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The inventory rotation is the relationship between the cost of goods sold and the average inventory valued at a cost in a certain period. A simple example: Cost of goods sold during 2019 = $ 24,000,000. Average inventory 2019 = $ 6,000,000. Then, the turnover of the inventory in 2019 was 24,000,000 / 6,000,000 = 4, which means that the inventory rotated 4 times a year. And since the year has 12 months and 12/4 = 3, the inventory has rotated once every three months. At the beginning of each three-month cycle, we would have said that we have inventory for 90 days.
The sales/inventory ratio is average. However, it can include products with very high turnover, many with medium rotation and some with very low turnover.
The rating of “high” or “low turnover” depends on the industry. In some convenience stores, bread is replenished more than once a day. In a supermarket, some dairy products are replenished once a week. In the clothing industry, some garments are sold for a season. In the automotive industry, some parts are demanded once a year. In the heavy machinery industry, some parts could be sued every two or three years.
The low turnover can occur because the numerator is low (sales) because the denominator is high (inventory) or both: low sales and high inventory at the same time. Inventory turnover is one of the key financial ratios because inventories are part of working capital for the business. For logistics, rotation is one of the KPIs, along with service level, cost efficiency and capacity utilization.
The low turnover as a nightmare
For many Logistics Managers, low rotation products are a kind of nightmare. The sword of Damocles weighs on their heads and requires them to reduce the items of low rotation. What to do with them? These are five typical solutions:
Liquidations: In the mass consumption industry, liquidations are an opportunity to sell low turnover products at a discounted price. This is particularly effective in the garment industry, making end-of-season closings since those items will probably not be sold next year if the fashion changes.
Promotions: Promotions are another way to get rid of low turnover products and can be done at any time, not only at the end of the season. Marketing areas are especially creative when designing promotions, but for logistical purposes, they are especially useful for moving immobilized inventory, for example, a promotional pack consisting of a product with high turnover and low turnover at a discounted price.
Returns to the supplier: In some cases, it is possible to return products to the supplier, before they accumulate dust in a shelf.
Scrapping: There are cases, especially of imported products, in which it is not possible to return them to the supplier and the liquidations or promotions are impracticable. In this situation, the destruction of the products or “scrapping” can be an extreme, but effective solution.
Measure better: There may be cases and cases in the category of low turnover products. If the products are homogeneous and there is no cost distortion, the inventory turnover ratio is absolutely correct. As these assumptions are not always met, some companies make an effort to measure better, (a) by stratification and (b) measuring rotation by units.
The stratification in Statistics consists of segmenting the mass of data into categories with distinctive characteristics, in search of causes that explain this or that behaviour.
When products are heterogeneous and there is distortion in costs, measuring turnover per unit can be a good solution. The rotation measured in units is used in the manufacturing industry. The rotation measured in units can be used in a Distribution Center in this way: a number of units dispatched a number of units in the distribution centre. Note that here “sales” is replaced by “dispatch”: the units dispatched are not necessarily sales, because they could be transferred to another warehouse. This measurement by units captures the outflow of inventories in a Distribution Center.
Low turnover products as an opportunity
And, nevertheless, the world is changing. Clients do not have brand loyalty and our preferences change frequently. Therefore, in many industries, it is happening that low turnover products are an important part of their income. Here are several challenges for the logistics world:
Decisions on location of inventories: In a distribution network composed of retail salons and decentralized warehouses, the decision of where to locate the inventories is not trivial. Let’s take as an example the products for the construction and the care of the home: for the clients of the south of Chile the articles of irrigation have high demand, but in a store of the north they would be products of low rotation. Correctly locating inventories according to seasonal and local demands is a great opportunity.
Improve forecasts: The big problem with low turnover products is their difficulty forecasting their demand (inventory forecasting). These are (1) intermittent products (2) and non-stationary products, that is, products whose consumption is irregular and, therefore, traditional methods of forecasting encounter a solid wall: exponential smoothing, moving averages, Poisson distribution and other methods fail. Discreetly when applied to this type of products. But a good forecast would allow us to buy and replace what is needed, neither more nor less. Here the solutions are technically more complex and their description exceeds the limits of this article.