Blog - Hidden costs of excess inventory: How to protect your bottom line

Did you know that excess inventory can erode as much as 25% to 32% of the inventory’s total value, severely impacting profitability? (Retailowner.com)

While having a large stock on hand might seem like a safety net, the associated costs can often go unnoticed until they significantly affect the bottom line. In this blog, we’ll uncover the high cost of holding inventory by exploring warehousing, obsolescence and carrying costs—and discuss how these hidden expenses impact profitability. But first, let’s take a look at what causes excess inventory in the first place.

What causes excess inventory?

There are many reasons why a business might end up with excess inventory. Understanding the root causes can help you proactively address the issue before it impacts profitability. Here are some of the most common reasons:

• • Inaccurate forecasting and predictions: One of the primary causes of excess inventory is inaccurate demand forecasting, which should take into account key factors like historical sales data, market trends and economic conditions. Misjudging these elements can quickly lead to a surplus of unsold goods (Harvard Business Review)
• Legacy inventory management systems and siloed data: One of the major contributors to excess inventory is the use of outdated or inefficient inventory management systems. Legacy systems often lack the agility and integration needed to coordinate effectively across departments, leading to disjointed processes and costly errors.
  • Disconnection across teams: When inventory management systems operate in silos—separate from key departments like sales, marketing, and finance—miscommunication is inevitable. For example, without real-time sales data, inventory teams may order excessive stock, mistakenly preparing for demand that doesn’t materialize. This disjointed approach results in over ordering, and ultimately, costly overstock.
  • Limited data visibility: Legacy systems often struggle to provide comprehensive visibility into the entire supply chain. A lack of access to real-time data—such as demand forecasts, supplier performance, or inventory levels across multiple locations—makes it difficult to make informed decisions. As a result, companies are more likely to keep “just-in-case” inventory on hand, exacerbating excess stock issues.
  • Studies show that businesses using outdated inventory management systems are twice as likely to experience overstocking and underutilised warehouse space compared to those utilising integrated, modern solutions that provide real-time data and predictive analytics (McKinsey & Company).
• Unreliable vendors: If your suppliers are inconsistent, you might overcompensate by ordering more stock to avoid shortages. For instance, if deliveries are frequently delayed or back-ordered, you may place larger orders than necessary just to ensure availability. While this might seem like a precautionary measure, it can easily lead to overstock (Supply Chain Dive).
• Lengthy lead times: Long lead times from vendors and manufacturers create a challenging environment for accurate ordering. When lead times stretch beyond what is manageable, businesses may feel compelled to keep additional inventory on hand “just in case” of delays, leading to excess stock (Logistics Management).
• Demand variability: Monthly fluctuations in demand can make it difficult to maintain optimal stock levels. This often causes businesses to err on the side of caution by ordering extra inventory, even if it means incurring higher holding costs (Accelera, Amzprep).
• Shifts in market demand: Market trends are constantly evolving and shifts in consumer preferences can leave businesses with excess stock of items that are no longer in demand.

The hidden costs of excess inventory

Once excess inventory is on hand, it introduces a range of hidden costs that significantly affect a company’s profitability. Let’s break these down further:

1. 1. Warehousing costs: A significant and often overlooked expense

Excess inventory demands larger warehousing space, which leads to an array of additional expenses. Here’s a breakdown of what this can cost your business:

• • • Storage space: Warehousing can account for up to 15% of the total inventory value. For instance, if a company holds $2 million worth of inventory, they could be spending $300,000 a year on warehouse rental alone (Business.com).
    • Utilities and maintenance: Maintaining operational efficiency within warehouses incurs significant costs for electricity, heating, cooling, and regular upkeep. Large operations managing high volumes of inventory can see their utility bills escalate by tens of thousands of dollars per year (WallStreetMokjo).
    • Labor costs: Managing a larger warehouse requires more personnel to handle receiving, picking, storing, and shipping. On average, every additional 10,000 square feet of warehouse space increases labour costs by approximately $50,000 annually (Supply Chain Dive).

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3. 2. Obsolescence: A universal challenge across industries

Inventory obsolescence is a significant issue, particularly in industries where trends or technology move quickly, such as fashion, electronics, and retail.

• • • Write-downs and write-offs: Companies must often write down the value of obsolete products or, in severe cases, write them off entirely. In the consumer electronics sector, for example, companies may write down up to 20% of their inventory annually due to rapid product turnover (Forbes).
    • Discounting: To clear out obsolete stock, businesses frequently rely on heavy discounting, which sacrifices margins. A fast-fashion retailer, for example, might have to slash prices by 70% to move last season’s unsold items, effectively losing nearly 30% of the original value (McKinsey & Company).
    • Industry examples: Obsolescence risk varies by industry. In fast fashion, trends shift quickly, forcing retailers to discount deeply to clear outdated items (Harvard Business Review). Conversely, a construction company may face lower obsolescence risk, as materials tend to have longer lifespans, though the costs of storing these materials in larger spaces remain high (Construction Dive).
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3. 3. Carrying costs: The hidden drain on resources

Carrying costs are often overlooked, but they can quickly add up over time. These include capital tied up in unsold goods, insurance, taxes, and depreciation.

• • • Capital costs: Excess inventory ties up capital that could be better used elsewhere in the business. For instance, if $1 million is tied up in unsold inventory, the company could lose out on $100,000 in potential investment returns, assuming a conservative 10% return (Supply Chain Quarterly).
    • Insurance and taxes: The cost of insuring inventory and paying property taxes on its value can add a significant financial burden. A company holding $5 million in inventory might face an additional $50,000 annually in insurance and tax costs (Business Insurance).
    • Depreciation: Perishable goods or items with short lifespans, such as food or electronics, depreciate over time. In industries like food distribution, depreciation can reach 10% per month for items nearing their expiration date, leading to major losses (The Produce News).
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The impact on profitability: Why you should care

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2. 1. Reduced cash flow

Excess inventory ties up cash that could be better used elsewhere. For example, imagine a company with $500,000 tied up in excess inventory. That money could instead fund a marketing campaign projected to generate $100,000 in new revenue, but it remains locked in unsold goods (Investopedia).

2. 2. Lower profit margins

The hidden costs of warehousing, obsolescence, and carrying inventory significantly reduce profit margins. For example, a retailer might have to discount obsolete products by 40%, deeply cutting into profits that could have been preserved with better inventory management (Forbes).

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4. 3. Increased risk

Holding large amounts of inventory increases the risk of financial loss from unforeseen events. Market shifts, economic downturns, or natural disasters can render excess inventory a liability. For instance, in the electronics sector, rapid product obsolescence can lead to substantial financial losses if inventory cannot be sold before it becomes outdated.

4. 4. Reduced customer satisfaction

Excess stock can lead to operational inefficiencies, such as disorganised warehouses and outdated products reaching customers. This can damage customer satisfaction and loyalty. For example, an electronics company that mistakenly ships outdated devices may see increased returns and customer complaints, damaging its reputation (Supply Chain Dive).

Real-world example: The cost of excess inventory

Let’s say a company holds $1 million in excess inventory. Warehousing alone could cost $150,000 annually (15% of inventory value). Additionally, assuming an opportunity cost of 10%, the business loses $100,000 in potential investment returns annually. That’s a total of $250,000 lost per year.

How Ligentia can help

At Ligentia, we understand the complexities of inventory management and the hidden costs that can affect your business. Our advanced inventory and supply chain management solutions are designed to help you optimise stock levels, reduce excess inventory, and minimise associated costs. Here’s how we can be your partner in success:

• • Real-time supply chain visibility: With our Ligentix platform, you gain real-time visibility into your entire supply chain. This allows you to respond to fluctuations in demand and optimise inventory levels across your network. Exception management tools allow you to quickly and easily identify issues in the inventory critical path and make decisions to expedite or slow down the movement of stock.
• AI-powered optimisation: We leverage cutting-edge artificial intelligence to analyse your inventory data and identify optimisation opportunities. This can involve recommending optimal stock levels for different products and predicting potential stockouts or over stocks many weeks before they occur. The AI analyses stock levels throughout the supply chain from that on order, being manufactured, in transit and in destination warehouses as well as historic sales, sales forecasts and safety stock levels required. The AI constantly analyses impacts in the supply chains such as a delayed shipment to assist in decision making to fill potential gaps in stock cover or slow down the movement of stock should sales have weakened.
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Transforming inventory management

The high cost of holding inventory is a significant challenge that can erode profitability if not managed effectively. By understanding the hidden expenses and their impact, businesses can take proactive steps to optimise inventory management. Ligentia offers innovative solutions to help you overcome these challenges, ensuring your inventory is a strategic asset driving profitability, not a financial burden.

To untap real competitive advantage, businesses must embrace dynamic inventory optimisation to enable real-time decision-making as goods move through production and the supply chain. This approach goes beyond static predictions, allowing companies to adapt to shifting conditions—such as sudden changes in demand, supply chain disruptions, or unexpected market trends—by making smarter, data-driven adjustments on the fly.

In this way, businesses can minimise excess inventory, reduce waste, and maximise profitability because their supply chain is delivering the right products to the right places at the right time, every time.

Connect with us today to discuss how our solutions can help you transform your inventory and supply chain management.