Market conditions have dramatically changed over the course of 2022. Unfortunately for many brands and retailers, this implies a dramatic drop in demand that wasn’t anticipated at the time of ordering goods to sell for the year. The consequence: a higher likelihood of overstock.
Overstock, inventory bloat, or simply: excess inventory that sits on the shelves of warehouses without being sold. It is a common concern for brands and retailers around the world. With the dramatic shifts in demand during recent years, we’ve seen companies go from having gaping shelves and stockouts due to production and shipping delays, to slashing prizes to reduce overstock as consumers tighten the purse strings.
Even during “normal circumstances”, keeping the right stock levels is tricky. If you understock you run the risk of losing out on sales. On the flip side, if you overstock you tie up cash in excess inventory. To get the balance right you need to take some calculated bets. In this article, we take a closer look at the implications of overstock, how to identify and quantify it.
This article is part 1 of 2. In part two, we outline how to address overstock.
Undeniably, overstocking has major implications for your cash flow. For many businesses, the cash tied up in stock can be 20%, 30%, or even 40% of annual turnover. Tying up capital in excess inventory means that you have less capital to run the rest of your business. It means that you can't purchase products that would be more profitable or it might hinder you from introducing new products that attract customers. By extension, this has implications for your customer loyalty and brand.
In the long run, to free up capital many brands are forced to sell overstock at reduced prices and effectively eat up their margins and profit. In turn, this threatens to take revenue from future sales and new product releases as customer demand is saturated from previous sales. It also poses the risk of consumers holding out on buying new releases and rather wait for them to be subject to reductions as well. On top of all this, operational costs follow as warehouses are overflowing with excess inventory and the organization is focusing on activating, marketing, and selling overstock instead of optimizing for future sales.
In any market, overstock is a looming problem for growing brands. Putting in orders for future projected sales before having grown into those larger shoes is a risky venture. So what’s the solution? How do you tackle these issues before they happen? Let us take a look at how you can identify and quantify overstock to take needed action.
Overstock is the value of the stock you have at hand, that exceeds the estimated demand over your desired sales window. The sales window can be the period until end-of-season, or for continuity products the lead time to get a re-stock. For example, if you have 1000 units of an article and you can get the next re-stock in six months, during which time the estimated demand is 500 units - you have an overstock of 500 units. At a purchase price of EUR 100 per unit, this corresponds to an overstock value of EUR 50,000.
Occasional overstock is a natural part of running a consumer goods business, you need to take some bets and some articles won’t sell as well as you thought they would. If you never take any bets, you probably have a low degree of assortment newness which is important for customer loyalty. It is, however, important to take educated bets and be aware of the overstock as early as possible to address the issue in time.
So how do you identify and quantify the overstock?
I.e. the products you plan on having in the assortment for a long time and purchase continuously. These make sense to calculate as follows:
If the number you get from this calculation is negative, you are obviously not sitting with an overstock but rather low inventory.
For products that you sell only over a certain period the logic would be:
For a simplified calculation, set a target average stock coverage ( = days inventory). By looking at how much you exceed that with your current inventory you can derive how much the excess is worth at cost price.
Why we typically look at the value rather than overstock units is to make identification easy: ordering your assortment based on overstock value makes it easy to see where the most impactful overstock sits.
What is important is that this calculation is done in good time. Estimating overstock a few weeks before the end of the season limits your ability to do something about it. Though patterns might change over time, you can typically make a reasonable review of the demand forecast with early sales data - giving you time to take action without panic.
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