How to reduce obsolete Inventories

The problem

Obsolete stocks are an old problem: any purchasing organisation is bound to base its activity on forecasts and forecasts are just that: not reality. Errors, miscalculations, lost sales and abrupt changes in the product life cycle are bound to take their toll. Many companies end up with warehouses cluttered with non-moving goods (which generates huge costs in terms of inventory space, useless logistic movements and administration) or scrapping millions-worth of stock every year.

The usual recipes

Most companies try to control their obsolete stock problem in two ways: they build financial reserves based on a fixed calculation model, adapting the amounts in their accounts typically once or twice per year and they ask their product management to reduce obsolete stocks by either sending back goods to the supplier or selling them at or below cost. Typical problems with this method are the following:

• The amount of obsolete stock does not change during the year and there is little warning when things move into a bad direction. One basically either has a good or a bad surprise when running the stock evaluation program
• Operations are not aware of the way finance calculates the amount of obsolete stock (they often don’t even know the amount itself) and typically dare unable to tell which articles are those which are obsolete. Even when the amount to be reserved is per item, it usually is either everything or nothing (finance considers the product to be either totally worthless or worth its actual purchase cost)
• Once obsolete articles are identified (often with other methods than the ones used by the finance department), operations have to get approval for the losses on stock returns, scrap, or sell-out promotions before they can act
• The management of obsolete stocks is not a standardised activity and has to be "relaunched" constantly or gets forgotten
• The systems in place normally prevent proactive action (you can’t sell at a loss and anyway don’t know which articles you should act on). Once an obsolete item is identified, it is often too late!

How to make things change

There are some simple ways to improve the management of obsolete inventory:

• Financial and operation stock evaluation models have to be aligned on each other and exist down to item level, so that the people in operations will know what is the residual value of the inventory on an article and will be able to act in accordance with clear rules
• The system has to be proactive, signalling when an article is in danger of becoming obsolete and building up the financial reserve progressively
• There must be statistics that allow to monitor exactly the evolution of obsolete inventory and make this information "public" within the company
• The control of obsolete stocks has to be part of day-to-day business and be integrated into the objectives of every product manager. It should also have an impact on his compensation

Implementation barriers:

Typical problems with the implementation of such systems are the following:

• As the financial procedure to calculate reserves on inventory needs to be changed, the approval of the auditors is needed (the solution is to create a model that will calculate a total amount equivalent to the one in the accounts and then switch the system)
• "Cultural" resistance in operations has to be overcome (this can be done with good communication, management speaking with one voice and changes in standard reporting)

If you would like to discuss this or other similar topics with us, please contact Grégoire Depeursinge.