Most companies carefully consider each new purchase of capital equipment. Every truck, desk and computer must have the potential for increasing profitability. After all, money doesn't grow on trees, and management knows the limited funds available for new capital equipment must contribute to the company's profits. Unfortunately, new inventory items don't always receive the same careful consideration.
Why? Because introducing new inventory items is often an emotional decision. You have a “hunch” that something will sell and you act by investing in some of the product for stock. Unfortunately, often these hunches are wrong, and the result is dead inventory. Is there a better way than simply relying on hunches?
The chances of a new item turning into dead stock are very high if one person makes a snap decision to introduce a new product. To encourage careful thought in stocking decisions, make it a point to answer the following questions before taking on a new product. Ideally, any salesperson pushing for a new product should answer all these questions.
If the salesperson doesn't answer the questions completely, you may not have all the information necessary to make an informed decision on whether it's a good idea to take on the product.
What is the salesperson's track record for introducing successful new products? Speculating on what products might sell (especially products requiring a significant investment) is an activity that should be reserved for salespeople with a history of successful product introductions.
What company branch (or branches) or warehouse(s) should initially stock the product? Consider testing the product in one location.
Who are the potential customers? If the product is only going to be used by one customer, the risk of the product dying in inventory is much higher than if multiple potential customers exist. If the product is only going to be purchased by one customer, be sure that customer has met previous commitments for purchasing special-order products. If he or she has not, consider asking for a written commitment to purchase the initial purchase quantity required by the supplier.
What's the reason for adding the product into inventory? In other words, how will the customer(s) use the product? In an existing application or process? In a new application or process?
If the product was previously purchased from another supplier, why did the customer decide to switch vendors? Be sure to have your accounts-receivable department perform a credit check with the previous supplier to ensure that the customer is not on credit hold with them.
If the product is replacing another stock product, how can you liquidate the remaining stock of the old item? Has your purchasing department been notified to discontinue or modify the purchasing parameters of the old product?
What is the customer's potential market or usage for the new product? The smaller the potential market or size of the application, the greater the chance the customer will not buy the new product on a regular basis.
At what rate will the new product be used or consumed? At least six months of demand projections should be provided. What is the source of this prediction? How reliable has this source been in the past?
How will sales or usage of this new product affect the usage of other existing stock products? Can an existing product be replaced by this item and be discontinued? Should the stock of another product be reduced because this new item will assume some of its sales or usage?
How much product do you have to purchase in the initial order? It's usually not a good idea to purchase more than a projected two-month supply of any new stock item. Because the forecast demand quantities of new stock items are historically inaccurate, there should be a substantial difference in cost to purchase a larger quantity of the product.
Can a smaller initial quantity be purchased, even at a higher unit cost? It may be better to lose money on a small quantity of a new product (i.e., test market) than obtain a low unit cost and end up with a large amount of dead inventory. If the small initial quantity sells within a reasonable amount of time, it's probably safe to issue a purchase order for a quantity that will provide the cost necessary to achieve the target gross or adjusted margin.
What is the liquidation cost/value of this material per unit? If there is a cost of disposal for expired quantities of this product, the initial purchase should be limited to the smallest practical quantity for test marketing purposes.
It's important to continually remind the salespeople of the sales and current available quantity of all new stock items. Print and distribute a report containing the following new product information to each salesperson at a weekly sales meeting until the initial purchase quantity has been sold or used:
Product number and description.
Current month sales (in units).
Sales projection for the current month (provided by the salesperson before the item was added to inventory).
Total sales (in units) of the item to date.
Total sales projection to date (provided by the salesperson before the item was added to inventory).
Current on-hand quantity.
Manually set minimum stock level of the item.
Manually set maximum stock level of the item.
Name of salesperson who requested that the item be stocked.
Reason why the item was added to stock.
By continually reminding salespeople of the existence and sales volume of new stock items, the hope is they will continue to enthusiastically promote these products. Interestingly, results tend to be positive when the report is reviewed in a sales meeting. Many salespeople will offer excuses to a purchasing agent or company management as to why a product hasn't sold, but their competitive nature makes them reluctant to make these same excuses in front of peers at a sales meeting. They're embarrassed to admit they can't sell a product they requested be stocked. As a result, they will avoid having to make excuses by pushing the sales of new stock products for which they are responsible before each sales meeting.
Many firms have adopted a budget for new inventory items by setting aside a specific amount of money for sales or marketing to invest in new products. This type of budget can put an end to the “head butting” common between sales and purchasing:
Salesperson: “I need you to bring in this item.”
Buyer: “I can't bring in the item until you show me some orders for it.”
Salesperson: “I can't show you the orders until it's on the shelf. And, in order to achieve our target gross margin, you had better bring in enough to get the 100-case price.”
If you implement a new-item budget, whenever a salesperson requests that a new item be stocked, a buyer can simply respond, “Sure, if you have the money in your budget.” As soon as most of the initial shipment of a new product is sold or used (i.e., leaving an amount equal to demand during the anticipated lead time), it's considered to be a normally stocked inventory item. The appropriate buyer will assume responsibility for reordering stock and the new-item budget is replenished by the value of the initial stock purchase.
New-item budgets also provide two other benefits. Because of the limited funds available, the sales department will tend to buy small quantities of a lot of new items, and the result is an effective test-marketing program.
There is substantial peer pressure among salespeople to sell new products. If one salesperson uses part of the new-item budget for a product he wants to stock, he is tying up funds that could be used by another salesperson.
It's time to replace emotion with analysis in making decisions concerning new products.
With more than 36 year of experience, Jon Schreibfeder is president of Effective Inventory Management Inc., Coppell, Texas, a consulting firm dedicated to helping distributors maximize the productivity and profitability of their investment in stock inventory. Schreibfeder is author of the recently published “Achieving Effective Inventory Management — 3rd Edition.” Contact Schreibfeder at (972) 304-3325 or via e-mail at firstname.lastname@example.org.