Obsolete inventory, the stock of products that you’re not actively selling anymore, holds back many small businesses from future investment and growth. It ties up cash and hogs valuable warehouse space. While small businesses can certainly implement various methods of liquidating old products and move on, the best solution is to stop over-purchasing in the first place. Of course, never buying obsolete inventory is an obvious solution, but it’s a very elusive goal. Obsolete inventory has a way of sneaking into warehouses. As a cowboy would say, “how did all those sick cows wander onto my ranch – and how can I avoid them in the future?”
In order to reduce future stockpiles of obsolete inventory, you can work with your supply chain team to implement a simple hybrid purchasing and manufacturing strategy that combines small-batch validation with high-volume price discounts. It combines the power of validation and speed to market with the cost benefits of large-batch, long lead-time outsourced manufacturing. We’ll look to a calendar company to explain the hybrid strategy.
Hybrid Strategy Example: ABC Calendars
ABC Calendars sells a wide variety of unique and fashionable calendars. Each year, some of its styles do very well and sell out, but some of its styles barely sell at all. In July, ABC doesn’t know which of its styles will sell well, and in February of next year, its leftover inventory will drastically drop in value. Not too many people buy new calendars two months into a new year. In the past, ABC Calendars has moderated focus groups to forecast the winners. Based on forecasts, ABC sent out large purchase orders to its Asian vendors. These vendors produce in large batches with long lead times, but their low cost helps keep ABC’s margins high. ABC needs these margins to offset the money it loses from the styles that don’t sell. Historically, ABC has done pretty well picking winners, its right about two-thirds of the time. However, as the competitive market changes, ABC needs to do much better.
The real problem ABC Calendars is facing is that the low-cost, outsourced vendors require long lead times and high order quantities. This forces ABC to guess the winning styles before it has any real sales data. To make a good margin, ABC can’t rely on local or in-house manufacturing because it costs so much more. Nevertheless, ABC is trying a new hybrid strategy that will give it quick and valuable validation while still enjoying the lower margins that outsourced vendors offer. The following graphic and explanation show how ABC utilizes a hybrid purchasing and manufacturing strategy to reduce inventory and better calibrate which products deserve a large purchase order.
ABC defines the first step in each product’s life cycle as the prototype phase. More than just a working prototype to proof and pass around the office, this is a chance for ABC to get some initial customer feedback and validation. Even at a very high cost, this phase enables ABC to print around a hundred of each calendar design. It then places them in a few test stores to see how they sell. This first wave of customer voting with their pocketbooks will guide ABC to know which styles show promise.
Based on initial sales in the prototyping phase, ABC begins low-volume, higher-cost manufacturing. Whether ABC manufactures itself or uses a local company, it can slowly increase volume with smaller batches. It can then continue to sell to its early customers and obtain more validation. Usually the higher cost of local manufacturing erodes ABC’s profits. However, before it jumps into the investment of a large outsourced order, ABC doesn’t mind paying a higher price to gain market insight. It actually prefers giving up some margin to avoid piles of obsolete inventory later.
Now that ABC knows which styles have the most positive momentum, it’s ready to place the large orders and capitalize on the lower price from higher volumes. However, before placing goliath-sized orders, ABC plans its exit strategy for the items it’s ordering. ABC orders a substantial amount to carry it through most future demand, but not enough to sustain demand through February. Instead, ABC orders enough to satisfy around 80% of projected demand, planning to run out of inventory around mid-January. Then, when inventory starts to run low, ABC switches back to the local manufacturing option. Again, this decreases margin, but it helps guarantee its warehouse will be nearly empty when March 1 comes and demand disappears for its product.
In addition to printing calendars, any business that produces a large number of SKUs and relies on slow but cheap outsourced manufacturing can significantly benefit from this hybrid strategy. It’s certainly not a lean, one-piece flow or a built-to-order supply chain strategy, but it’s a realistic step in an effort to reduce inventory through hybrid purchasing strategic shift.