What is Distressed Inventory?

Distressed inventory is comprised of those goods or materials that have spoiled, become ruined, or are otherwise impossible to sell on the standard market. It can also be items in good condition that have remained on the shelf too long, taking up valuable resources that could be used towards more profitable merchandise. Sometimes distressed inventory comes about due to overstock; other times, demand simply dries up. Distressed inventory is a serious threat to the livelihood of any business.

The Cost of Distressed Inventory

For many businesses, the cost to buy goods for sale or manufacture eclipses even the cost of labor. When inventory levels are allowed to grow beyond sales forecasts, margins are reduced because excess stock must be sold at discounted rates, resulting in lower margins. Stagnant inventory is a source of money a business cannot access when it may be most needed. This slows down a company’s ability to maneuver in a competitive market. The money would be put to better use in purchasing the next high-margin product of the day.

Beyond tying up dollars, unsold inventory declines in value over time, creating a double jeopardy. Not only is the business losing profits it could be securing, it is also losing monetary value on the product itself. This makes it harder to sell, forcing deeper discounts and lower margins. This is especially damaging if the inventory was purchased with a loan. Now it is also costing to company money in interest fees.

Product Life Cycles

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Every product stocked by a company has a life cycle. There will be increasing demand until a peak is reached and then the demand will subside. These trends may run along seasonal lines or simply be a one-time fad event. Once demand begins to ebb, huge mark downs are needed to keep sales going. The value of the merchandise can go down as much as 50% annually while it sits on the shelves taking up the space of cash that could be used to grow the business.

Why does Overstocking Occur?

Overstocking comes from several sources, most of which are forces from within the company. This means the business can control overstocking through proper management. Market forces are only the cause of overstocking in a small percentage of cases.

Internal Causes of Overstocking

Various managers are encouraged to maximize inventory investments to paint a rosier picture on balance sheets. In addition, buyers look at the cost per unit, rather than paying attention to the bulk of the inventory. The more they buy, the cheaper they get it, making them look good at review time. Operations managers like to over-buy so that the production line will not come to a stall because the supply of a part has been depleted. Salesmen are ever-optimistic and will over-buy in anticipation of gains in sales and fears of running out of stock just when a big sale is being closed. The various motivations of these workers are well-intentioned, but they lose sight of the effects over-buying has on the company’s bottom line.

Trying New Items

Market forces can also contribute to over stocking and dead inventory. The biggest culprit is often a new product that the business tries in an effort to find new sources of profit.

Too often wholesalers try out new items based on a vendor’s recommendations without getting any assurances about what will happen to items that do not sell. When agreeing to try a new product, wholesalers should negotiate terms for the vendor to take back unsold merchandise at or near cost, within a specific time frame. A good target date is six to nine months after the wholesaler receives shipment of the stock.

Market surveys show that only a small percentage of customers who said they would try a new product actually come through with a purchase. This means that the market research done by the vendor is skewed to present higher sales forecasts than can really be expected.

Another way to reduce the risk of dead inventory on new products is to search the market for smaller quantities of the item that can be tested to see how the sales will be. Even if the cost per unit is higher, the reduction in dead inventory will be well worth the extra cost.

What to do About Dead Inventory

Distressed or “dead” inventory is a problem for any company in the distribution business. While sooner or later every company must deal with this problem, any business caught in a cycle of over-buying must take measure to break the trend. This means ridding the business of distressed inventory, freeing up cash to purchase goods that will sell quickly and monitoring stock more closely in the future. Managers must be level-headed and sober in assessing the steps needed to liquidate the inventory.

Mark Downs

The most popular method for ridding the business of distressed inventory is to mark the goods down for quick sale. It is common for businesses to keep a regular practice of scheduled mark downs as long as particular products remain in inventory. Managers must be merciless in discounting merchandise to make it move quickly. While marking items down as much as 75% can be painful, the cost of keeping the goods is even more so.

Returns

In some cases, the company can communicate with distributors to request that they take back excess inventory. Proposals should be structured in a way that benefits the distributor, such as offering the merchandise in exchange for other merchandise that may sell better.

Charitable Donations

If all else fails, charitable donations are always an option. If goods have been drastically reduced and still remain on the shelves, a charitable donation allows the business to write the donation off on taxes.

Monitoring Stock

Close monitoring of inventory levels is needed to keep them at healthy limits. Cycle counting should be done to maintain control of stock on a regular basis. This allows the business to spot problems before they cause serious financial concerns. In addition, strong inventory management systems should be kept in place that base purchase decisions on market forecasts and stock levels, not on the influence of salespeople or operations managers.