Capital expenditures (CAPEX) investments are crucial for any business. They help to purchase new equipment, upgrade technology, and enhance operational efficiency. However, finding the funds to support these investments can be challenging, especially when the pressure on inventory in companies is high.
Currently, a lot of companies have to deal with very high inventories caused by the recent economic crisis, when everyone ordered more than they needed (ordering for "just in case" instead of "just in time") and was struck by shortages on critical components, leaving the rest of their stock unused. Much of that expensive inventory is now gathering dust and, naturally, CEOs want to get rid of it to generate cash for the many CAPEX investments they want to do as the economy picks up again.
But is cutting back on working capital the holy grail to find these CAPEX funds? In this blog, I’ll discuss how you can decrease your inventory in a controlled way, with plenty of attention for the underlying strategy and safeguarding the balance between service, cost and inventory.
How to downscale your inventory without hurting your business
One of my B2C retail customers is in the same inventory boat: during Covid, most of the retail market got a boost of 20 to 30%, but that effect is now gone. Margins are under pressure due to a price race to the bottom, while retailers need to invest in the transition from brick-and-mortar to e-commerce and an omnichannel customer experience. This transformation asks a lot of additional investment in IT systems and warehouses, but retailers are struggling to find the cash needed for these projects. Normally, they can resort to profits from their margins – which aren’t cutting it at the moment –, or they ask for a loan from the bank or their investors. Unfortunately, with their finances under pressure, this isn’t an opportunity to ask for loans, so most retailers end up at their last resort: reducing their inventory numbers.
All right, but how low can you go in this? How much can you reduce your inventory before you start hurting your business? Many organizations rely on gut instinct, without understanding the impact or knowing well enough where to look and find the necessary reductions. For instance, the same B2C retailer I mentioned before drastically reduced its product portfolio and corresponding inventory in its search for CAPEX funds. But this, of course, led to a confrontation with its Sales department, which wanted to retain as many SKUs as it could to keep its customers happy and meet their individual product demands.
So, how can we figure out which products to cut and which to keep on the road to a more balanced, and slimmed-down, inventory?
Finding the right strategic balance in your portfolio with GMROI
In my opinion, it all starts with strategy. Having more or less inventory is related, among other things, to a smaller or broader portfolio and the corresponding supply chain setup. You can reduce your inventory by following up on its status on an almost weekly basis, but once you take your eye off it, you’re right back where you started. The more structural – and more successful – approach in my opinion is to improve your planning process as a whole. Focus on improving your company’s balance between service, cost and inventory and invest in better planning processes and tooling.
During this strategic exercise, you must ask yourself: is everything we sell today still giving us value? Which of our products sell very infrequently and/or which ones give us very little margin? At Solventure, we use a metric that can assist you in finding the answer to these inventory questions: the Gross Margin Return On Inventory or GMROI. The GMROI indicates the profitability of your inventory by showing how much profit you can make on it in comparison with the cash already invested in your inventory. For instance, an end-of-life-cycle product will sell less, and provide less margin, but will still require the same amount of service as your other products. This will significantly bring the GMROI down for this product while giving you the data you need to convince your Sales, Marketing or Production colleagues that this SKU should be cut from the company’s product portfolio.
Portfolio management data is key to the right inventory cuts
Apart from the GMROI, Solventure can assist you with plenty of other insights and arguments to streamline your portfolio management, efficiently down-size your inventory and, hopefully, free up enough cash for the CAPEX investments you want to make in your company. Take our Data Connector tool for instance, which helps to connect planning systems with your ERP system and make portfolio management more accessible. Within the week it provides you with the inventory data you need to discuss (the right) inventory cuts with your management or Sales department. One additional bonus: you’ll have no issue convincing your colleagues from Finance when they see the plethora of numbers you brought to the table.
So, if you are going to cut inventory, consider the following: what is the margin over inventory (Gross Margin Return on Inventory, or "bang for the buck") of the various divisions or product groups? Where is the growth? Are you going to make linear cuts or segment and diversify? If you really want to save cash on inventory, in a sustainable way, you need to ask the fundamental questions. Dare to take up the debate, and with the correct data on your side, you can’t go wrong.