Here's a dilemna frequently faced by small and medium sized ("SME") distributors / wholesalers:
You're preparing an order to replenish a particular product. You usually purchase 3 months' worth of estimated sales volume at a time, due to vendor lead times, etc. Right now, your vendor is offering a limited time extra discount of 10%, for a minimum quantity of slightly more than double what you would normally order. And there's the dilemna: do you order 7 - 8 months' worth of demand, or do you forgo the additional discount?
Most SME business owners find it hard to resist a deal that will increase their gross margins. In the above example many (if not most) would take the deal on offer. And that may sometimes be the right choice - but it will also very frequently be a poor decision. Why? Well, there are a number of other factors to take into account, and while some of these may seem somewhat theoretical to a hands-on trader, they are in fact very real and very important.
First, does the additional margin you'll earn when you eventually sell the products offset the extra holding and financing costs associated with handling, stocking and financing the additional inventory? This question alone will often refute the apparent value of the extra discount.
Additional aspects to consider include:
- Changes in demand are harder to predict the further out you go - you may never sell the additional items. Scrapping a small portion of a shipment could than wipe out all the extra margin earned.
- Tying up your working capital and warehouse space could hamper your flexibility to react to other changes in product lines and demand.
- The longer you hold products in inventory, the more vulnerable you become to being saddled with discontinued or superceded items.
- Currency fluctuations: if you buy in a foreign currency, a drop in that currency's value could allow your competitors to import the same products at a lower cost. You know what that would do to your margins.
In the real world, many discount deals lead wholesalers and distributors down the dead stock alley. Following up on a previous post about Dead Stock, I ran something called a ranking report against one particular customer's inventory. We identified over 200 SKUs as probable dead stock. More than half of these were only in stock because of past price-based purchase decisions. In comparison, less than 20% of the remaining SKUs had been available on any bulk quantity / price deal in the preceeding couple of years.
Essentially, a properly designed and carefully thought out, systematic approach to inventory replenishment will almost always pay off big time. (I say "almost" because there are a handful of exceptions to this, typically industry-based. ) Such an approach will allow you to calculate on replenishment quantities and frequencies based on all relevant factors - price and discount being just one of them.
I'll share more on inventory ranking reports and dead stock analysis in future posts.
I'd be very interested in your comments, particular if you disagree with these thoughts. (I love a good argument.)