“So what if I carry a little too much inventory? I’ll sell it eventually, and at least I can always fill orders…”

I’ve heard this logic frequently, and it can be tough for those not schooled in inventory optimization concepts like carrying costs and EOQ to fully understand the real cost of carrying (holding) inventory that does not turn over quickly.  Here’s a great real life example of a small company using inventory management and analysis tools to save money.

The company leases a warehouse, and the lease term ends later this year. The company has run out of space in the existing warehouse, and so the intent was to move to larger premises at the end of the lease term. Moving costs would run at close to $100,000, and monthly costs would of course increase by a significant amount too.

Before committing to a new lease, the company (with outside help) ran an analysis of their inventory. They managed to very quickly identify a large number of SKUs in inventory that did not contribute significantly to gross margin. Of those, a number of SKUs that they always kept in stock were large items, taking up quite a bit of space. They then reviewed these items in terms of shipment urgency, and looked at the availability and costs of having these items, when occasionally ordered by customers, drop-shipped directly by the manufacturer.

The cost of the drop-ship option would substantially reduce the gross margin on these items. However, the number of items sold per year was low enough that the overall impact on annual gross margin would be less than $30,000.

Now here’s the best part: after eliminating those items from their warehouse completely, they had plenty of space in their existing location. They simply extended the lease and cancelled all plans to move. The net annual savings in rent more than offset their diminished gross margin, and in addition they saved the moving costs (not to mention the aggravation).

The cost of the software tools and outside help to perform the analysis? Less than $10,000. Not a bad return on investment.