at faster and faster rates, this results in an increase in parts becoming obsolete and no longer produced by the manufacturer. The demand for this product, however, may still be present, resulting in a severe mismatch between supply and demand.
- Disposal costs. Products with expiry dates, or those that are becoming obsolete, are ticking clocks that must be sold in a timely manner. If they’re not, they’re either sold at a deep discount to make room for other (faster-selling or newer) products, or they will be thrown out. The disposal of products, however, can be very expensive and must be done properly and in accordance with the law. Donation is a cost too.
- Increased holding costs. An unforeseen surplus in product means that there must be a place to store it. And it can be expensive to expand warehousing capacity. This clears warehousing space for new products or other more-in-demand products, which may have a better chance of bringing in revenue.
- Transshipment and repositioning costs. Let’s say that excess inventory is sold to a discount retailer at a deep discount, but that retailer is located on the west coast — 2,000 miles from your east coast-based warehouse. That’s a cost you’ll have to eat as well, adding to the cost of goods sold. This ties back to having an agile warehousing strategy that takes into account warehouse locations that house inventory, and whether or not they are centrally located.
Accurate Demand Predictions = Less Excess Inventory + Lower Costs
Excess inventory can have a domino effect across supply chain, causing a flurry of unforeseen downstream costs. Many CPG companies who know these realities of this fallout also understand that excess inventory can push business to the brink.
One effective way to avoid excess inventory is to have accurate consumption-driven demand forecasts available. When sales teams are confident in predictions, inventory management teams can help to support future demand targets. When sales are forecasted accurately, the entire supply chain can benefit, including inventory, which can plan to have the right number of products in the right place at the right time.