Not all inventory is the same. There are fast movers, slow movers, and dogs. When open to buy is tight, inventory managers face challenges to stay in stock. A high overall volume that allows you to always meet order minimum helps. But if your order volume across a vendor’s product line is thin but for a few high movers—and worse, companions to high movers—you have a problem making order minimum.
So what can an inventory manager do when they have to replenish but don't need enough for order minimum? Of course they order more stuff. Sometimes they order the fast-moving product; other times they order some of the other slower-moving product so they don't end up having that dating problem because they bought deep. But they order more than what they need to make that minimum, sometimes unaware of what the extra inventory is doing to cash flow. This is an Inventory Replenishment Squeeze Play, created by purchase terms. All retail and distribution companies get caught in Inventory Squeeze Plays—most often one of these three classics:
Order Minimums: Almost any purchase agreement for stock replenishment under Freight Prepaid terms will carry a minimum order value. For a buyer of goods who enjoys a steady demand across their whole product line, “making” prepaid minimums usually is not an issue. As we illustrated above, the buyer has the option to increase the quantity ordered for the fastest-moving SKUs. The problem manifests when the required replenishment quantities are far less than the minimum, so the buyer “orders up” across multiple SKUs. The problem grows when the next out-of-stock approaches and the there is not enough demand against the product line to make minimum. The best defense is to pay the additional freight cost, which will commit far less cash than the inventory value of the stock-up.
Product Line Coverage: Many manufacturers require a stocking distributor or small retailer to carry their entire product line. For many product lines there is limited demand for much of the product mix, and less than 20% of the line will account for over 80% of the volume, what we call Prato's Law on Steroids. Much of the inventory will become FISH, as in First In Still Here inventory. The best defense against this kind of inventory growth is for the buyer to insist on carrying only the smallest order multiple quantity of each of the slow-moving SKUs.
Back Order Double-Up: This is a problem we see with suppliers that have multiple distribution channels and poor inventory management and allocation policies. A supplier short-ships/backorders a key component that can be obtained through other channels and is critical out-of-stock for the distributor. The distributor turns to another source and purchases the product to fill in the out-of-stock need, often having to meet a minimum requirement. Days later, the supplier ships the backordered product, and the distributor is now badly overstocked on the product. The best defense is to set order terms to backorder cancel, also known as “fill and kill,” so backorders are canceled when the buyer places a new order with an alternative source.