The two big CASH TRAPS in machinery dealerships are:
- Old un-sold used trade-in units
- Obsolete parts inventory.
Dealers who launch serious Operations Improvement efforts for the first time often find they have as much as 35-40% of parts inventory value in dead/obsolete stock. This article discusses reasonable and practical approaches to eliminate parts inventory line items that have not sold in over 12 months. (The one exception to “dead stock” is items that have been brought in to support new products. This is called “protected stock.”)
If you are intent on properly maintaining your inventory, here are recommendations based on the best practices of leading high-profit machinery dealers:
- First things first, make sure the processes are in place to manage parts inventory moving forward, otherwise, you’re just adding to the existing problem. Is your Stock Status Report being properly utilized? Are the algorithms calculating safety stock based on replenishment lead times updated for today’s economic conditions? Does your parts team know how to utilize the report generator in your business systems software to analyze your inventory?
- From a behavioral perspective, incentivize your parts teams on their operating profit weighted towards the parts department but also include the service department and overall branch operating profit. Properly managing parts inventory should be a condition of payment of the incentives – i.e., timely cycle counts, no open documents (stock not receipted), and vendor surplus returns completed monthly.
- Run a ranking report of all items that had ZERO movement in the past twelve months by each of your manufacturers.
Rank report by the value of inventory line item:
$ Cost x Units on Hand = Line Item Value
Focus management attention on the top 20% of items that generate 80% of the total cost of the excessive stock. - Exhaust all avenues to get cash or OEM credit for obsolete parts:
- Aggressively work on annual returns to manufacturers. Be sure to optimize stock order placements to qualify for better annual return privileges. You may have to pay freight or restocking charges, However, most OEMs will accept a return with an off-setting order but it takes diligence to get it done. Manufacturer credit for stock returns is one level of solution. Not great but better than many other options.
- Market to existing customers at a deep discount. Identify parts by equipment model. Offer special purchase deals to customers with those units. For the large-value items, try to find where that part is used (what model machines). Then, locate customers in the area who own one of them, and contact that customer with a great deal. Customers who own the model(s) supported by these parts will be interested because you can tell them that the items will no longer be carried and will have to be special ordered at much higher prices. Also, be sure to offer them other parts.
- Set up a “SALE TABLE” in the Dealership, especially during Open House events. Price each item. Pricing on items dramatically improves unit sales. This encourages impulse purchases by dealer visitors and bargain hunters.
- Build an online parts exchange program with other dealers in your network to reduce the need to purchase these items from manufacturers.
- Used parts resellers will give you something for the parts – or at least a profit-sharing when they sell it.
- Utilize Craigslist list or any online marketing works to move parts by expanding your potential customers. Sell to Anyone at 80% of cost.
- Offer an internal contest to reward those that sell the target list of parts – something as simple as a gift card once a target part is sold, or a threshold is achieved.
- Share 50/50 of any Gross Profit with an employee who sells an obsolete item over a specific price.
- Flea Markets. Employees take turns hauling items to flea markets on weekends. Give the employee 25-50% of cash receipts as long as he sells the item above a preset amount. Results are often very surprising.
- Review the inventory with field technicians. Off them incentives on moving the parts.
- Give your list to OEMs. Try to get their help moving these items to dealers in other parts of the world, especially Latin America where many more used units are refurbished.
- Donate to vocational-technical school.
- Special Write-Off at Higher Than Cost. When donating merchandise to organizations that qualify under IRS Code 170(e)3, you may deduct up to 200% of the cost. Confirm this with your CPA or CA.
- Once you’ve done the above, there is truly no value in the parts – scrap them – they take up space, need to be counted and there is no apparent upside to holding on to them. One leading dealer says they write off 1% obsolete stock each month as scrap. Starting with the assumption that this remaining inventory really is dead, their approach is to write it down quickly and write it down often. “If not, I have inventory doing nothing for me. I have to turn the good stuff that much quicker.”
Preventive Management
To start, if you are a multi-location dealership, set up a centralized parts ordering system with the involvement of the local branch parts management. Some larger dealerships have as many as five (5) Centralized Parts Ordering Specialists ordering parts for 55+ locations. Work with your OEM to identify and highlight their parts supersession plan in which a new part replaces an existing one with a new part number. A large amount of obsolescence often happens because manufacturers supersede a part and dealers do not catch it.
Do weekly parts cycle counts so your dealership will stay on top of any issues as they arise.
Through the parts ordering process, take slow-moving inventory and transfer and relocate it to fill weekly stock orders at locations with higher demand. This will result in a better turnover of parts and a reduction in the net amount of investment in inventory with less
duplication of stock.
At the beginning of each fiscal year, look ahead and analyze what parts will be aging and approaching zero sales throughout the year. Challenge each location to sell these aged parts, hopefully at retail but at least at wholesale before the end of the year.
Take a conservative approach and use the above-forecasted aging and your historical scrapping and have a monthly obsolescence accrual for each branch. Dead Stock should be budgeted for and written down every year. Otherwise, it can accumulate “like a weed.”
If you can show that your parts margin is being maintained above 35%, possibly use that excess margin value over 35% as your write-off amount. So, if you’re operating a 37% parts gross profit margin, take 2% of sales and write it off that month. There are no dollar restrictions. However, the law is very clear on one point. If you write it off, it must be thrown away. Writing inventory off and keeping it to sell again is an absolute no-no
Parts that are returnable to the OEM should be returned within the OEM guidelines. For example, Case New Holland (CNH), parts with no turns can be returned for 100 % of value for items up to 1-year-old. Same for obsolete parts so deemed by the OEM, but there is typically no cash credit, just a replacement for those parts.
(Dealers in the U.S. should ask their CPA to provide you with the Supreme Court’s Thor Power Tool Company v. Commissioner, 439 U.S. 522 (1979) decision. This was a United States Supreme Court case in which the Court upheld IRS regulations on how taxpayers should value and write down inventory.) Then, of course, be sure that you are not depleting your financing collateral without realizing it.
Conclusion
The lesson many leading dealers learn from this overall obsolescence-controlling effort is the importance of doing monthly returns and keeping current with that process that eliminates building up obsolete inventory. When a dealer writes down the inventory value, they typically start early in the year and take the large chunks and dissipate the expense over six months or more.
The first good management principle is not to have obsolete inventory. Manage your active stock better, and watch it before it becomes obsolete!