If you think your closet at home is disorganized, you don’t want to see what’s lying around H&M’s closet. The Swedish fashion giant is sitting on $4.3 billion in unsold inventory.
The company says its massive stockpile is due to new store openings and expanded ecommerce operations, but analysts blame poor inventory management and underwhelming product offerings.
Whatever the reason, it’s clear that H&M has a problem on its hands. Overstocking inventory is a gamble that can easily lead to losses. Inventory is necessary to make sales, but having too much of it means you’re binding capital. Even worse, what happens if nobody wants to buy the goods? H&M can spin this however it likes, but the reality is that a surplus of inventory is bad for any business.
A business-school lesson on inventory
The most basic mantra is: "Money in is better than money out." Or, in reference to what I'm writing about here: "Money in is better than money sitting around gathering dust."
Students of entrepreneurship learn that the best startup model involves getting paid earlier and paying their bills later. Producing an influx of inventory only to have it wait in storage will not set a company up for success. The key is to minimize inventory—to have as close to zero inventory as possible—while still having enough in stock to take advantage of any sudden increase in demand.
New businesses will always need a learning curve to figure out how to properly align production with demand; they haven’t been in business long enough to know what customers want. But even established and large companies such as H&M face uncertainty. Look at Microsoft’s original Surface. The Surface RT tablet computer (like the Zune before it) was a massive flop and caused a write-off of almost a billion dollars for the tech giant.
These flops hurt big businesses but are even more detrimental to cash-strapped startups that might be pinning all of their future production or growth goals on wasted inventory. Even if a startup can sell its products, scaling up makes inventory strategy that much more complicated.
Optimize your inventory strategy.
It’s easy to accumulate expenses by producing and storing inventory and hard to make things up with sales. Prudent entrepreneurs will pay very close attention to inventory policy and formulate a strategy based on four key points:
1. Minimize inventory.
The best inventory from a cash point of view is an empty inventory, meaning the goods have been sold and the money is in the bank. If your business can produce on demand, it might get paid before production even commences. But even merchandise-heavy companies can find ways to keep inventory slim without sacrificing sales opportunities.
H&M isn’t the only company struggling to survive with inventory surplus. Nike has more supply than demand, too. Its excess inventory problem is so bad that Goldman Sachs lowered its rating from "buy" to "neutral," as the company struggles with its Asian markets.
If your business expects growing demand for its goods, it should keep inventory to meet those increased sales. But don’t overdo it. If those sales don’t materialize, that inventory could spell death.
Kohl's, for example, is midway through a five-year plan to improve its inventory management. The retailer has strategized its inventory overload by localizing merchandise according to each store's preferences and climate, which reduces the amount of leftover stock at the end of each season. With more reactive technology, the company has also been able to pivot major brands and online sales faster, to reduce inventory pileup. Kohl's attributes this inventory strategy to much higher
2. Produce on demand
Instead of producing and storing goods, which binds cash, push that cost onto suppliers. Write a contract that allows you flexibility while expecting suppliers to produce for you on demand. It’s called just-in-time (JIT) manufacturing.
JIT costs more, but it is a better solution for improving cash flow than sitting on unsold inventory. Harley-Davidson recently implemented this process to avoid wasteful overproduction. In doing so, the company dropped inventory levels by 75 percent and eliminated inefficiencies in its productivity.
3. Plan your inventory for targeted sales.
Entrepreneurs are often too optimistic about their business's potential. To maintain realistic expectations, target inventory to meet the needs of your prioritized customers in your beachhead market.
The No. 1 reason businesses fail? Failure occurs because they don’t serve a specific market need, according to CB Insights. Other segments might want to buy your goods, but that doesn’t mean you need to have enough products on hand to satisfy them all. Supply your most important customers first, and think about the rest when you're more stable.
Inventory management is one of the most important aspects for businesses of any size in any market. You might think stockpiling for the future is a smart move, but it only ties up capital into potentially unlovable products. H&M is just the latest in a long line of businesses dying because of a surplus of unsold inventory. Don’t fall into the same trap -- make inventory management your business’s top priority.
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This article originally appeared on Entrepreneur.com. Minor edits have been done by the Entrepreneur.com.ph editors