Businesses are well aware of the costs of slow moving inventory. The longer product is held, the more expensive it becomes and the more likely parts, raw materials and finished goods will become damaged beyond repair, or worse, become obsolete and outdated. Any of these outcomes are unacceptable. As such, it is incumbent upon companies to ensure that their sales team is selling slow moving inventory. In fact, it’s their responsibility. After all, sales provided the forecasts on the finished goods they wanted held in inventory, so it’s ultimately up to them to sell those products.
The Impact of Slow Moving Inventory
A number of companies sometimes find it difficult to get their sales representatives to focus in on those products that seem less popular to customers. In some cases, companies are reluctant to hold their top sales performers accountable for slow moving inventory. In other instances, companies account for their inventory holding costs within the product’s overall costs, thereby affecting the gross profit on the sale.
While this aforementioned example makes sense from the company’s point of view, to the sales department it means a lower gross profit per-sale, which ultimately leads to the sales force being less than enthusiastic to sell this slow moving inventory. So, what’s the solution? Well, it’s predicated on accounting for the company’s cost to carry inventory and holding sales accountable for those costs. The video below explains the costs of carrying inventory, while also addressing the costs of not having enough inventory to make sales.
The above video explains the two main costs of inventory - lost sales and high holding costs.
1. Account for Inventory Holding Costs
It’s essential that the company understand what its inventory holding costs are to support its slow moving inventory. Therefore, the company must determine its inventory turnover rates for each and every one of its product lines. This means to determine the average number of days the inventory is held before it’s sold and to use this information to calculate the company’s holding costs. In our example, the company is applying the standard 3% carrying costs to their inventory value on hand.
2. Apply a Sales Team “Penalty” for Slow Moving Inventory
Now, a number of you may be concerned with the connotation of sales team penalty, but as mentioned, it’s ultimately the responsibility of the sales team to sell slow moving inventory. The fact is, inventory was placed there at the request of sales and based on their sales forecasts. As such, the sales team is responsible for moving that inventory. If the company must incur inventory holding costs, then the sales team should understand that they bear some responsibility as well. So, how is this penalty applied?
- Sum up the total inventory holding costs for slow moving inventory – by product line and or by product group.
- Take the holding costs totals for each product group and divide it by the number of salespeople in the department.
- Deduct the company’s inventory holding costs from the sales commissions of each and every salesperson based on their share of that cost.
- Provide a “get out of jail free” card to those proactive salespeople who sell slow moving inventory. Reward those who sell this inventory by not penalizing them and if needed, by giving them a higher commission for doing so.
The table below is taken from the article Product Management: Determining Inventory Holding Costs By Product Line. It shows the company’s inventory holding costs by taking the average number of days the inventory is held for each product line, and using it to determine the company's costs to hold those products. These holding costs are summarized in the “inventory holding cost estimate” column.
The column on the far right is the company’s “total holding costs by product category” and sums up the holding costs for each product category – in this case, the “B” & “C” product categories are those categories that sales should focus on as the “A” product categories have a high inventory turnover rate. Therefore, sales should not be penalized for the "A" product lines. Every product in these “B” & “C’” categories is held in inventory for more than 30 days before it’s sold. The company incurs significant holding costs to support these lines.
Example of holding costs from the table below:
The second product line listed is "Funnel Tubes". The company's 3% holding costs are applied against the product's COGS of $21,000.00. This means that if the company held the product for a full month, it would incur $630.00 of holding costs - $21,000.00 multiplied by 3%. However, the company only holds the inventory for 12 days, so the holding costs are approximately 1/3 of the above, or $252.00.
Summary of the Holding Costs for B & C Product Lines
The $1103.00 total for the B product lines is calculated by totalling up all the inventory holding costs for all B product lines that average between 30 to 60 days of inventory days held.
The $361.70 total for the C product lines is calculated by totalling up all the inventory holding costs for all C product lines that average greater than 60 days of inventory days held.
A company’s sales management strategies can’t be predicated on only rewarding sales for those products with the highest gross profit per sale. After all, those products have a higher gross profit because they have a high inventory turnover rate. Hold those parts too long and the gross profit declines. As such, the sales team should understand their role in reducing these costs. Faster sales means lower costs. It's just that simple.
Those sales people who are proactive in selling slow moving inventory should be compensated for their efforts. This approach forces the sales team to take ownership of this inventory and encourages competition – which is always healthy for the entire sales team. It's up to you on how best to apply this sales team penalty for both the "B" and "C" product lines. However, a good rule of thumb is to divide these totals by the number of sales team the penalty applies to and deduct it from their individual commissions.
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