“It’s always the same story. The company accumulates too much slow moving inventory, then suddenly goes bankrupt.”
I was having coffee with a 16 year ecomm veteran and successfully exited CEO. He built a large division inside a big ecomm company, then ran another company to successful exit and now was focused on his own brand which he had started as a side hustle and steadily grown profitably for years.
The conversation moved on, but what he said stuck with me. Why is that? Why does slow moving inventory accumulate? How do companies get themselves in that position?
I have seen it when I start an engagement.
‘You guys have 260 days of inventory. Why?’
‘Yeah, we have to whittle this down. We had some products not pan out. But we are still stocking out of our bestsellers! We need to cut some PO’s now!’
Before we get to how to prevent buying too much inventory, let’s look at the three factors that drive over-buying:
1/ Failing to predict the predictable
2/ Loving the new new
3/ Not seeing cash
1/ Failing to predict the predictable.
The rationalizations are always the same.
- Ads got too expensive and we don’t have the budget to pay more CAC or
- Ads got less efficient and we don’t have to budget to pay more for CAC
- Our margin structure can’t support the increased ad spend and required discounts. We have to make our profit, so if it just takes longer, then that’s what we have to do.
- Our style / color / price is missing the mark
- A competitor is suddenly hot and everyone wants that
- We don’t want to discount and train our customers to wait around for sales
- Our product just got some bad PR and now no one will buy
- We messed up fulfillment, got some bad reviews and need to make some fixes.
Is there any brand which hasn’t faced several of these events? These events aren’t outliers, they are the normal course of business. Does your buying process factor these in? Do you place PO’s assuming one or more of these will happen? Or does your process assume that the predictable won’t happen?
Humans are terrible at inflections. We like to project smooth trends from observed events. So what looks like a steady or slightly decaying sales volume is projected to continue when in reality, a cliff is up ahead.
Often the purchasing decision is essentially taking trailing trend lines i.e. the last 30 or 90 days of sales and then making some adjustment for the upcoming season and known sales. This process is then repeated for each SKU.
While reasonable at the individual SKU level, it’s unreasonable at the aggregate level because each SKU is purchased to perfection. In aggregate, we end up with a very optimistic bet.
Some powerful human traits are at work here. ‘The Gambler’s Fallacy’ is the assumption that what has happened in the past will continue to happen in the future. We see that in the trend analysis. We should be thinking of our PO’s as bets or investments. Like investments, products have variance in their performance. We can learn from portfolio theory where investors seek to balance risk and reward. I am going to tackle this topic in a future post, but for now, think of your PO’s in aggregate and be careful you are not stacking one optimistic bet on top of another and thus are not prepared when the entirely predictable happens.
2/ Everyone loves the new new
Selling the same old thing gets boring no matter how successful or profitable it is. We all get caught up in the new thing. Marketing wants something new to advertise, build campaigns around and attract new customers. Product is convinced they have the next hit. The CEO wants growth and how better to do that than launch a new line or product? Everyone wants the new. And everyone is optimistic. Otherwise, why do it?
One, the new thing by definition means the unknown. You don’t have direct experience with demand for this product. You are making all sorts of bets on the product, pricing, colors, sizes, merchandizing and advertising. You don’t know if it will cannibalize other sales or how it will sell across your channels. But it’s the new new! Everyone is fired up. It’s going to be a hit. And that enthusiasm can’t help but leak into the projections and purchasing decisions.
So the new new often gets over ordered. And they are then stacked on top of the over optimistic orders for the evergreens discussed in #1.
3/ Not seeing cash
If your business were a store and the backroom in that store was stacked floor to ceiling with inventory and you had boxes piling up in your bedroom and spilling out of your trunk, you might think you had too much inventory and decide to sell it.
But because your bad bets are hidden in your 3PL and show up only on your balance sheet, it’s easy to ignore. Out of sight; out of mind.
As humans, we hate facing our bad bets. So as slow moving inventory piles up, we tend to view it as ultimately sellable. ‘We can move this. We just need to wait to next season. Or we can package it with other stuff. Or we will unload it in our upcoming sale.’
Our inventory is cash.
Instead of envisioning SKU’s and products, think stacks of cash lining the shelves in your warehouse. Every day one or two bills from each pile float away. They are removed to pay for storage and removed to pay the interest. More bills disappear as the market moves further away and our discounts have to increase. So, why aren’t you grabbing those stacks of cash off your shelves and putting them into your bank account?
This is Part 1 of Death by Inventory. In part 2 I will tackle changes to your process to prevent overbuying.
I help founders create wealth through growing sustainable Free Cash Flow. If you need more cashflow, let’s chat.