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Excess And Obsolete Inventory

Organizations have differing definitions for excess and obsolete (E&O) inventory. One common definition for excess inventory is or a multiple of lead time or days’ supply on hand. As an example, if an item can be replenished in 30 days and there is a 90-day supply, then the excess inventory (neglecting safety stock) is a 60-day supply. Obsolete inventory cannot be sold at its normal selling price. In fact, it is usually sold at a very large discount from standard cost, if it can be sold at all. It should be written off the balance sheet if it is not saleable. High volume and popular products seldom have excess inventory because they are sold quickly, but low-volume and infrequently produced products quickly become problematic if not properly managed (e.g., with forecasting accuracy and cycle-count audits).

Common causes for E&O inventory are new products that do not sell because of inaccurate marketing or sales forecasts. In Chapter 3 we discussed that it takes a methodological approach to accurately estimate demand for a new product. Organizational issues may also contribute to E&O inventory. This occurs when new product forecasts are manipulated. These practices reduce operational efficiency because capacity is allocated to non-saleable products and cash flow is reduced when inventory is built but not sold. Forecasting error also impacts established products.

Another contributor to E&O inventory is purchasing materials and components or producing them internally hem in lot sizes that are multiple of lead times. Transaction errors for ordering raw materials and components comprise another contributor to E&O inventory. These errors occur for a variety of reasons including ordering, shipping, and inventory control. Breakdowns in cycle-counting systems also contribute. Long product lead times are especially problematic when a product’s design changes and older inventory is not used quickly. An example is packaging obsolescence. Finally, inventory may become damaged as it moves through a system, and perishable products can become obsolete when their shelf-life expires.

The disposal of E&O inventory is a coordinated effort to attain the highest possible price. Disposal activities also require coordination with several organizational teams, including marketing and sales, finance, materials, and logistics. Although an item may appear obsolete, another team may still need it for various reasons (e.g., spare parts, testing, or to satisfy long-term contracts). The strategy of disposal is to attempt to sell

E&O product using discounts from the normal selling price if current sales are not eroded. A third strategy is to sell the items in other markets or countries, or at or below their standard cost to customers or back to suppliers. Finally, E&O material could be sold for scrap or donated to charity to reduce taxes. It should be noted that any sales price that is below an item’s standard cost requires a write-off to a balance sheet.

Some methods to implement these disposal strategies include using the current sales force to sell the material, advertising in various industry media, or using auctions (in person or on the Internet) to dispose of the E&O material. The ability of the E&O disposal team to sell the E&O material mitigates the E&O problem to an extent, but prevention of the problem is the best course of action for an organization.

How can an organization prevent or minimize the occurrence of E&O inventory? A cross-functional team associated with these issues can be created with the authority to take action to eliminate the root causes for the E&O inventory problem. A common issue is product or component proliferation. Proliferation causes a higher frequency of expediting inventory and material handling. A proven way to minimize proliferation is to periodically review product offerings. The goal should be outsourcing or discontinuing products with low profit margins. This profitability analysis should include a careful review of a product’s profit and loss statement because low profitability may be due to factors unrelated to inventory management, such as sales adjustments or high standard cost, which can be improved. Marketing is usually a major contributor to a proliferation problem because their goal is to provide broad product offerings. Design engineering is a second major contributor to proliferation problems. Product designs should be simple with the minimum number of components using the design-for-manufacturing methods discussed in Chapter 4.

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