Tired of Obsolete Inventory? Here’s All E-Commerces Need to Know
Published on October 11, 2024
E-commerce businesses strive to keep their inventory moving. You’ve nailed your product strategies and forecasts, responding to trends in real-time. But what happens when things go wrong? What do you do with items that no longer hold value, sitting on your shelves with no chance of selling? Welcome to the world of obsolete inventory.
Obsolete inventory is more than a warehouse headache; it’s a direct threat to your profitability. You face this challenge due to changing customer preferences, poor demand forecasting, or seasonal shifts. If ignored, these unsellable goods can drain resources, consume storage space, and tie up working capital that could fuel your next big seller.
In this article, we’ll break down what causes inventory to become obsolete, its financial impact on your company, and proactive strategies to avoid it. These insights will help you minimize the risk of unsellable stock, from leveraging AI for better forecasting to managing supplier relationships.
Table of Content
What Is Obsolete Inventory?
Obsolete inventory refers to units that have reached the end of their product lifecycle and cannot be sold or used due to lack of consumer demand. These items have little or no market value. For example, last year's smartphone model may become obsolete when a new version is released with significant upgrades.
It is important to distinguish between dead stock and obsolete inventory. While both represent unsold goods, they have key differences:
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Dead Stock: Items unsold for a long time but with potential value. These products could be sold through discounts or in a changing market.
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Obsolete Inventory: Has little to no market value due to technological changes, consumer preferences, or product lifecycle endings. Outdated technological product can be hard to sell, even at discounted prices.
What Are the Impacts of Obsolete Inventory on Your Business?
Obsolete inventory can negatively impact your business:
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Consumes working capital: When your money is tied up in unsellable inventory, you can't invest in new, fast-moving stock to satisfy consumer demand.
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Increases storage and handling costs: Obsolete items occupy valuable space in warehouses, fulfillment centers, and stores. They also require ongoing handling for inventory counts and movements.
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Requires write-downs or write-offs: As the value of obsolete inventory decreases, you'll need to adjust its value on your books, impacting your financial statements.
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Reduces profit margins and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization): Obsolete inventory expenses directly affect your financial results, reducing profitability.
What Are the Financial and Fiscal Impacts?
Obsolete inventory can also result in write-downs or write-offs, directly impacting your profit. Obsolete items are usually written down to their net realizable value—the lowest amount expected after selling or disposing costs. This value reduction appears as an expense on your income statement, lowering your margins and EBITDA.
To calculate obsolete inventory, determine the cost of goods minus potential recovery through liquidation or sale.
Tax Implications
In Canada, obsolete inventory write-offs are a deductible expense for tax purposes. To qualify for a tax deduction, the obsolete inventory must be disposed of in one of the following ways:
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Sold to a liquidator or junkyard
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Donated to a charitable cause at no cost to the charity
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Destroyed
The tax deduction equals the fair market value of the obsolete inventory, minus any recoverable amount. Be sure to document all actions for dealing with the disposal of obsolete inventory as proof when submitting the tax deduction.
A significant legal case in Canada (Yorkwest Plumbing Supply Inc.) highlights important principles for e-commerce owners:
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Per Section 10(1) of the Income Tax Act, inventory write-downs are only permitted for unsold goods.
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Inventory costs can only be recognized in the tax year when goods are sold.
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Unintentional cost understatements in one tax year can’t be fixed by intentional overstatements in later years.
This case highlights the importance of addressing inventory issues promptly and accurately within the correct tax year. E-commerce owners should know they can’t claim deductions simply because they failed to take them on time.
Why Do E-Commerce Retailers Have Obsolete Inventory?
1. New Technologies and Product Upgrades
Technological advancements can quickly render products obsolete, especially in consumer electronics. Companies invest in R&D to release newer, advanced versions so understanding the product lifecyle and product releases is key when forecasting and purchasing inventory.
This creates a cycle where previous ones lose demand as consumers choose the latest models. For instance, a new smartphone release often leaves older ones unsold, despite their functionality.
2. Changes in Consumer Preferences
In the digital age, consumer behavior has shifted dramatically. Trends move fast, driven by social media and influencers. Consumers quickly adopt new products and abandon old ones.
This “trend-chasing” behavior creates a shorter product lifecycle, making some items obsolete faster. Fashion, beauty, and consumer electronics are all susceptible to this shift.
3. Poor Demand Forecasting
Despite best efforts, demand forecasting isn’t always accurate. Misestimating product demand often results in inventory mismanagement.
Overstocking based on an inaccurate forecast can lead to excess inventory and longer item retention. Unsold products can become obsolete, especially if seasonal or subject to changing trends.
4. Product Quality Issues
Another factor contributing to obsolete inventory is poor product quality. Once customers use a product and share negative reviews, the sell-through rate can drop dramatically.
User-generated content influences future buyers, and poor reviews can discourage new customers. This negative feedback loop can lead to products becoming obsolete before they’re fully sold.
5. Seasonal Products
Some products have a limited shelf life due to their seasonal nature. For instance, holiday-related items experience high demand for a specific period but become hard to sell once the season passes.
The challenge with seasonal inventory is predicting the right amount to stock without excess that can’t be sold when it ends. Halloween costumes and Christmas decorations are examples of products that become obsolete quickly after their seasons.
How Can You Identify Obsolete Inventory?
To spot obsolete inventory before it becomes a problem:
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Track Turn Rates and Days on Hand: Monitor how quickly your inventory is selling and how long items have been in stock.
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Analyze Sales Trends and Demand Patterns: Use data analytics to understand when product demand peaks and falls.
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Set Thresholds for Slow-Moving Items: Establish criteria to flag items that aren't selling as expected. and actions at each threshold to turn units; marketing, bundling, mark-downs are all options you can explore.
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Conduct Regular Inventory Counts: Frequent checks help maintain an accurate picture of your stock levels and item conditions. This way you make sure to catch any inventory discrepancies that may lead to errors in your records
How Do You Know if Your Obsolete Inventory Rate is Normal?
E-commerce businesses face unique inventory management challenges due to rapid market changes, seasonal fluctuations, and evolving consumer preferences. They often require stricter obsolete inventory benchmarks compared to traditional retail. As you track your inventory KPIs, it’s a good idea to keep an eye on these metrics:
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Obsolescence Rate: For e-commerce companies, it is crucial to maintain a low obsolescence rate. While benchmarks vary, a general target is to keep it below 10% of total inventory value. However according to some studies they can reach 20% to 30%, even for well-run businesses. For example, the fashion and electronic sectors can experience much higher rates due to the nature of the products.
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Inventory Turnover Ratio: E-commerce businesses typically aim for higher inventory turnover ratios than brick-and-mortar stores. A healthy benchmark for e-commerce inventory turnover is 4 to 6 times per year, with some high-performing companies achieving higher rates.
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Days of Inventory on Hand (DOH): For e-commerce, a lower DOH is desirable to reduce obsolescence risk. A benchmark range of 30 to 60 days is common for businesses, depending on the product category and supply chain efficiency.
How to Deal With Obsolete Inventory in Your E-Commerce Business?
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Implement just-in-time inventory practices: This approach minimizes excess stock by aligning orders closely with demand.
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Improve demand forecasting: Leverage technology and data to better predict future sales trends.
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Trigger discounts and promotions: Use markdown strategies to sell slow-moving items before they become obsolete.
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Consider online auction sites for bulk sales: These platforms can help you sell large quantities of obsolete inventory to markets outside your primary sales region.
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Dispose of expired products sustainably: For unsellable items, ensure environmentally friendly disposal.
Liquidation Options
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Discounting and Sales: A common approach is to offer discounts on slow-moving or obsolete items to clear inventory quickly, even if it means selling at or below cost. Consider running flash sales, bundle deals, or clearance events to attract bargain hunters.
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Liquidators and Resellers: If you have large quantities of unsold inventory, working with liquidators or resellers can be effective. These businesses buy excess stock at discounted prices. While you may not recoup your full investment, you can recover some cash and free up storage space.
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Donation: For unsellable inventory, donating to charities can be a viable option. This approach helps clear space and may provide tax benefits. Document the donation process properly for tax purposes.
How to Prevent Obsolete Inventory
1. Improve Demand Forecasting
To prevent obsolete inventory, improve your demand forecasting. You can leverage data and predictive analytics to help you predict future demand accurately. By tracking sales trends and monitoring consumer behavior, you can avoid over-ordering and minimize slow-moving inventory risk.
2. Regular Inventory Counts
Regular inventory counts across all sales channels—e-commerce, physical stores, or fulfillment centers—are essential. They provide a clearer picture of your inventory’s health, helping you identify slow-moving items early. Regular counts can trigger markdown strategies or promotions before the product becomes obsolete.
3. Shift Inventory Between Channels
Inventory may be slow-moving in one channel but performing well in another. Visibility across all channels allows stock transfer where it’s needed most. This strategy maximizes the sell-through rate and prevents obsolete accumulation.
4. Flexible Supplier Relationships
You can manage your inventory efficiently by maintaining strong supplier relationships. Negotiating flexible ordering options allows you to avoid over-committing to large product quantities. This ensures you’re not tying up working capital in products that may become obsolete before they’re sold.
5. Online Auctions and Disposal
When products become obsolete, consider using online auction sites to sell them in bulk. These platforms allow you to offload unsellable items outside your primary market, preventing your brand from being associated with discount products while recovering some revenue. For expired or unsellable products, ensure environmentally friendly disposal following regulations.
Conclusion
Obsolete inventory is a challenge for e-commerce businesses, but it doesn’t have to cripple your finances. By closely monitoring your stock and taking proactive steps like improving demand forecasting and leveraging liquidation options, you can keep your business agile and reduce the financial burden of obsolete products.
A proactive inventory management approach will protect your margins and keep your business agile in an evolving market.
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