Sometimes your best investments are the ones you don't make. ~ Donald Trump
We recently took a trip up to Clayton, Georgia, where they have some of the best hiking trails around, including the challenging Tallulah Gorge Trail. One day we decided to go up to Highlands, North Carolina to have lunch and look around at the many neat shops.
We decided to stop in one clothing store because we were drawn in by the sign outside. However, what we found inside was an unbridled, disorganized warehouse masquerading as a store.
Now this "store" carried really high-end merchandise, including men's pants priced at more than $200, but the experience of shopping there was far from luxurious. They had so much inventory that you could only walk sideways through the aisles. The round racks were loaded with pants on hangers as well as 50 or 60 pairs stacked on top. There was so much inventory out on display that you just could not get a good enough look at anything to make a wise buying decision.
What the managers of this store fail to realize is that inventory, if not managed well, can be a liability rather than an asset. If they would secure an offsite storage facility and reduce the amount of inventory on their shelves, I guarantee their sales would go up significantly. Their current arrangement is just too overwhelming to the customer, and many just walk out because of the disorganization.
Clearly this store is an outlier. I think you are unlikely to find another one with such extreme circumstances. However, it helps illustrate the point that many businesses need to better manage their inventories.
Inventory is a big investment and an important contributor to success. With too little inventory, you have "stock outs" and you lose sales -- possibly customers as well. But with too much, you have dollars committed to inventory that is not generating a return.
There are a few times when having excess inventory makes sense. For instance, if you get a great price break on a product that makes it worth the investment of carrying extra inventory. Also, if you expect prices to increase in the near future, it may be beneficial to build up your inventory while the cost is lower. And finally,
if you expect there may be a shortage caused by a delivery issue or something else, it may be a good time to compensate with excess inventory.
Other than these situations, however, you want to aim for a level that balances your stock-out costs against the costs of carrying inventory (interest paid on what you borrowed to build the inventory). If your inventory is over 10 percent of your total assets, you should carefully consider whether you are buying too much or too little. Obviously there will be times that your inventory will vary because of market conditions, so you will need to continually monitor your levels.
Jerry Osteryoung, a consultant to businesses, is a Jim Moran professor of entrepreneurship (emeritus) and professor of finance (emeritus) at Florida State University. Reach him at firstname.lastname@example.org.