Excess and Obsolete Inventory: An Outcome of a Series of Unfortunate Events!
Inventory continues to be a problem for many companies. In particular, inventory that is considered “Excess and Obsolete” often accumulates and has to be dealt with – often at the end of the fiscal year. During tax season, this is also a time when people begin to look over their balance sheets, and start to question how they ended up with so much slow moving or junk inventory that must be written off.
As we discovered in a workshop last year, excess and obsolete inventory is the result of a number of problems that occur due to “a series of unfortunate events”, that often spans multiple functions. Here are some of the reasons why Excess and Obsolete Inventory occurs to begin with…
Lack of Communication: E&O inventory is often a by-product of misaligned decisions in areas such as product lifecycles, design standardization, and promotional sales forecasting incentives; the true cost of E&O inventory is often misunderstood and not truly measured, and a lack of communication and a misalignment between consumption and forecasting can lead to further E&O issues.
Not Applying the True Cost of Inventory: Elements of inventory cost should be documented, which might include labor (warehouse management), damage, carrying cost, liability insurance, contractual obligation costs, and other factors. But this often doesn’t lead to accountability for inventory by function, and whether it belongs to sales, manufacturing, or purchasing/suppliers.
Poor End of Life Planning: End-of-life cycles are another component of excess and obsolete inventories. This can occur when a product is phased out, or when a capital project concludes, and there is leftover inventory. Contractual commitments for holding inventory are often not well-defined, and the cost of these commitments are also not factored into the sales account management cycle.
Lack of Visibility: When functional groups don’t communicate decisions it can also lead to inventory issues. Even within functional groups different locations may be buying the same materials but not sharing information. One division may have $10 million worth of inventory, while another one is chasing down material of the same part!
Underestimating the Financial Impact: Every industry seems to have an E&O inventory problem, which is often misunderstood and understated. An example was cited of a $4-billion company that believed its E&O inventory was valued at $4 million. After a study was conducted on the company’s E&O inventory, it was found to be $44 million! Most of the company’s material was obsolete, and it had warehouses of material that was 10-years old that they didn’t know was there.
It’s Not a Mistake: There is also a root cause in the misalignment between consumption and forecasting. In the majority of instances, this is a root cause for much of the E&O inventory problem that exists. E&O is often viewed as a mistake. And when it occurs, it is frequently not acknowledged, and the decision on what to do with it is postponed. Eventually “the sins of the company fall on the supply chain,” and the E&O inventory becomes the ownership of the supply chain team.
Here are important issues to consider when evaluating how to deal with E&O:
- Do you have dedicated resources to manage E&O?
- Do you have a team who handles the issue across all lines of the business?
- Do you have a means to properly measure the cost of E&O?
- Do you formally designate ownership of inventory as a result of supply-forecast-demand errors?
An important point to note is that the forecast can never be “fixed” – forecasts will always be inaccurate. This is unlikely to change due to the shifts that are constantly occurring in the demand of products, the flow of new products, the increased complexity and customization of products, and the end-of-life issues that arise. By focusing on improved forecasting, inventory costs will often be directly improved as well!