Reducing Excess & Obsolete Inventory

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A Practical Approach

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It is said, “What gets measured, gets managed.”  The opposite is also true. 

If you have recently toured your manufacturing and warehousing facilities, you have probably seen Excess & Obsolete (E&O) inventory. E&O is in plain sight. It is the material in the corner of the plant awaiting rework that is never prioritized. It is the box with an extra layer of dust on top mixed in with the regular production inventory. It is the inventory in the rented storage container behind the building that the company has paid for three-times over, and the accounting department no longer questions the monthly container billing.

Many companies only see E&O when it rears up in an alarmingly large lump at the end of a financial reporting period. The discovery is oftentimes accompanied by some level negative emotion from the C-suite, as GAAP requires that all obsolete inventory be written off at the time it is determined obsolete.

What is Excess & Obsolete Inventory?

According to ASCM, excess inventory is any inventory in the system that exceeds the minimum amount necessary to achieve the desired throughput rate at the constraint or that exceeds the minimum amount necessary to achieve the desired due date performance. Obsolete inventory is inventory that is no longer useable for its original purpose due to age, economics, and/or BoM supersession.

How is E&O created?

There are many ways excess and obsolete inventory is created. Planning contributes to E&O through supply/demand mismatches. On the demand side this can take the form of Sales requesting inventory stockpiles to facilitate “betting on the come.” E&O can be the result of an overly optimistic new product launch forecast from Marketing. Or can simply be the result of poor data cleansing and forecasting practices.

Engineering and Operations can create E&O as well. In the case of Engineering, poor design necessitating continuous redesigns can lead to E&O. Poorly communicated part supersession changes between Engineering and Supply Chain can create left over former revision level parts on the floor and in the supply pipeline. Lastly, parts lost or hidden by Operations and later found can also create an E&O situation.

The bad and the good news are that most departments in a manufacturing organization have a hand in creating – and therefore controlling – E&O.

 

The impact of E&O is both physical and financial

Physically, E&O makes the operation less efficient. E&O inventory gets in the way of day-to-day activities. Operators must constantly work around the non-production inventory in their way, travel farther to get to the inventory that is actually needed, and simultaneously maintain the integrity of the non-moving inventory. Over time, packaging of the excess inventory becomes torn or worn out from constant movement and the inventory inside becomes damaged.

Financially, E&O ties up working capital and increases operational expenses. Additional racking, storage space, transportation for inter and intra-facility movements, labor for inventory counting and material movement, shrink, and damage, must all be expensed to preserve the non-moving inventory. These items have a cost, but they are typically hidden among the period costs of an operation.

 

Containment

Containment begins with seeing the E&O inventory in the operation. Some quick steps on the path to visibility include identifying all non-current revision parts in inventory, identifying items lingering in the Quality non-conforming area for greater than 6 months, reviewing test/prototype inventory in R&D, identifying items in inventory with zero usage for over a year, and items with supply greater than demand to name a few.

The next step to visibility is to put a number on it. Many companies track inventory turns (Sales / Average Inventory). Although the inventory turn number does consider all excess and obsolete stock, it does not call it out specifically. Adding up the inventory value of the items identified in the paragraph above and dividing it by the average inventory will provide a more accurate percentage that can be used to calculate the amount of reserve to set aside for E&O. For example, a company may determine that it wants to lower its E&O from 30% to 10% over the next 24 months. Dividing 20% / 24 months provides an accrual target of 2% per month.

The amount of excess inventory in your organization may be shockingly high. It is not unusual for manufacturers to have 20-30% excess and obsolete stock on hand. And for some manufacturers, like small run batch builders with a large customer base, there can be a large amount of slow-moving inventory as well.

Disposition

The hardest part of reducing excess and obsolete inventory is getting the authorization to disposition. For whatever reason, organizations tend to generate increasingly more creative ways to disposition inventory with each successive request for authorization. From selling excess inventory to employees to selling it on Ebay, disposition ideas abound.

Time and resources are the enemy of inventory disposition. The probability of an E&O item being successfully dispositioned is inversely proportional to the number of times it must go through the disposition process. For example, if an item were to first be dispositioned rework, then return to vendor, then donate, the probability of successful disposition would be – 1, 1/2, 1/3…  Each time through the process scarce resources must be (re)allocated to push the item through the process making the probability of success successively smaller. Therefore, it is important to limit the times an item must go through the disposition process before being scrapped.

Below I have included common disposition actions. There is a hierarchy among the actions. Actions that retain the most value are at the top of the list, and the actions that retain the least value are at the bottom.

  • Re-classify the inventory item for aftermarket part sales
  • Obtain Engineering authorization to use the item in a different product
  • Cross-sell the product in a different channel
  • Bundle the product with another product for sale
  • Return the item to the vendor for a restocking fee
  • Transfer the item to a sister manufacturing operation that uses it
  • Rework the part into a different part that can be used for production
  • Offer customers a discount to purchase the excess stock
  • Donate the item
  • Sell the item on an online marketplace
  • Liquidate the inventory at a deeply discounted price, but more than salvage prices
  • Sell for salvage value
  • Scrap

Prevention

Reconciliation and communication at strategic points in the manufacturing process is the key to minimizing the E&O.

The Sales and Operations Planning (S&OP) function is ideally suited to capture mismatches in supply and demand. Regular meetings provide a forum for Sales, Marketing, Procurement and Operations to come together, identify, and correct supply/demand imbalances before they make it into the operation. A robust S&OP process considers the product life cycle of all planned items and can pre-disposition all end-of-life items to minimize the fiscal impact to the company.

The shop floor inventory control processes of cyclical counting can identify many inventory errors that may lead to inventory excess and obsolescence. Cyclical counting can identify discrepancies in BoMs, factory usage, and mis-marked parts. A statistically strong inventory counting program will uncover upstream process issues that lead to E&O.

Top management plays the largest role in the success of the E&O process. As the group that authorizes inventory disposition, the tone set at the top will drive the efforts of those below. Proactively identifying an acceptable level of E&O, accruing for inventory disposition, consistently reviewing the E&O inventory on a periodic basis, and overseeing a reduction in the causes of E&O will lower excess and obsolete inventory overall.

Companies will always have some level of E&O. Making E&O visible and proactively managing it helps companies both avoid large period wrecking write-offs and aids in tax planning.

REFERENCES

Lambert, Doug, and Stock, James. Strategic Logistics Management. Irwin, 1993.

Sanderson, Gerald, APICS Detailed Scheduling and Planning, The MGI Management Institute, 2000.

McCue, Ian, Obsolete Inventory Guide: How to Identify, Manage & Avoid It, Netsuite.com, 15, October 2020.

Barrett, Jennifer, Obsolete Inventory: Book vs. Tax Write-Off, MKSH.com, 29, February 2022.

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