This week we’ll look at the waste of inventory. It’s always tempting to “load up” on a good deal, but, many times, the math just doesn’t support this as a money saving strategy.
I was visiting with my neighbor the other day. It was one of those chance meetings, we were unloading the car after a trip to the grocery store and he happened to be working on his lawn. I like this fellow okay, but he’s somewhat odd just the same.
“I see ya been to da grocery” he remarks as I’m unloading the soda pop, the dog food, the soup, cereal, lunchmeat and the rest of it.
I’m out of breath, lugging a big bag thinking, can’t get much by you, and he goes on to explain that he doesn’t go to the grocery store anymore.
No, my neighbor explains that he belongs to a special service, a sort of co-op group that buys in quantity and delivers to his house every two or three months. He goes on to tell me that he is saving a fortune by doing this.
I ask him how the thing works and he invites me over to see his operation. I’m thinking, “Wow, he has an operation, all I got is a ‘fridge and a couple of cabinets.”
It turns out the service sends a form to him that lists all the stuff they have in their warehouse. He just makes a check mark by each item he wants and indicates the quantity he wants to purchase. A day or two later, a moving-van-size refrigerated truck pulls up and their guy unloads his order, putting it right there in his driveway.
As we walk up to his garage, I notice his car is parked outside. I remember noticing that he has started leaving his car parked in his driveway. After he opens his garage door, I see why the car is no longer kept inside.
The garage has been converted into a warehouse, complete with industrial, floor-to-ceiling type shelving, aisle lighting and four large chest freezers. It’s awe-inspiring. So much food, all stacked up, organized and ready to be used.
“That’s what four thousand dollars worth of food looks like pal!” He enthuses. He tells me that he figures this will feed his family of four people for three to four months.
I have to admit, it was mind-boggling. The racks of soft drinks, the huge bags of flour, the giant cans of olives, fruit, beans, tuna and tomato paste. The freezer units were tightly packed with meat. He had separate freezers for beef, pork and chicken. A fourth freezer held frozen desserts, ice cream and pizza.
He goes on to assure me that if I were to buy all this at a grocery story, I would be paying close to five, maybe six thousand dollars. I figure he’s probably right.
About that time, I notice a mouse running out from under one of the flour bags. The mouse was slow because he was so fat. He still managed to get away. My pal cursed and explained that he was bringing in some pest control folks to help him with this little problem.
“Never knew I had mice until I started doing this!” he informed me.
I made an excuse and left my pal in his food warehouse. I did ask him if they would like to get together for dinner out some night and he declined. He said something about not having enough cash for eating out.
Cost is More Than Price
My friend was making the same mistake many businesses make in terms of keeping inventory. A fixation on the price of supplies can get in the way of common sense. Let’s take a look at what my pal has invested in his operation.
He has created a major expense for himself. Not only does he have the cost of his supplies, $4,000 worth, he has spent money on storage equipment, lighting, floor space, freezer units, pest control and added energy costs for running all of the equipment. He will also experience additional auto maintenance expenses since his car is now exposed to the elements 24X7.
The cash alone is a killer. We both have identical families yet he has $4,000 tied up in food at any given time. I go to the grocery store once a week and have a maximum of $250.00 tied up in groceries. In terms of inventory, we are turning ours 12 times to his one. This gives us the use of $3,750 that he has tied up in food-on-the-shelf. We have no special expenses associated with extra freezer space, shelving, lighting, pest control or energy consumption.
Any money that is saved by buying such huge quantities is lost through the additional storage expenses and the loss of the use of the money tied up in inventory.
Our risk is much lower as well. A power failure, a burglar, a roof leak or careless person leaving a freezer door open could all do considerable damage to your stock. There may even be special insurance needed for managing this type of risk.
Even if it all works out, consider the inflexibility. Let’s say you get a great deal on strawberry oatmeal. Your minimum order is, let’s say, ten pounds. Think about how sickening that strawberry oatmeal is going taste after you have had it for 75 mornings in a row. You can’t change to something else, you have to finish the oatmeal or your whole economy of scale is shot.
Too Much Manufacturing Inventory is Just as Silly
Buying supplies for a manufacturing operation is just like this example. Tying up huge amounts of cash in inventory in exchange for a lower unit price is not a good deal. It costs you more in the long run and has the added potential of being disastrous from a flexibility point of view.
What if demand for a given product disappears? What if a better source is made available and your competition starts beating you on price by using the low-cost alternative?
Betting on a huge inventory is a sucker bet. Negotiate with your suppliers based on your anticipated annual consumption. If they can’t cut you a good volume discount, negotiate favorable payment terms. You can get a good deal one way or another.
But, above all, don’t buy stock for storage. Buy what you need, when you need it. Then, use it and move it downstream.