Do you measure the amount of sales you lose each year because of a lack of inventory? Many distributors assume lost sales are just an expected part of doing business in a competitive market. In reality, more lost sales happen because you couldn’t meet your customers’ demand for product than any other reason such as price, training or payment terms.
Because inventory is so critical to your customers, mistakes made in your inventory practices are more expensive than just replacement cost. You need to consider costs resulting from lost sales, lost customers and carrying costs.
Inventory Mistakes Lead to Lost Sales
The most critical part of any distribution business is inventory. You have to sell product to make a profit and your customers rely on you to have their most needed parts and products in stock to meet their requirements. Most customers would prefer to source most of their purchases from a small group or even single vendor because it is more convenient and cost-effective in their businesses to consolidate purchasing. They want to be a loyal customer. Service, payment terms and convenience account for a fair share of a customer’s loyalty to any distributor, but often loyalty and customer lifetime value hinges on your ability to immediately meet their demand for product.
To make a sale, you want to have the right inventory in place when and where the customer wants to buy. If you don’t have the right inventory at the right time and place, you will lose that sale to another source with the right inventory. Most of the time, these lost sales are the result of inaccurate forecasting of demand. Many distributors think they’re covered because their ERP system has a replenishment module for estimating purchase quantities. Unfortunately, using your ERP system is typically a “set it and forget it,” strategy. If you don’t have an automated way to make smart adjustments as customer activity changes, your replenishment will fail to accurately meet demand.
Our experience from talking with thousands of distributors over the last 18 years is that the typical distributor loses between 5-8% of annual revenues due to out of stocks. For a $100M distributor, that is $5M - $8M a year in lost sales.
The bottom line: if you lack a modern, automated forecasting engine you are losing many more sales than you should be losing.
Inventory Mistakes Lead to Lost Customers
Even worse than a lost sale is the loss of the lifetime value of a large, important account. Unfortunately, if you don’t work to stave off your lost sales due to lack of inventory, you will eventually lose important customers. It is an unavoidable consequence of bad inventory management. When you lose a sale, the customer doesn’t just wait for you to catch up to their needs. They immediately start shopping your competitors. Those competitors then work hard at stealing more business from you with that customer. This can even have a ripple effect with other customers as word of mouth increases in the market for your competitors.
The bottom line: it’s hard enough to land a big customer, you don’t want to lose them for something that can be avoided with better purchasing systems.
Inventory Mistakes Inflate Your Carrying Costs
Most buyers don’t get fired because they have too much inventory, but they can get into hot water if a distributor suffers too many stock outs. That leads to an overall tendency in most distribution organizations to overstock. In our experience, as many as 99% of distributors are overstocked, many of them dramatically overstocked. Because these distributors are worried about lost sales due to inventory, they often consider overstocks as “safety stock.” If they had a better way to forecast their purchasing, they wouldn’t need to tie up so much capital and resources in bloated inventory reserves.
Most distributors assume that 20% to 30% of their total inventory cost is carrying cost. Carrying cost can include things like taxes, insurance, obsolescence, shrinkage, warehouse overheads, access to credit, material handling and other areas that support inventory. An increase in stocking levels beyond what is needed for sales and for any reason increases carrying costs and reduces profits.
Bottom line: the more inventory you carry and the longer you carry it, the higher your carrying costs.