Where does Inventory Management Start and Why Does it Matter?
Inventory Management has become extremely important for larger dealer groups with tens of millions in inventory and millions at risk. Auctions have grown because it’s a controlled method to reduce inventory levels and risk. Because of the growth in auctions, the amount of inventory being sold at auctions has caused equipment values to decline. Additionally, consumer confidence and the decline in the Ag Economy have put pressure negatively on auction values as well. On top of this, we still have pressure to meet manufactures demands and sell new equipment… So you have to ask yourself, are you setting yourself up to repeat the not so distant past?
Inventory Management starts with the sale of New Equipment. New Market Share is important for many reasons. Future Used Machine Population helps fuel the Parts and Service Machine. This Machine is an essential revenue source for any dealership. Without strong absorption rates dealerships are relying on Whole Good Sales and during a downturn, Whole Good Sales suffer and Margin Dollars become thinner and thinner. The other reason New Market Share is important is Mainline Manufacture’s Expectations and the Incentives tied to their Expectations.
How does Washout tie into all of this? Simply, all of the aforementioned dialogue is 100% tied to your ability to the sale the Used Equipment generated from the sale of New Equipment. The dealership has to have an understanding of the volume of Used Equipment it can digest in a given amount of time. It also has understand how this will effect Cash Flow, Used Equipment Inventory Turn, and Return on Assets.
With all of being said, I am not suggesting to stop or even slow the sale of New but to understand what you are getting yourself into. How does the Sale of New Equipment affect Current Used Inventory as well as Future Used Inventory? How does the generation of Used Equipment affect ratios and metrics at your dealership? Last but not least, what are the contingences plans in place to control these predictive outcomes.
Washout Cycles are the best way I have found to control Used Inventory. I use this method when I look at Used Equipment Inventory, both current and future. For the sake of these article I will use combines as an example.
For easy math lets assume we sell 25 New Combines and on average sell 125 Used Combines. We will assume there is a 4.5 – 5 unit washout to the best three words in the Equipment Business; Cash No Trade! This means if you sell 25 New Combines then you will generate 113 – 125 Used Combines. Why is this important? This helps me understand the effects this segment of Used Inventory has on the overall Cash Flow, Used Inventory Turn, and Return on Assets.
I like to take a 2-year average of Used Combines sales to set a baseline. Once the baseline is established then I make adjustments based on where the market is year-over-year. So for example, if the average Used Units sold is 125 and the market has soften by 25% I adjust my expectations of Used Combine Sales by 25%. This means the expectation of 125 Used Units will drop to 94.
What happens if you sell 25 New Combines and the Used Combine Market falls off by 25%? It’s only 6 more New combines right. What’s the big deal!!It sounds sweet and innocent but it is a bigger than it looks. These combines have the potential to set in your inventory for a prolong amount of time. These are the combines Sales People call about asking what they can sell them for since they have been in inventory for so long. You know, “Don’t you think it’s time to move these.” If you don’t believe me take a look at your inventories. I am as guilty as the next guy. The next questions I ask is what do the effects of these 27 – 30 combines have on Cash Flow, Used Equipment Turn, and Return on Assets.
Unfortunately in this business the overwhelming amount of dealership cash is tied up in Used Equipment. Now, I now that’s not a shocking revelation to anyone reading this but, what does this cost? Depending on the Floor Plan Amount these combines could be costing the dealership a $1000 per month in Interest Cost alone. This does not account for any depreciation and infamous Lot Rot. So what does it cost to hold these machines in inventory for 1 year? Look at this illustration
Buy looking at these machines it is easier to assess the risk associated with selling new when you know and understand the washout cycles for equipment segments. It allows for planning the worst case scenario and the effects the outcome will have on Used Equipment Turn, Margin, and Return on Assets. This is Risk Management and this is what Remarketing Manager’s do. Manage risk!!
I will leave you with one last thought. No matter the emotional attachment to a deal or “How good of property” a machine will be, it is an imminent object. It doesn’t understand the time value of money, margin, equipment turn or, assets return. It doesn’t care! Have a plan and move forward even when it hurts you will feel better in the long run. Thanks for taking the time to read this and this is the view from my seat on the bus.