Insidious Inventory
"A billion here, a billion there. Pretty soon we'll be talking real money." With tongue-only-somewhat-in-cheek, a politician once said that about all the money being spent in Washington, D.C."A bag of nails here, and a case of copier paper there. Oh, yeah, there's a box of fasteners back in that corner; probably the ones that go on the fittings we don't sell anymore." That's a quote you could hear in thousands of businesses on any given day about insidious inventory; the unproductive stuff your company is accumulating even as you read. Before long, you're talking real money.
Webster: Insidious, adj., 1) more dangerous than seems evident; 2) lie in wait; 3) ambush.
You may never have heard anyone put the words insidious and inventory together. (I know, as Michael Keeton's character said in "Night Shift," I have that kind of mind.) When I say insidious, I'm not talking about your good inventory; the stuff you sell everyday that turns over, hopefully, at least 4 times a year. Insidious inventory is the stuff that was good inventory yesterday. OK, maybe it was good until last month or last year. Doesn't matter - today it's insidious.
So what makes a good SKU (stock keeping unit) go bad? Lots of things: Damage, obsolescence, lost, ordered too many, customer cancellations, drugs (just kidding about the drugs - wanted to see if you were paying attention), just to name a few. The list is long.
"What's all the fuss?" you may be asking. "I have a service business, I don't have inventory." Au contrare, mon ami! Our friend and inventory expert, Steve Martin, says if you own a business, you have inventory. It might be consumables, like tape or toilet paper, but like the tires your neighbor sells, it's still inventory that took cash out of your business.
Or you might be reminding me that, unlike the government money mentioned above, "At least we still have the stuff, right?" Well, sort of. True, it's there. But let's take a look at what's happening to your inventory when it becomes insidious, and what it does to your business. I'll use Webster's words as a guide.
Dangerous
Insidious inventory is dangerous if you have a bank line of credit that is collateralized, at least in part, by your inventory. Bankers don't like insidious inventory. Oh, they don't call it that. Truth is, they rarely even refer to your insidious inventory except when doing the math to subtract it from your total inventory number to get to the kind of inventory they like, which they call "eligible" inventory. The kind they believe is worthy as collateral.
If inventory is not eligible, you can't borrow against it. Yes, it was eligible last month, but now, as a result of the covenant language in your agreement with the bank, it has become ineligible, even though you haven't borrowed all of your line. You thought you had X dollars to draw on, and now you have something less.
Here's the picture: It's payroll Friday; your banker is on the phone and he wants to know how you are going to cover the checks you wrote before you knew you had so much insidious (ineligible) inventory. Your company is now in danger.
Lie In Wait
Like a Bengal tiger, insidious inventory can seem almost invisible. But, like the tiger, it's there ready to pounce when least expected. Oh, you see it in your inventory numbers, alright. Heck, you even boast in your marketing material how significant your inventory levels are, "The largest inventory of frufram fittings in the valley." And it shows up on your computer screen, "15 in stock." But if you have 15, and you only need 6 to meet just-in-time demand, those other 9 just took a bite out of your bottom line by landing in the "Interest paid" line in the "Other income and expenses" section of your P&L. Ouch!
Ambush
That's what it feels like when you realize that you've been carrying all of this insidious inventory that isn't producing. That's how it feels when you realize that you have dozens of something that just became obsolete. That's what it feels like when your banker makes that call I mentioned above.
Let's take a lesson from those who sell perishable goods, the produce and fashion folks, just to name two. Produce and fashion are a little like radioactive material, the usefulness of which is measured in terms of "half-life." Lettuce has a shelf half life of three or four days. Fashion, especially women's fashion, anywhere from a few days to a few weeks. Couple of months, max. (Oh, yeah, plutonium is good for four, maybe five hundred years, but that's another story).
When these guys take delivery of lettuce or a dress, there is a date in their minds, if not on the calendar, that is the point when they either sell the stuff or devalue it. Maybe they devalue it a little, and maybe they write it off completely, but either way, they don't fool themselves. When it comes to inventory, these guys practice extreme prejudice. For them, especially the produce guy, insidious inventory might as well be so much tiger droppings.
I mentioned Steve Martin earlier. He's an original member of our Brain Trust, and president of Business Solutions. He's also an expert on inventory management, and he and I have had several visits on my show to discuss this issue. One of the important contributions he has made to our show has been to help us understand the "Real Cost" of inventory.
He advances the proposal (and has conducted the research to back it up) that your indirect inventory expense could be as much as 29% of inventory value. Does that number shock you? I hope so! I want to get your attention about another insidious expense: insidious inventory management expenses (IIME, a new acronym I just coined). Ready for another shocker? That number is in addition to the routine shipping, handling, and payroll costs (but it does include interest, warehousing, overtime, etc.).
Obviously, you can't manage your inventory all by yourself. Your employees consume the consumables, plus they purchase, unload, stock, store, move, load, deliver, lose, damage, destroy, and unfortunately, sometimes steal your inventory. As you can see, your inventory is subject to lots of handling and mishandling. Steve says that one of the best ways to minimize IIME is to train your folks about the "true cost of inventory."
Train them and, while you're at it, train yourself. Look at that SKU you were so proud of yesterday with extreme prejudice, which means that you see it one of two ways: Either it is working it's little wrapper to the bone to make you money right now, or it is your enemy, because it is insidiously holding your cash hostage, or worse, causing your cash to fly out the window.
The challenge is to identify the insidious things you and your people are doing with your inventory. Stop buying stuff you don't have to have. Stop breaking things. Stop losing things. Stop building more warehouses until you've practiced some of that produce guy's "extreme prejudice."
Write this on a rock... Start thinking that everything you buy in your business, whether you sell it or consume it, is a cabbage that will start stinking in a few days. Oh, yeah, line one's for you. It's your banker.
