7 questions to ask yourself when planning inventory for new items
Posted on December 12, 2017
Making inventory decisions on new items can be a major challenge for purchasing departments, given there’s no historical usage to refer to, and often buyers are pressured by salespeople or customers to start stocking a new item.
To address this challenge, Jon Schreibfeder, President of Effective Inventory Management (EIM), discussed how to plan inventory for new items at our 2017 Forecasting & Replenishment Forum. The following points are excerpted from his presentation.
Don’t let your new stock end up DOA!
According to Jon, new stock items are usually the source of most dead inventory. This happens because typical new item decisions are:
- Made by one person or at the request of one customer.
- The result of a misplaced focus on the quantity you need to buy to achieve the desired gross margin.
- Undertaken with little regard for what effect buying new items will have on your total inventory investment.
To reduce the risk of new items becoming dead inventory, new items should be maintained with manually maintained forecasts or minimum/maximum parameters until enough usage history has been accumulated to calculate replenishment parameters accurately.
If you are an inventory planner, Jon suggests you have answers to the following seven questions before investing in new items:
New Item Questionnaire:
#1 – Who is requesting that the item be stocked?
How reliable has this person or customer’s predictions been during your relationship? Have they previously provided reliable information? Will the source provide a written commitment to purchase the product! It is important to get the name of who is requesting the new item. That way, when the item gets questioned later, your company knows exactly who to speak with about its performance.
#2 – What are the estimates of usage for each of the upcoming six months?
You don’t want to be told how many units to stock, you want to know how many the sales team will sell. Consequently, you need to understand the typical usage pattern of new stock items. Usually, new stock items will sell well initially because they are new and there will be a sales promotion to kick them off. However, all too often the sales will then take a dip. So it’s important to explore what has been the usage of products with similar characteristics. That is the type of information that will help guide the forecast. If you need estimates and you never sold similar products, you’ll need to ask a lot of questions. If on the other hand, you have products with similar characteristics, you’re in better shape.
#3 – What effect will usage of this product have on usage of other existing stock items?
Will the new item replace an existing item? If the answer is yes, then you’ll need to be concerned about how to liquidate the inventory of the existing items.
Or will it partially replace an existing item? If so, you’ll be faced with the dilemma of “Why do we have to carry both?” “Can’t we just move customers to the new item?” But if you can’t do this, then according to Jon, you should look at your usage history and order half of what you did for the old item, with the expectation that the new item forecast will cover the rest of your demand.
#4 – How many months’ supply must initially be purchased? What investment is necessary?
Ideally this calculation should be based on the new item usage estimates gathered in Question 2 above. If estimates are not available, you should consider stocking for one or two typical sales or usage quantities.
Jon generally doesn’t recommend buying more than 2-3 months’ supply. If the manufacturer wants to sell you more than 2-3 months’ supply, he suggests you try ordering some from an alternate source to test it to see if it will sell. Test marketing at a small margin versus getting stuck with excess inventory is the way to go. (And if a vendor wants to sell you a huge quantity it’s likely someone else already bought a too-large quantity and would be receptive to selling a smaller quantity to you.)
#5 – What is the anticipated gross margin for sales of this item?
On this point, Jon made it abundantly clear that gross margin is the worst metric ever in business. Why? Because inventory carrying cost is not considered. Instead, he suggests that you migrate from gross margin to adjusted margin in order to determine the true profitability of the new item.
Gross margin = (Sales – Cost of Goods Sold) / Sales Dollars
Adjusted Margin = (Sales – Cost of Goods Sold – K Cost (carrying cost)) / Sales Dollars
Adjusted margin is important because it includes the inventory investment required during the time it takes to sell the inventory.
(TIP: If you need help figuring out your K Cost, the Effective Inventory Management website has a calculator. Simply look under the resources area to locate a 24-question worksheet that your bookkeeper can answer. Once you send it back to EIM, they will confidentially calculate your K Cost and tell you if it is too low or too high for your industry in your geography.)
#6 – Where will this new inventory be stored?
Seems obvious but you’ve got to have space for the new material that will be stored in your warehouse. After all, warehouse walls are not elastic.
#7 – How can any unsold or unused stock be liquidated?
If the new stock doesn’t sell, what are your options? Jon suggests if the stock hasn’t sold after nine months of introduction that you’ve got one or more of the following options built into your forecast:
- Return it to the vendor
- Sell it to the customer who requested the product be stocked
- Sell it at a discount
- Substitute it for another product
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To kick off a planning process for new item inventory, you should consider forming a new product committee comprised of marketing, sales, management and purchasing areas to provide consensus on new product decisions. It’s also crucial to keep sales focused on new stock items. To do this, Jon suggests you produce a weekly report of new stock products (product lines) where usage <75% of the forecast. For each item you’ll need:
- Item and description
- Sales and gross margin projections
- Actual sales and gross profits
And, last but not least, you will need to develop a new item budget for each stocking warehouse.
If you would like more information on Lanham’s Demand Planning solution, let us know at education@lanhamassoc.com.
The 2018 Forecasting & Replenishment Forum will take place in Scottsdale, AZ May 8-10. Early bird registration runs through April 4, 2018, so we encourage you to register now.
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Lanham Associates is proud to work closely with Jon Schriebfeder, president of Effective Inventory Management (EIM). If you haven’t checked it out already, we recommend visiting the EIM website for additional insights, information and educational opportunities. Jon can be reached at 972-304-3325.
