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Why Non-Stock Inventory is a No-No

May 14, 2015
The problems with nonstock inventory have been around since the days of Kardex inventory-management systems, and they continue with modern-day ERP systems.

On the way to the bank to deposit my profits, I looked at my smartphone report that said my inventory grew by 28% without my knowledge or consent. Aside from almost having a wreck and heart attack, I threw my phone on the car floor!

Is that a little too dramatic? Not for some distributors I know. Many of them tell me their inventory has grown anywhere from 15% to 35% in a single year even though they really didn’t plan on investing that much money to service their customers. Many said they had pre-determined the amount of dollars they were prepared to invest at their yearly planning sessions, but to their frustration the overall dollar size continued to grow. Following are some examples that might raise your eyebrows. Names and all descriptions of the guilty distributors are being withheld because of likely embarrassment.

Example #1. This distributor does about $225 million to $260 million in annual sales but has approximately $14 million on the books as non-stock/unclassified and unpriced items. That’s a big deal, particularly when you consider how many people a distributor needs to handle this inventory.  This distributor figures he has enough inventory to service over 110% of his current customer base. On top of that, he knows he’s being cherry picked by certain contractors.

To make matters worse, in a rising copper price market, customers hedge their bets on the price of copper by placing a large order for the copper and then putting it on hold. The distributor’s salesperson knows that the customer is hedging the price of copper and doesn’t charge the customer any money to play with the “distributor’s money,” because the distributor buys at that price. If the price of copper goes down, the customer cancels the order and then re-orders at the lower price. It’s like buying fuel or oil futures, and it’s a no-risk bet for the customer.

Example #2. This distributor is in the $190 million to $210 million range in annual sales and has approximately $11.9 million in non-stock/unclassified inventory. There was no telling what was lurking in dark corners. Approximately $3.3 million in these items were eventually reclassified and is available for sale. While it was reclassified, it was not planned inventory. But it sits on the shelf unwanted, tying up cash.

Why Non-Stock Inventory

Appears on the Shelves

Non-stock inventory is the scourge of all distribution industries. Distributors didn’t plan on having it and certainly didn’t plan on investing money in it, but they get stuck with it on the shelf. With the purchase of new ERP (enterprise resource planning) systems, many distributors now have the software to collect SPAs (special pricing authorizations). But non-stock inventory is still something that many distributors aspire to conquer, but few have solved. Let’s look at how unplanned inventory ends up your shelves. Generally speaking, non-stock can be lumped into several categories.

Local fill contract agreements gone bad. A local fill contract is a gentlemen’s agreement between two competing distributors who are often in the same marketplace. They usually agree that if one company has a customer who needs an item, the other one will sell it to them at a pre-determined benchmark price, such as 20% off one of the Trade Service price columns, which are supposed to be published by manufacturers.

In these agreements, the distributors generally don’t expose their inventory levels, because a competing distributor could make a very good living off someone’s inventory investment and have no risk at all. Local fill agreements turn sour when final billing does not match perceived agreements. Distributors are just trying to service their customers.

Non-stock-purchases from the manufacturer. The order cancels mid-shipment and ends up on the distributor’s shelf. To add to the problem the manufacturer has a minimum amount greater than the distributor needs.

Unassigned freight cost. Distributors sometimes see this at the end of the year.

Shipping delays. Products for projects that ship long sometimes end up on the distributor’s shelf.

Non-stock inventory with mispricing or no pricing. This happens when salespeople game the system when they log in the order. Some salespeople place the order in a ship-complete category and place it on hold. At a later date, they add it to another order and it will ship. Because the other order is still on hold, your inventory count is off, and no one trusts it.

Distributors have an ongoing fight with customers to pay for freight on non-stock items. Some distributors think that because an item isn’t in stock, maybe they should order it. Salespeople have a hard time having that freight discussion with customer.

When the customer is not advised or even notified of the freight cost, strange things happen with the way an order is entered or handled by salespeople. Depending on the business software and the way it’s set up, sometimes a salesperson can figure out a way to game the system. Without getting into great detail about how salespeople do this, it often involves forcing a product into a distributor’s ERP system with a phony description and price and putting that product on hold. Oftentimes these nonstock items sitting on hold cause lots of problems for the year-end inventory counts distributors need for rebate purposes and SPAs. The bigger the distributor, the bigger the problem.

Some distributors will blow away the non-stock issue by thinking money is cheap at 1%. The problem with that logic is if bank interest rates go up over 1% what do you do? You’ve got a larger problem than you think.

Off-Book Hidden Inventory

Through all these discussions, keep in mind that opportunities exist for non-stock inventory that goes off book or out of the vision of management. In most cases, money has been used to buy this stock one way or another. But the question is, if it’s not in your cycle count or visible in your system, is the problem compounded?

The problems with nonstock inventory have been around since the days of Kardex inventory-management systems, and they continue with modern-day ERP systems.

They won’t go away unless distributor management makes an extreme effort to put in productivity processes that rely on their computer systems  to carefully check and clean out the cancelled orders.  Other ways to cut down on non-stock inventory is to watch sales order patterns more closely and to reinforce positive behavior.