Executive Briefings

Measuring 'Real Money Cost' of Inventory Would Help Reduce Overstocking

Since the end of 2008 a trend known as "destocking" has occurred at many manufacturing plants across the country. Simply put, manufacturers have been cutting or halting production while unloading inventory stockpiles that built up because of decreasing demand.

The unloading process signals that much of the manufacturing industry underestimated the severity of this year's recession. One reason why manufacturers may be grappling with excessive inventory levels is their previous focus on reducing transportation expenses during gasoline price spikes rather than total stocking costs, says Tom Speh, associate director of MBA programs at Miami (Ohio) University's Farmer School of Business.

"Everyone wanted to address the fuel issue. People were trying to reduce miles and increase loads, and in many cases shipping full truckloads, which was driving up inventory," he says. "We did have a natural evolution of increasing inventories because everyone was trying to save transportation dollars."

Consequently, when fuel prices came down and demand for their products dropped, many manufacturers were left with warehouses full of inventory that they've been unloading for the past year, says Speh. Some of the inventory glut may have been avoided if manufacturers had implemented accounting systems that measure the "real money cost" of inventory, Speh says. That includes capital expenses tied to storing inventory, borrowing rates, insurance costs and losses incurred from damages and obsolescence.

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Since the end of 2008 a trend known as "destocking" has occurred at many manufacturing plants across the country. Simply put, manufacturers have been cutting or halting production while unloading inventory stockpiles that built up because of decreasing demand.

The unloading process signals that much of the manufacturing industry underestimated the severity of this year's recession. One reason why manufacturers may be grappling with excessive inventory levels is their previous focus on reducing transportation expenses during gasoline price spikes rather than total stocking costs, says Tom Speh, associate director of MBA programs at Miami (Ohio) University's Farmer School of Business.

"Everyone wanted to address the fuel issue. People were trying to reduce miles and increase loads, and in many cases shipping full truckloads, which was driving up inventory," he says. "We did have a natural evolution of increasing inventories because everyone was trying to save transportation dollars."

Consequently, when fuel prices came down and demand for their products dropped, many manufacturers were left with warehouses full of inventory that they've been unloading for the past year, says Speh. Some of the inventory glut may have been avoided if manufacturers had implemented accounting systems that measure the "real money cost" of inventory, Speh says. That includes capital expenses tied to storing inventory, borrowing rates, insurance costs and losses incurred from damages and obsolescence.

Read Full Article