The hidden costs of excess inventory

In June of 2022, Target Corporation announced an aggressive campaign to reduce and right-size inventory after building it up during the supply chain disruptions of 2020 and 2021. They took actions across their entire supply chain, including adjusting markdowns to sell through store inventory faster, holding inventory further upstream to pool demand and only deploy it when it was needed, and working with vendors to cancel unneeded orders and shorten lead times.  This multi-pronged attack on excess inventory “laid the groundwork for the recovery and profitability” of 2023, according to CEO Brian Cornell. 

After the supply shortages of the early pandemic, retailers have overcorrected, with a dramatic increase in inventory levels that, in some cases, can be seen from space. Across the U.S., average days on hand for retailers has increased by 12% since 2021, and the majority of retailers haven’t followed Target’s example of rightsizing, resulting in inventory remaining high. More recently, Target’s earnings missed expectations partially due to the cost of having accelerated imports in advance of the potential port strikes. Even Target isn’t immune to the downside of being over-inventoried in these disrupted times.

For U.S. retailers and distributors sourcing from outside the U.S., we anticipate this problem will only get worse in the short term. President-elect Trump’s plan to implement significant tariffs on imports, especially from China, will likely accelerate inventory purchases, tightening capacity within warehouses and driving up freight costs. While the impact of these tariffs could be significant and the right answer in some cases may be to pull forward purchases and build up inventory in anticipation of policy changes, it is crucial for companies to accurately assess the cost of holding this inventory and balance it against the benefits of accelerated purchases.

Many companies have delayed taking action on their current inventory levels as they don’t realize the full impact of holding excess inventory, in part because the people making inventory decisions are siloed from those managing holding costs (often from “temporary” trucks and overflow storage), shrink costs (sometimes the stock on trucks goes missing), and obsolescence costs (electronics in particular date very fast, to the point that earlier models are worthless several years on).

These costs have risen dramatically in the past few years, and as companies realize the impact these changes are having on their finances, more will make moves to adjust their positions. As they embark on these transformations, it is important to remember that forecasting, inventory optimization, and product lifecycle management are the core to a right-sizing operation, but ensuring processes outside of the inventory team are structured and incentivized to keep inventory low is equally important. 

How the problem started 

Straying toward overstocking product might have been a good-enough strategy in the post-pandemic era, when retailers were still coasting off pent-up demand and borrowing costs were low, but in the last two years, the fundamentals have changed. 

Soaring interest rates have pushed interest costs for retailers up by 40% since 2021, warehouse rents have hit record highs, and warehouse labor rates have increased by 13% since 2021, per the US Bureau of Labor Statistics. All these overlapping cost increases results in a total cost of holding inventory which can have a sizeable impact on a company’s financials. 

This situation is compounded by changing customer expectations. As the 2024 AlixPartners Consumer Sentiment Index finds, customers expect a seamless experience with the right product at the right place, and per the AlixPartners Holiday Survey, customers are unforgiving when met with out-of-stocks: two-thirds will pursue a different retailer if the item they want is not available on the spot. This makes reducing overall inventory more difficult, as the cost of a stockout often outweighs the cost of excess inventory, so striking the right balance is critical.

Addressing the underlying problems causing overstock

Ensuring availability while reducing inventory levels isn’t possible without an accurate demand plan. Fortunately, over the last decade this space has seen huge leaps in technology and capability, with AI and machine-learning (ML)-enabled forecasting becoming the norm. 

AI/ML technology is extremely powerful as a forecasting tool due to its ability to incorporate hundreds of factors including historical sales patterns, new product introductions, promotions, pricing, competitive actions, social media data, and hyper-local weather patterns, just to name a few. This technology combined with the incredible cloud computing power which is readily available lets companies run these intricate analyses on every stocking point which could be in the hundreds of millions for larger SKU-heavy retailers such as grocers.

Leveraging AI/ML capabilities can allow retailers to reduce working capital by 10-20%, reduce store shortages by 50-60%, increase sales by 2-4%, and increase EBIT by 1-3%. 

Once an accurate consensus forecast is created, inventory can be optimized based on supply chain factors and constraints including supplier lead time and variability, minimum order quantities, demand variability, lead time to stores, space constraints within the distribution center or store, truck rounding, and a variety of other factors. This is streamlined if there is a holistic inventory platform integrated with the demand-planning platform.

Putting inventory into the right locations is as critical as buying the right total amount. We often see a large chunk of company’s slow-moving inventory sitting in stores when they are light on that inventory in another part of the country. 

It’s also worth analyzing and questioning the constraints that are put on purchasing inventory. Constraints such as minimum order quantity are often flexible through negotiation of a higher per unit price, which may be worth it if a single order represents months of inventory volume. We’ve seen buyers strike a deal to absorb a huge amount of inventory at a discounted price, but when you consider the true cost of holding that inventory, it’s a losing proposition. It’s important to instill inventory governance principles in everyone making inventory decisions, otherwise the decisions they make might not be best for the overall organization.

Seeing products through the lifecycle

Too often product is bought without a plan on how to get out of it at the end of its life. Fashion retailers are traditionally the best at this, as the seasonal nature of their business results in costly markdowns for any inventory still on the shelf near the end of the season. However, this skillset is important for all retailers as all products have a lifecycle, and planning for and understanding the impact of liquidation can drive better purchasing decisions up front.

Unfortunately, we frequently see retailers wind up with a large volume of product near the end of its life, often in excess of 52 weeks of supply. For this product, it will take over a year to get back to a reasonable level if you don’t take any actions outside your normal sales channels. The easy lever to pull is markdowns and having your salesforce push these products before others, but it’s worth exploring other avenues.

Retailers have options across the supply-chain to address inventory overages:

Normal channels: Obviously the best way to get out of excess inventory is to sell it, but sometimes it needs to be helped along. We have seen retailers succeed in moving product off their books through cross-functional collaboration and strong analytical capabilities to decide whether geographic rebalancing, markdowns, or salesforce pushes would be the most effective to get inventory back to a healthy level, or if a more drastic measure is needed.

Upstream: When selling through inventory is difficult, one of the first things to look at is returning inventory to the vendor.  This won’t work in every case, but depending on the retailer’s negotiating power with the vendor, or in situations where the vendor has other customers they can quickly turn around and sell that inventory to, they will sometimes be happy to take a shipment back.

New e-commerce channels: While there is an up-front cost, new e-commerce channels can often provide a way to sell through inventory at a discount, but at a better price than a normal liquidation channel. Retailers can also consider own-brand or industry specific liquidation avenues such as Flashfood, or generalized third-party e-commerce platforms like Amazon or eBay.

Liquidation sales: When normal channels are not successful, liquidation through sales to competitors, discount retailers, overseas markets, or to general liquidation providers can enable some cash to be extracted from the inventory.

Destruction: When all else fails, the decision should be made quickly to destroy the product so it doesn’t continue to accrue cost while being stored and moved around within the distribution center network, where it takes up valuable space that can be better used for other product. With the increases in warehouse rents and labor rates, sometimes simply holding onto inventory is more costly than disposing of it, especially for the many retailers we’ve seen use expensive offsite or temporary storage.

Making a move

Macroeconomic changes are causing inventory sitting in stores, warehouses, and rented trailers to weigh more heavily on balance sheets, and there are signs that the consumer is, at this time, more cautious about their spending.  In other words, there is no better time to make a plan to draw down your current inventory positions and instill a company-wide inventory effectiveness mindset to ensure investments are made in the best interest of the organization as a whole.