Your furnace just went out on the coldest day of the year. It is almost supper time and you fear that the local hardware store will soon be closing for the day. A night of cold sleeping doesn’t hold much appeal. You scramble to unscrew all the screws to access the pilot light. Once inside, you begin to go through the trouble-shooting checklist in your owner’s manual. You find the thermocoupler needs to be replaced.
Now, it’s time for the mad dash to the store to buy the replacement part. Unfamiliar with the plumbing and heating section, you scurry down the aisle scanning to find the furnace parts section. You begin to look over the various assortment of parts to find a thermocoupler. You find the bin that is marked “thermocouplers”. Then your worst nightmare comes true — the bin is empty.
You quickly find an attendant who confirms the bad news. He tells you they sold the last thermocoupler two hours ago, and their next delivery truck is not expected for two days.
Your frustration quickly turns to anger at store management for being so short-sighted in their ordering and stocking.
While you stomp out of the store and next door to the blanket shop, the attendant finds the store manager to inform him about the lost sale.
The manager sees this as an opportunity to teach the young employee about inventory management. He tells the youngster the store generally only sells about 20 thermocouplers a year. Because of the small amount of “turns” for this item, he finds it financially feasible to only stock two units at a time. While he may lose an occasional sale because of not enough inventory, the alternative would be to have too many in stock and therefore tie up money unnecessarily.
To further illustrate this last paragraph on inventory management, let’s use an example of a peg holding three units of the same product on the retailer’s shelf — we’ll use hammers as an example.
We’ll call them Hammer 1, Hammer 2 and Hammer 3. When a customer comes in to buy a hammer, he grabs Hammer 1. All that remain in inventory is Hammers 2 & 3. Those two remain until a delivery truck comes and Hammers 2 & 3 get pushed back on the peg by the new Hammer 1.
This happens repeatedly. Hammer 2 seldom gets sold before a new Hammer 1 arrives. Hammer 3 almost never gets sold.
What if we never bought and stocked Hammer 3? Obviously if Hammer 2 were to get sold, the peg would be empty. And, in the case of the thermocoupler above, we may miss a sale before the delivery truck arrives to restock. But we must weigh the cost of Hammer 3 versus the sales Hammer 3 produces.
It obviously costs money to buy Hammer 3. This is a financial investment for the store owner just like buying shelving units, cash registers and other assets.
Most astute people understand that money hidden under the mattress leads to poor returns. Purchasing Hammer 3 — only to have it sit on the shelf month after month — is akin to hiding one’s money under a mattress. While the financial folly of the latter is well understood, often purchasing excess or slow-moving inventory is not.
For any business dealing with inventory, the successful management of this aspect is often the difference between financial success and the ongoing stress of cash-flow problems.
Damon Carson is a Longmont business owner and small business investor who can be contacted at firstname.lastname@example.org.