Abstract

Inventory Management Strategies

for Local Farm Supply Cooperatives

James J. Wadsworth

Agricultural Economist

This report presents fundamental yet important strategies for farm supply

cooperatives to use during the everyday management of the inventory they purchase and carry for sale to patrons. Basic elements and concepts associated

with strategies are described within the framework of a management plan. The

goal is effective inventory management. This material is intended to provide

farm supply cooperative managers and employees with information that will

enhance inventory management in their cooperatives.

Key Words: Inventory management, merchandise, strategies, plan.

Service Report 41

July 1994
Preface

Effective inventory management is imperative for successful operation of farm

supply cooperatives. Inventory management requires continuous decisionmaking. Cooperative managers can increase the probability of making good inventory management decisions by using fundamental inventory management

strategies implemented as part of an organized plan.

The strategies and concepts described in this report do not include all the

approaches that farm supply cooperative managers can use in developing or

enhancing inventory management. Rather, this report selects and focuses on

10 fundamental strategies or concepts. These strategies or concepts should

be included in cooperative plans for the everyday management of the merchandise ordered and held for sale and clearly understood by employees.
Contents

Highlights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . V

Planning for Effective Inventory Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Inventory Management Strategies ............................................................... 2

(1) Attain Proper inventory Mix ................................................................ 2

(2) Maintain Efficient Inventory Levels ..................................................... 4

Inventory Level by Type of Inventory .............................................. 4

(3) Minimize Costs of Inventory ............................................................... 5

(4) Order Efficiently .................................................................................. 7

Economic Order Quantity ............................................................... 7

Inventory Reorder Point ................................................................. 9

Automated Inventory Systems ....................................................... 11

Vendors/suppliers ........................................................................... 11

(5) Understand Pricing, Markup, and Margin Concepts .......................... 11

(6) Track Inventory Performance ............................................................. 12

Inventory Turnover Ratio ................................................................ 12

Inventory Management Index.. ........................................................ 13

(7) Make Physical Inventory Counts ........................................................ 15

(8) Handle Inventory Like Dollars ............................................................ 15

Inventory Shrinkage ....................................................................... 15

Warehousing .................................................................................. 16

Proper Warehousing Techniques ......................................... 16

(9) Merchandise and Promote ................................................................. 16

Store Layout and Inventory Display ............................................ 16

Showroom Layout and Display Techniques ......................... 17

Signs .................................................................................... 17

Color and Lighting ................................................................ 18

Product Promotion ...................................................................... 18

(10) Coordinate Inventory Between Multiple Branches ........................... 18

Summary ................................................................................................. 18

Strategic Considerations .............................................................................. 19

Competitive Forces and Current Strategy ............................................... 19

Is the Cooperative Completely in the Business? ..................................... 19

Differentiate as a Cooperative.. ................................................................ 19

Specialization Among Multiple Branches ................................................ 20

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

. . .

III
Highlights

Incorporating a well-organized inventory management plan will increase

the probability of achieving effective results in managing the required inventory

investment. Fundamental strategies should be implemented in a plan to reach

the cooperative’s clearly defined goals.

Strategies for an effective inventory management plan include:

(1) Attain proper inventory mix-provide the goods and services that

members (patrons) demand, the market reveals, contribute financially to the

cooperative, and coincide with the cooperative’s defined strategic direction.

(2) Maintain efficient inventory levels-minimize the costs of having too little or too much inventory. Types of merchandise have different efficient levels,

so understand them and work to attain the “correct” levels.

(3) Minimize costs of inventory-make sure that all employees know the

costs associated with maintaining (or not maintaining) inventory. Balance the

cost of being out of stock with the cost of maintaining inventory at the least

total inventory cost.

(4) Order efficiently-balance the higher ordering costs associated with

more frequent orders with the higher inventory maintenance costs associated

with less frequent orders; use tools-economic order quantity, inventory

reorder point, automated inventory systems, wholesale supplier programs, etc.

(5) Understand pricing, markup, and margin concepts-make sure that all

employees involved with the functions of selling merchandise understand the

formulas and basic principles of price, markup, and margin.

(6) Analyze inventory performance-examine the cooperative’s financial

performance relative to inventory. Analyze data and determine sales, gross

margins, inventory turnover, and inventory management index.

(7) Make physical inventory counts-carry out a count and report regularly.

(8) Handle inventory like dollars-carefully handle inventory. Work to

decrease shrinkage and follow correct handling procedures.

(9) Merchandise and promote-take pride in the merchandising of inventory (display, showroom, warehouse) and develop product promotion programs.

(10) Coordinate inventory among multiple branches-coordinate both purchases and sales among the different store and warehouse locations of the

cooperative.

As part of the inventory plan, cooperatives need to regularly assess the

effectiveness of their overall inventory strategy design. The resulting implications of employing their current inventory management strategies relative to

serving members and achieving the cooperative’s financial goals must be evaluated, given competitor presence and strategic behavior.

Build an inventory management plan-broad inventory management and

specific performance goals should be developed and strategies employed to

reach the goals. All cooperative employees involved with inventory must

understand the plan, the components within it, and their responsibilities. Plan

feedback is critical-goals and strategies must be monitored and then modified

to achieve expected results.

V
Inventory Management Strategies

for Local Farm Supply Cooperatives

James J. Wadsworth

In farm supply cooperatives, as in all retail

establishments, inventory designates merchandise

carried for sale. Merchandise includes the physical

items being moved from their primary source (the

wholesale supplier) to their final destination (the

member/patron).

Farm supply cooperatives serve their members/patrons by continuously buying and selling

merchandise. The cooperatives derive their principal income from the sale of that merchandise.

The typical farm supply cooperative has a

large investment in inventory. Data from a sample

of U.S. cooperatives (table 1) indicate that the average local farm supply cooperative had $521,000

invested in inventory at year end 1990. This investment made up a significant proportion of the sample cooperatives’ assets-about 49 percent of current assets and 25 percent of total assets. As with

other assets, farm supply cooperatives must strive

for high returns on their inventory investments.

Cooperative managers must take inventory

management seriously. The ability they demonstrate in managing inventory often translates into

business success or failure. Inventory management

involves constant decisionmaking that in turn

requires astute planning. Planning for effective

inventory management involves understanding

basic inventory management concepts and strategies and implementing them in an organized manner to reach defined goals.

This report addresses strategies and concepts

related to the inventory management decisionmaking process. It provides information to help managers and employees prepare a plan for their cooperatives.

PLANNING FOR EFFECTIVE INVENTORY

MANAGEMENT

Like most management functions, effective

inventory management does not just happen-it

takes a lot of work. This can be simplified by taking

an organized planning approach. Planning

involves defining inventory management goals and

incorporating strategies to meet those goals.

Figure 1 shows what an inventory management plan might entail for farm supply cooperatives. This plan involves defining a mission, broad

goals and specific performance goals, implementing an array of inventory management strategies,

and monitoring the plans (feedback).

The mission of effective inventory manageTable l--Selected financial data from sample of U.S. local farm supply cooperatives, 1990’

Variable Mean Minimum Maximum Standard Deviation

Inventory $520,773 $8,558 $4,435,349 $548,630

Inventory/current assets 49.4% 14.9% 81.3% 14%

Inventory/total assets 25.2% 5.4% 57.7% 9%

1 Source: U.S. Department of Agriculture, ACS farmer cooperative supplies and services data base. Number of cooperatives in sample = 139.

See appendix table 1 for more data on U.S. local farm supply cooperatives.

1
ment is defined in the top box of the diagram.

Broad goals are listed below the mission statement:

service-to members (patrons) by providing merchandise that meets their needs and demands; efficiency-of inventory operations; cost containment-of costs associated with maintaining

inventory; and competitiveness-with pricing and

products. These broad goals, essentially providing

the definition of effective inventory management in

farm supply cooperatives, define specific performance goals, and incorporate strategies to meet the

goals.

Management must define specific performance goals-in line with broader goals-related

to inventory management. Figure 1 shows examples of specific performance goals: sales goals-relative to the cooperative’s budget, set specific targets for gross sales of merchandise; capital

investment goal-prescribe upper and lower limits

for dollar inventory investment; gross margin

goals-specify targets for gross margins attained

on different classes of inventory and for inventory

overall; turnover-seek to reach specific levels (i.e.,

past performance levels, industry averages, etc.) of

turnover relative to inventory type and gross margin percent; and management index-strive to

achieve high inventory management indexes (i.e.,

past performance levels, industry averages, etc.).

Once specific performance goals are in place,

upper management and line personnel should take

responsibility for implementing specific strategies

and concepts.

Ten inventory management strategies are listed in the bottom box in figure 1. (Their numbers

correspond to those in the text.) These fundamental

strategies need to be well understood so they can

be effectively implemented. There is an inherent

need for strategy cohesion during their implementation. In other words, strategies should be implemented within an organized framework because no

single strategy can achieve all the goals of effective

inventory management.

Strategies listed in figure 1 are:

(1) attain proper inventory mix;

(2) maintain efficient inventory levels;

(3) minimize costs of inventory;

(4) order efficiently;

(5) understand pricing, markup, and margin concep ts;

(6) track inventory performance;

(7) make physical inventory counts;

(8) handle inventory like dollars;

(9) merchandise and promote; and

(10) coordinate inventory between multiple

branches.

The feedback loop included in figure 1 indicates the need for assessing whether strategies are

achieving the cooperative’s goals. As in all strategic

planning, feedback is critical to a plan’s success.

Plan initiators, developers, and implementors need

to periodically assess goals and strategies. If goals

are not correctly identified and strategies don’t

achieve desired results, modifications must be

made to get the plan working correctly.

INVENTORY MANAGEMENT STRATEGIES

The ten strategies listed earlier are explained

in this section. Examples are included where possible to help clarify explanations and the concepts

associated with the strategies.

(1) Attain Proper Inventory Mix

A good inventory mix is paramount to effective inventory management. For farm supply cooperative operations, inventory mix is maintaining

the types of merchandise and providing related

services that best serve the needs of patrons. A

number of factors relate to a good inventory mixthe cooperative’s strategic direction, needs and

demands of patrons, financial performance, and

market trends.

The cooperative’s inventory mix reflects the

strategic direction being followed. In other words,

the types of inventory handled indicate what a

cooperative is to its members and where it is going.

Cooperative management must continually

analyze inventory to gauge whether it is consistent

with the cooperative’s intended strategic direction.

Does the inventory mix indicate the direction the

cooperative wishes to go? Do all inventory items

2
Figure l- Planning Inventory Management

Mission

Effective inventory management

I

Broad Goals

Service

Efficiency

Cost containment

Competitiveness

Performance Goals

Sales

Capital investment

Gross margins

Turnover

Management index

Strategies

(1) attain proper inventory mix;

(2) maintain efficient inventory levels;

(3) minimize costs of inventory;

(4) order efficiently;

(5) understand pricing, markup, and margin concepts;

(6) track inventory performance;

(7) make physical inventory counts;

(8) handle inventory like dollars;

(9) merchandise and promote; and

(IO) coordinate inventory between multiple branches.

Achieving goals?

If not, examine/modify

strategies and/or goals

3
have an adequate market demand, or are some

obsolete and unprofitable? Inventory in low

demand and not reflecting strategic direction

should be removed and such products or services

discontinued.

Needs of patrons must be understood and

anticipated, either by using a formal

interview/survey approach or by frequently visiting with them. Management will then be able to

better plan inventory to meet their needs. In special

circumstances-when members are active patrons

for some products and services and want their

cooperative to maintain inventories of infrequently

demanded products-high cost elements of an

inventory mix can be a part of a strategic plan

when its total costs are fully explained to the entire

membership.

Financial analysis (e.g., sales and margin statistics) of merchandise provides a record of past

performance and is a key factor in determining an

inventory mix and evaluating a cooperative’s

strategic direction.

For instance, what are the sales and margin

dollars for particular merchandise items and classes of inventory and what products or classes contribute the most margin dollars to the operation?

This type of analysis identifies the types of

inventory contributing most to the cooperative’s

financial viability. Knowledge of these statistics and

the trends they show help determine what inventory to carry and what to promote more heavily.

Trends and unexpected events in a cooperative’s environment must be factored into the inventory mix. For this reason, regular market outlook

must include a review of what competitors are

doing-what their products are, services they offer,

etc. Regular market outlook allows management to

keep inventory mix current-to make adjustments

such as increasing or decreasing certain merchandise lines, and eliminating or creating lines.

(2) Maintain Efficient Inventory Levels

Inventory mix involves strategic planning to

define the type of cooperative members want,

while inventory levels involve operating decisions

to achieve efficiency and cost control. Inventory

levels vary by product or service. Some merchandise requires high inventory levels while others

require lower levels. The required inventory level

is tied to the demand for the merchandise. An efficient level minimizes the costs of having too little

or too much inventory. A balance must be maintained. Inventory level can be affected by product

promotions, supplier performance, and delivery

logistics.

For cooperatives, maintaining efficient inventory levels can pose a dilemma. As a service to

members, cooperatives may not only include infrequent demand items in their inventory mix, but also

maintain some popular products at higher levels to

reduce the risk of depleting the stock. While this

practice may be desirable to members, they must

understand the costs associated with maintaining

higher inventories and their adverse affect on profitability. Again, such decisions that entail higher

costs must be made within an explicit strategic plan.

Inventory Level by Type of Inventory There are

three types of inventories: fast turnover, slow

turnover, and seasonal. Fast turnover products

should be stocked at high levels, slow turnover

inventory should be stocked at low levels, and

seasonal inventory should be stocked at levels that

will enable the cooperative to meet demand but not

be left with excess inventory at the end of the

season.

Inventories of popular merchandise must be

well stocked to meet patron demand. Examples of

fast turnover products include animal feed, cleaning supplies, petroleum products, etc. The strategy

is to maintain levels dependent on supplier and

delivery logistics, sales history, and promotional

activities.

Slow turnover inventories have low or unbalanced demand. Products are often large ticket

items such as farm machinery, livestock equipment,

household appliances, etc. The strategy is to maintain inventory levels dependent on demonstrated

need, sales history, and promotions. Members

should be encouraged to order this merchandise in

advance to keep inventory costs low.

4
Seasonal inventories are determined by a fixed

period when products are in high demand. When

that season arrives, patrons usually won’t wait for

this merchandise because of their immediate operational needs related to the planting or harvesting

season. The strategy is to build supplies in anticipation of the season; encourage pre-orders by patrons

and maintain a suitable inventory; supply products

known to be needed, and assess inventory level

based on past sales and perceived demand.

(3) Minimize Costs of Inventory

Inventory is costly. There are order and maintenance or holding costs associated with inventory.

Costs include transportation, ordering, and physically placing merchandise in storage. Maintenance

or holding costs include finance, storage, fire insurance, property taxes, and obsolescence (damage

and deterioration). There is also an opportunity

cost-the return that capital resources could earn if

invested elsewhere-associated with the capital

resources tied up in inventory.

Table 2 provides estimates on the value of

inventory associated with maintenance costs. As a

general rule of thumb, these costs range from 20 to

30 percent of the value of a cooperative’s inventory

annually. The cost of capital used for inventory

ranges from 8 to 12 percent while obsolescence

costs range from 4 to 6 percent. Deterioration and

damage is also a major cost. Estimates range from 4

to 5 percent of inventory value.

Table 2- Inventory maintenance cost breakdown

Type of Cost Percent of Inventory Value

Transportation

Handling

Storage facilities

Insurance

Taxes

Obsolescence

Deterioration/damage

Cost of capital

112-l

2-3

112-l

112-l

1/2-l

4-6

4-5

8-12

While these are costs of doing business-holding merchandise to turn into receivables-inventory level has a direct bearing on how high or low

these costs will be.

The major cost of an inventory level that is too

high is inefficient use of capital. For example, if the

cost of capital is 8 percent, each $1,000 of excess

inventory has the effect of reducing net income by

$80. Excess inventory reduces asset turnover, in

turn reducing return on assets.

Carrying costs such as insurance, taxes, depreciation, and overhead (e.g., utilities, rent, and

administration) increase with excess inventory.

Obsolescence and shrinkage costs also increase due

to spoilage, damage, and disappearance.

There are also difficult to measure costs due to

insufficient inventory:

l Sales lost from depleted stock. The loss in

gross margins is the volume lost multiplied times

the gross margin usually attained from the sale of

the item.

. Cost of losing disgruntled patrons (who

have also purchased other merchandise).

*Cost of acquiring a poor service image.

Some tangible costs associated with low

inventory levels include special delivery and pickup costs to satisfy patrons, added order costs, and

time lost by employees.

Many wholesale suppliers offer booking or

incentive programs to cooperatives that often

include reduced wholesale prices for volume purchases. These programs must be carefully analyzed. If the merchandise isn’t likely to be sold

quickly, then it’s probably not an advantage to purchase in large quantities.

With inventory maintenance costs averaging

20 and 30 percent of inventory value per year, the

benefit derived from volume discounts quickly

diminishes if sales are relatively slow. Volume discounts are only beneficial if the merchandise is in

relatively high demand and can be sold quickly so

that additional inventory maintenance costs are

less than the discount.

Example l-Purchase of merchandise at a

discount. This illustrates the effect maintenance

Total cost 20-30

5
costs have on margins when merchandise is purchased at a discount but remains in inventory

because of slow sales. The normal cost of the merchandise is $5,000 ($10 per unit, thus 500 units) but

a 10 percent discount lowers the cost by $500 to

$4,500 ($9 unit cost). Maintenance costs are estimated at 20 percent of the wholesale inventory value

per year (1.66 percent per month).

The cooperative sells 25 units per month and

each unit retails for $12. Table 3 shows the impact

of maintenance costs that accrue at 1.67 percent per

month on the value of inventory not sold. Because

sales are relatively slow at 25 units per month, the

entire inventory volume is not sold in 12 months.

Relatively high maintenance costs reduce margins

substantially in the early months and have less of

an impact in later months.

Inventory maintenance costs accrue to more

than $500 by month 9 and thus eliminates all of the

discount gained on the volume purchase. At this

sales level and margin opportunity, this cooperative would have had better results if it had ordered

this merchandise on a monthly basis (e.g., 30 units

or so a month), even at the higher $10 cost per unit.

Cooperatives need to carefully analyze volume incentive programs offered by suppliers. If

sales, margins, and the discount are relatively high

on a particular type of merchandise volume discount purchases can be of significant benefit. These

purchases can provide extra margin and lessen the

risk of running low on stock. But management

must calculate maintenance costs to ensure that

their levels do not counter the net positive effect

associated with this strategy.

Cooperatives must balance the cost of maintaining inventory with the cost of being out of

Table 3- Purchase of merchandise at discount, example 1 I

Monthly Monthly

inventory sales sales

Time Units value (units) (6)

Monthly Accrued

maint. maint.

cost costs

Accrued

margin

dollars

Accrued

margin

after maint.

costs

Month 1

Month 2

Month 3

Month 4

Month 5

Month 6

Month 7

Month 8

Month 9

Month 10

Month 11

Month 12

500 $4,500 25

475 $4,275 25

450 $4,050 25

425 $3,825 25

400 $3,600 25

375 $3,375 25

350 $3,150 25

325 $2,925 25

300 $2,700 25

275 $2,475 25

250 $2,250 25

225 $2,025 25

$300

$300

$300

$300

$300

$300

$300

$300

$300

$300

$300

$300

$71

$68

$64

$60

$56

$53

$49

$45

$41

$38

$34

$30

$71

$139

$203

$263

$319

$371

$420

$465

$506

$544

$578

$608

$75

$150

$225

$300

$375

$450

$525

$600

$675

$750

$825

$900

$4

$11

$23

$38

$56

$79

$105

$135

$169

$206

$248

$293

1 Assumptions for example 1:

Total units purchased = 500.

Normal cost = $10 per unit = $5,000 total.

Discount = 10 percent = $500 total discount.

Discounted cost = 55,000 - 5500 = $4,500 total discounted cost.

Retail price = $12 per unit.

Sales per month = 25 units.

Gross margin percent per unit = 25 percent.

Maintenance cost percent = 20 percent per year or 1.67 percent per month.

* Maintenance cost = inventory value ($4,500) less value of sales times monthly maintenance cost (1.66 percent).

6
stock to achieve minimum total inventory cost. Out

of stock costs decrease as inventory level increases,

but maintenance costs increase and vice versa.

(4) Order Efficiently

Ordering is a major part of inventory management. Efficient ordering keeps inventory levels at

correct levels. Inventory should be purchased in an

organized manner. Inventory levels and quantities

demanded must be carefully monitored. Selected

individuals should be responsible for ordering

inventory. Cooperatives with a broad line of merchandise may select individuals to be responsible

for different classes of inventory.

There are two major variable costs associated

with ordering a quantity of inventory: (a) the order

processing cost and (b) the cost of maintaining the

inventory.

A cooperative might place a few large quantity orders each year or many small ones based on

certain factors. Placing a few orders will lower

order processing costs, but increase inventory

maintenance costs because the average inventory

level will be large. Placing many orders will

increase order processing costs, but lower inventory maintenance costs because the average inventory level will be small. The next example shows

how order processing and maintenance costs vary

by order size for a highly demanded item.

Example 2-Costs associated with different order

sizes. A cooperative sells 100 tons of hog feed a year

in 50 pound bags (4,000 units). The order processing cost is $6, the wholesale price per bag is $6, and

the annual inventory maintenance cost is 20 percent of the wholesale inventory value. Table 4

shows that as order size increases, the annual cost

of ordering decreases while the inventory maintenance cost increases, and vice versa. The 200-unit

order quantity provides for the least total annual

costs ($240). The 175- and 225-unit quantities are in

the general vicinity ($242 total annual costs).

This example shows that the best order strategy balances the higher ordering costs associated

with more frequent orders with those associated

with less frequent orders.

Figure 2 graphically illustrates inventory

costs. The total cost curve is the sum of the maintenance and ordering costs at various inventory

quantity levels. The cost of maintaining inventory

increases steadily as order quantity increases while

ordering costs decrease. The minimum point on the

total cost curve is where the cost of maintaining

inventory equals the cost of ordering inventory.

This is the goal to seek when ordering particular

merchandise items. This quantity is commonly

known as the economic order quantity (EOQ).

Economic Order Quantity EOQ is a useful

inventory management concept for finding the

Table 4-Costs associated with different order sizes, example 2 l

Order size (quantity) 50 loo 150 175 200 225 250 300 400 500

Average inventory 2 5 5 0 75 87.5 100 112.5 125 150 200 250

Number of times to order 8 0 4 0 2 7 2 3 2 0 18 16 13 10 8

Annual ordering costs $480 $240 $160 $137 $120 $107 $96 $80 $60 $48

Annual maintenance cost $30 $60 $90 $105 $120 $135 $150 $180 $240 $300

Total annual costs $510 $300 $250 $242 $240 $242 $246 $260 $300 $348

1 Assumptions for example 2:

4,000 units sold per year, wholesale value $6 per unit.

Order cost $6 per order.

Maintenance cost is 20 percent of inventory value ($1.20 per unit).

Annual ordering cost = $6 x number of orders.

Annual maintenance cost = $1.20 per unit x average inventory.

7
Figure 2- Basic Cost Curves of Inventory

Management

Total costs

Order quantity EOQ

EOQ = economic order quantity: minimum total cost

quantity

efficient quantity of select inventory items to order.

The EOQ quantity corresponds with the minimum

total inventory cost (ordering and maintenance

costs are equal). The concept is most adaptable to

merchandise regularly in high demand (fast

turnover). Using this tool requires knowing how

much of an item is needed during a given period

(usually a year), the cost of processing an order,

maintaining inventory, and the per-unit price.

Some fundamental mechanics must be followed to successfully meet these requirements:

l Keep accurate inventory figures.

l Record sale rates of individual items that

account for seasonal variations and ranges of unexpected variations in sales (i.e., management should

analyze within year trends, year to year trends, 3-

to-5 year moving averages, etc.).

. Record costs associated with processing

orders, purchase prices, and maintaining inventory.

The EQQ minimizes total costs calculated by

knowing the units of merchandise needed during a

given period, the cost of processing an order, the

per-unit purchase price of merchandise, and the

annual cost of maintaining the inventory.

This tool determines the amount of inventory

to order, but to be pragmatic, managers should use

the derived quantity to determine the order range.

Using a range around the optimal point usually

will not significantly increase total costs.

The economic order quantity is calculated

using this formula:

Economic order quantity (EOQ) = 2xuxc

PxMC

where:

U = units of merchandise needed during period,

C = cost of processing an order (employee time,

paperwork, phone calls, etc.),

P = price per unit of merchandise being purchased, and

MC = annual inventory maintenance cost as a percent of annual inventory value.

These two examples provide an analysis of

EOQ for a high- and a low-demand item.

Example 3-EOQ of high-demand merchandise.

Using the same merchandise example as in example 2, the EOQ is calculated for a cooperative’s

sales of bagged hog feed:

U = units of feed

= 4,000 units (200,000 lbs. + 50 lbs./bag),

C = cost of processing order = $6,

P = price per unit

= $6,

MC = annual maintenance cost (inventory value)

= 20 percent.

(EOQJ =

2x4,000x6

6 x .2

= +@Z= 200 units

For the lowest total cost, the cooperative should

order 200 units 20 times (4,000 units + 200 units) a

year (corresponds to the fifth column of table 4

from example 2).
Example 4-EOQ of low-demand merchandise. A

cooperative sells 50 electric fence control units a

year. The per-unit price is $100 (the processing and

maintenance costs same as above). The economic

order quantity would be:

U = 50 units

c = $5

P = $100

MC = 20 percent

CEOQ) = 2x50~5

100 x .2

= $Z = 5 units

The cooperative should make 10 orders of 5 fence

controller units each during the year.

inventory Reorder Point Another tool is the

Inventory Reorder Point (IRP). This concept

requires setting a safety stock level of inventory,

knowing the lead time it takes to deliver an order,

and knowing how many units (average) of an item

are sold,during a given time period (usually a day).

To use this concept, cooperative management must:

l Establish a safety stock level for individual

items. This is the lowest acceptable level that

inventory should reach by the time the next shipment arrives. This level allows the cooperative to

meet patron needs during periods of unusually

high demand.

l For individual items determine the “order

time” between the date the order is placed and

expected delivery. Add the safety stock level to the

amount of inventory required during the lead time.

Here’s the formula:

Reorder point = safe level + required invent0 y

Required inventory is calculated by multiplying the order time in days by the average sales per

day.

Example 5-1RP. This example also uses

bagged hog feed. The cooperative has average sales

of about 13 units a day (4,000 units + an assumed

310 business days a year), sets a safety stock level

of 10 units, and has an order lead time of 3 days for

bagged feed. The EOQ is 200 units (see examples 2

and 3). The inventory required for the 3 days lead

time is 39 units (13 units/day x 3 days) so the IRP

is 49 units (39 units required + 10 units safety stock

level). Thus, the cooperative would order 200 units

when inventory level drops to 49 units (about

every 11 to 12 days).

An IRP is calculated by determining a safety

stock level and an accurate estimate of order time.

The safety stock level is a sufficient inventory to

cover the maximum expected sales of inventory

between the order and delivery. The order or lead

time is the period between ordering and inventory

arrival. To ensure enough inventory is available to

cover sales during this period, it is critical to have

prior knowledge of order time. Past experience and

use of accurate sales and delivery data usually provide accurate data on safety stock levels and order

time.

Figure 3 illustrates inventory management of

merchandise with stable demand. This inventory

frequently turns so a constant quantity of 350 units

(the EOQ) is ordered at regular intervals. This is

commonly referred to as the fixed order quantity

method. Figure 3 illustrates that the EOQ of 350

units is ordered when the IRP of 150 units is

reached. Under this scenario, the time period

between orders is the same. During the lo-day

order time, sales continue at the rate of 10 units per

day, thus a total of 100 units. Inventory reaches the

safety level of 50 units before the new merchandise

is received. The 350-unit order brings the level of

inventory back up to 400 units.

Figure 4 illustrates inventory management of

merchandise that has varied demand-slow

turnover. Order timing depends on when the

inventory reaches the reorder point.

In the first two trend lines, strong demand

causes a rapid depletion of inventory stock after

orders are made at the reorder point. The third line

shows that the order Q2 does not bring the inventory level above the reorder point, making it necessary to reorder Q3 at the same time inventory Q2 is

received.

The lower demand indicated by the third

9
Figure 3- Inventory Level Management Given Stable Demand

Quantity of inventory ordered

500

400

150

50

0

Maximum

inventory level

P --------------I____

Safetv level

__-_L-----*

’ 6-r ’

I n-r ’

1 0 2 0 3 0 4 0 5 0 6 0 7 0 8 0 9 0 100 110 120 130 140

Time in days

Ql , Q2, Q3, and Q4 = quantity ordered = 350 units when inventory level drops to 150 units.

OT = order time = 10 days.

Thick line denotes inventory level.

Figure A Inventory Level Management Given Unbalanced Demand

Quantity of inventory ordered Maximum inventorv level

Time

IAT-I-+- -f -)~=l+----- T ~~1

OT = order time.

T = time between orders.

10
trend line allows inventory level to recoup well

above the reorder point only to have demand dramatically increase. In this scenario, the time

between orders varies depending on the rate of

sales. Sales of this merchandise are not predictable,

so the safety level may or may not be reached.

Automated Inventory Systems Automated

inventory systems aid in their systematic control.

Through computerized systems (e.g., point of

sale-POS), cooperatives can track sales of

merchandise on an individual item basis as well as

by inventory class. Perpetual inventory 

Vendors/Suppliers Local farm supply

cooperatives purchase inventory from vendors.

Often, local cooperatives are members of a regional

cooperative from whom they purchase most of

their inventory. In this case, the regional is the local

cooperative’s primary supplier. Most regionals

require their locals to purchase a significant

amount of inventory. On the other hand, some

independent locals develop their own supplier

system, purchasing their inventory from many

vendors.

Cooperative managers must work to develop

relationships with vendors that result in efficient

inventory purchasing. For farm supply locals that

are members of regionals, management should

work for special deals when purchasing a significant volume of a given type of inventory through

the regional.

When the marketplace creates a situation

where a local is having difficulty competing on certain goods or services, the manager should ask the

regional for help in alleviating the problem.

For inventory that locals purchase from vendors or suppliers other than regionals, local management must shop for a supplier that can give the

cooperative the best deal. This is a continuous

effort because suppliers often change their products and pricing relative to the circumstances of

their own competitive market.

The inventory ordering process for farm supply cooperatives often entails attending product

promotion meetings and information conferences

conducted by specific wholesale suppliers, and

participating in early order conventions where

many supplier-vendors promote their products,

offer order incentives, and book deliveries for

future dates.

Such programs can be an extremely important

aspect of inventory management. Solid product

promotion and market information programs give

managers insight into expected future sales and

provide important education on how to successfully promote products for greater sales.

Most farm supply cooperatives use an early

booking strategy for high-demand farm supplies.

This involves the use of special programs to urge

patrons to pre-order supplies in advance of when

needed.

This strategy affords cooperatives the ability

to order inventory contingent on what they know

they will sell. Cooperatives can take advantage of

special programs (early order and bulk discount

incentives) presented by wholesale suppliers (vendors).

(5) Understand Pricing, Mark-up, and Margin

Concepts

Employees must fully understand the pricing,

mis11
takes will likely increase and inventory costs will

increase.

Markup is the percentage amount (or actual

amount) above cost that merchandise price is

increased for retail sale. The percentage is calculated on a cost basis. Gross margin is the difference

between retail price and purchase price. Percent

gross margin is calculated on a retail price basis.

The formulas for calculating the percentages for

markup and gross margin are:

Markup = price - cost

cost x 100

Gross margin = price -

Example 6-Markup and gross margin. 

price of $50 - cost of $35

cost of $35

= -$15 x 100 = 42.86%

$35

Gross margin price of $50 - cost of $35

=

cost of $50

$15 = - x 100 = 30.00%

$50

When merchandise is readied for sale, some

items are priced via market dynamics-ompetitive

pressures. Other merchandise is priced based on

the gross margin management wants to attain. The

desired margin is added to purchase price to set

the retail price. If a certain gross margin percent is

needed, the following formula is used to derive

retail price.

Retail price = cost

(1 x 100%) - gross margin (percent)

Example 7-Retail price calculation. A cooperative purchases an item at wholesale for $10 and

wants a 25-percent gross margin. The retail price

would be $13.33, calculated by:

Retail price = cost of $10

(1 x 100%) - gross margin of 25%

= $10 x 100 = $13.33

75

Because $13.33 is an unusual number for the

price of an item, the price would be rounded to

$13.29 or $13.39.

(6) Track Inventory Performance

Management must analyze and track the

cooperative’s financial performance as it relates to

inventory. The analysis should examine data relative to inventory turnover rate, gross margins, and

sales. These ratios should be regularly analyzed

and tracked in total and by inventory class. This

section provides information and examples on

some important concepts that should be included

in routine inventory performance examinations.

lnvenfory Turnover Ratio The turnover ratio

indicates the liquidity of inventory. It tracks the

rapidity with which inventory is turned over into

receivables through sales during the accounting

period. This ratio is calculated by dividing cost of

goods sold by average inventory:

Znven tory turnover ratio = cost of goods sold

average inventory

Average inventory = beginning + ending inventory

2

As earlier indicated, types of inventory turn at

different rates. Some turn manv times and others

12
only a few times. The turnover ratio aids in inven- Inventory Management Index The inventory

tory management. It should be routinely calculated management index measures profitability. It

for classes of inventory, individual items, and for analyzes inventory turnover related to gross

all inventory combined. margin.

Turnover ratios should be judged in relation

to past and expected future ratios of the cooperative and against ratios of other cooperatives (or

farm supply businesses), and available industry

averages. But be careful when comparing inventory

turnover ratios to industry averages.

The inventory management index relates the

turnover of inventory with the gross margin return

the inventory generates. It is calculated by multiplying the inventory turnover ratio by gross margin percent. The formula is:

Departures from industry averages do not

always indicate a business is doing especially well

or badly. A high inventory turnover ratio could not

only indicate efficient inventory management, but

also a serious inventory shortage and inefficient

management. In many instances, low inventory

levels translate into sales losses.

Inventory management index =

On the other hand, a low ratio implies a large

investment in inventories relative to the amount

needed to service sales. This indicates excess inventories that tie up capital resources and increase

maintenance costs. Performance has been adversely

affected.

This index is simple to analyze-the higher

the resulting index, the better inventory management. Cooperatives should strive for an index of

1.0 that usually yields profitable results. For example, if the gross margin of a class of inventory is 25

percent, that inventory should be turned over four

times during the year to achieve an index of one

(.25 x 4 = 1).

Table 5 provides some inventory turnover

guidelines for product categories commonly carried by farm supply cooperatives. Some inventory

categories turnover only a few times while others

turnover more often. A turnover ratio of 7 to 10

times is a common guideline for total inventory,

Example 8--Inventory management index. This

example calculates the inventory management

index for an inventory class-hardware. Data

include:

The average inventory turnover ratio for U.S.

local farm supply cooperatives was 7.68 in 1990,

according to data in appendix table 1 (same sample

of cooperatives discussed earlier in table 1). In four

different size groupings established by sales volume, the inventory turnover ratio averaged

between 6.84 and 8.10.

. hardware sales = $25,000

l beginning inventory = $4,000

. purchases during year = $20,000

. ending inventory = $5,000

. cost of goods sold = $4,000 + $20,000 - $5,000

= $19,000

. average inventory = ($4,000 + $5,000) + 2

= $4,500

. gross margin = $25,000 - $19,000

= $6,000

Petroleum

Hardware

Feed

Fertilizer

Tires/batteries/auto

Miscellaneous items

Overall

7-lOtimes

2 - 3 times

lo-12times

2 - 3 times

3 - 4 times

7-lOtimes

7-lOtimes

. gross margin percent = $6,000 + 25,000

= 24 percent

Using these data, the inventory turnover ratio

is $19,000 (cost of goods sold) + $4,500 (average

inventory) = 4.2 times and the inventory management index is 4.2 (inventory turnover) x .24 (gross

margin percent) = 1.01.

This example shows that hardware inventory

is relatively well managed. The turnover ratio is

above the guideline for hardware of 2 to 3 times

13
(table 5) and the inventory management index is

more than one.

Turnover and management index calculations

should be made regularly on all classes of inventory, the cooperative overall, and on individual

inventory items. Some classes or types of inventory

will have relatively high indexes while others will

have low ones. This is normal. Some classes or

types will essentially subsidize other parts of the

inventory. Strive for an overall high index for total

inventory.

The average U.S. local farm supply cooperative in 1990 had an inventory management index of

1.37 (table 6). The average gross margin was 18 percent and operating margin was 2.7 percent. Based

on this data, the average cooperative managed its

Table 6-Selected financial data from sample of U.S. local farm supply coopeyatives, 1990’

Variable Mean Minimum Maximum Standard Deviation

inventory turnover ratio 7.68 2.63 21.46 3.62

Gross margin 18.2% 6.3% 30.7% 3.9%

Inventory management index 1.37 0.45 4.67 0.67

Operating income/sales 2.7% -4.9% 8.6% 2.7%

1 Source: U.S. Department of Agriculture, ACS farmer cooperative supplies and services data base. Number of cooperatives in sample = 139.

See appendix table 1 for more data on U.S. local farm supply cooperatives.

2 Inventory turnover ratio = average inventory + cost of goods sold; average inventory = (beginning inventory + ending inventory) + 2.

3 Inventory management index = inventory turnover x gross margin percent.

Table 7-Financial data of a mid-size local farm supply cooperative, example 9

Inventory classification

Farm General

Total SuDDlies’ Merchandise* Feed Seed Fertilizer Chemicals

Net sales

Beginning inventory

Purchases

Ending inventory

Cost of goods sold

Gross margin

Average inventory

Total assets

Operating expenses

Net income

Performance measures:

Inventory turnover3

Gross margin/net sales

Management index4

Return on assets5

Inv./total asset@

$14,820,000

1,540,000

12,380,OOO

1,720,OOO

12,200,000

2,670,OOO

1,620,OOO

8,370,OOO

1,720,OOO

950,000

7.53

18.02%

1.36

11.35%

20.55%

$1,830,000 $2,850,000

370,000 770,000

1,520,OOO 2,210,000

430,000 800,000

1,460,OOO 2,180,OOO

380,000 680,000

400,000 780,000

3.65 2.79

20.77% 23.86%

0.76 0.67

$5,920,000 $1,060,000 $2,300,000 $860,000

180,000 80,000 50,000 90,000

5,130,000 830,000 1,930,000 760,000

230,000 90,000 40,000 130,000

5,080,OOO 820,000 1,940,000 720,000

850,000 250,000 370,000 140,000

210,000 80,000 40,000 110,000

24.19 10.25 48.50 6.55

14.36% 23.58% 16.09% 16.28%

3.47 2.42 7.80 1.07

1 Farm supplies refers to general farm supply merchandise not included in other categories (e.g., cleansers, animal medicine, small farm

equipment, fencing, etc.).

* General merchandise refers to hardware, lawn and garden, clothing, appliances, etc.

3 Inventory turnover = cost of goods sold + average inventory; average inventory = (beginning inventory + ending inventory) + 2.

4 Management index = inventory turnover x gross margin percent.

5 Return on assets = net income + total assets.

s Year-end inventory figure used in calculation.

14
inventories relatively well as suggested by the

management index over one and relatively profitable, as suggested by the operating margin of 2.7

percent. (See appendix table 1 for these same figures categorized by cooperative size.)

Example 9-Inventory performance analysis.

Table 7 illustrates the type of analysis farm supply

cooperatives should regularly conduct to assess

their performance of operations as related to inventory. This table shows an example analysis of a

cooperative with total merchandise sales of $14.8

million. The analysis table includes merchandise

sales, beginning and ending inventory, purchases,

cost of goods sold, gross margins, total assets,

operating expenses, and various measures related

to the operational and inventory performance. The

table provides total figures and some breakdown

by inventory classification-farm supplies, general

merchandise, feed, seed, fertilizer, and chemicals.

For the year, the average inventory was $1.6

million for the cooperative in table 7. Total inventory turnover was 7.5. By merchandise class,

turnover fluctuated from 2.8 for general merchandise to 48.5 for fertilizer (the general merchandise

ratio is relatively low, but all other inventory categories fall within or exceed the turnover guidelines

specified in table 5). The cooperative’s overall

inventory management index was 1.36.

Like the inventory turnover ratio, the management index fluctuated among the merchandise

classes, from 0.67 for general merchandise to 7.8 for

fertilizer. Other measures include gross margin to

net sales of 18 percent, return on assets of 11.4 percent, and inventory to total assets of 20.6 percent.

Regularly conducting an analysis like this

(preferably monthly but at least annually) permits

management to identify problem areas and make

adjustments for more effective inventory management.

(7) Make Physical Inventory Counts

Making physical inventory counts is a basic

but critical inventory management procedure.

Regular counts control pilferage, decrease the

potential for excess and redundant inventory, keep

inventory insurance premiums at correct levels,

and provide information on the cooperative’s storage conditions. Counts also identify specific shortage and problem areas so management can then

take corrective measures.

Procedures for effective physical inventory

counts include:

. count on a regularly scheduled basis;

0 count accurately;

l count in a coordinated, organized manner;

l count using easily understood inventory

forms; and

l report physical levels accurately for accounting and insurance purposes.

All employees involved in the process must

recognize the importance of taking a physical

inventory and procedures to follow.

(8) Handle Merchandise Like Dollars

Inventory is a major portion of current assets.

They are short-term funds the cooperative has

invested to earn returns. Therefore, inventories are

comparable to actual dollars and should be handled as such. When merchandise is stolen or damaged due to improper handling, money is lost.

Types of shrinkage and methods for handling merchandise should be well understood. Procedures

should be followed to minimize losses.

lnwentory Shrinkage Inventory shrinkage is a

problem in retail business. Sound inventory

management techniques can counter the problem.

Shrinkage occurs from merchandise deterioration,

damage, and pilferage (both internal or external).

Inventory on the books that cannot be sold

diminishes turnover and reduces inventory

management efficiency. Poor inventory handling

and poor control practices contribute to shrinkage.

A number of strategies help control deterioration

and damage:

l rotate inventory-first in, first out;

l carefully load and unload inventory and

check invoices and dock receipts;

15
. control pests and maintain equipment and

facilities;

. store inventory in an organized and safe

manner; and

. handle inventory carefully.

Here are strategies that help guard against pilferage:

. take a physical inventory count regularly;

l organize warehouse inventory so patron

activity can be monitored;

. stock high-value merchandise away from

doors (warehouse and showroom);

. maintain inventory at efficient levels;

. check patron warehouse docking slips carefully;

. complete periodic management checks on

incoming inventory against packing slips or receiving invoices;

. organize showroom to allow for full visibility of patrons; and

. use perpetual inventory system or some

other automated system that continually accounts

for inventory received and sold.

Warehousing Follow correct inventory

warehousing procedures. Most inventory damage

and deterioration occurs in the warehouse. Poor

handling and sloppy organization and storage of

inventory contribute to losses. Warehouse

inventory must be stored in an organized,

systematic, and efficient manner. Proper handling

and storage help protect against damage, make

inventory more readily available for sale, aid in

loading delivery trucks and patron vehicles, and

help in taking physical counts. Patrons often walk

through the warehouse, so it is important that they

see a clean inventory environment where

merchandise is well organized, well kept, and

handled with respect and care.

Proper Warehousing Techniques-

* Stack inventory (pallets, boxes, etc.) in neat

rows with sufficient aisle space between rows.

. Store inventory in an organized manner.

. Rotate inventory so first-arrived product is

sold first.

. Handle products carefully to avoid damage.

. Repair damaged merchandise immediately

(e.g., tape a torn bag of fertilizer).

. Keep warehouse clean and inventory correctly placed.

. Monitor loading slips closely so the correct

amount of merchandise is given to patrons.

. Check dock receipts against incoming inventory to ensure that the right types and amounts of

merchandise are received.

Personnel should be acquainted with warehouse techniques and understand costs associated

with techniques that lead to inventory damageimproper rotation, poor storage methods, and inaccurate receiving, counting, and distribution of

inventory. Provide incentives to warehouse personnel to reduce inventory shrinkage and ensure that

proper warehouse techniques are followed.

(9) Merchandise and Promote

Merchandising showroom inventory is also

important. Well-displayed products enhance sales.

Show merchandise relative to the type of merchandise carried, promote specific products, and consider the size and layout of the showroom. Sound

merchandising practices contribute to more effective inventory management by decreasing inventory damage, theft, and loss, making it easier to

find and order inventory (control), and making

patrons want to own displayed merchandise.

Store Layout and inventory Display Store

layout and inventory displays can boost sales.

Effective merchandise displays can turn “just

looking” shoppers into buyers.

To achieve the most productivity from the

store, arrange merchandise in an organized manner. Departmentalization-breaking the showroom

into specific departments based on type of merchandise-effectively organizes inventory, both for

use of space and satisfaction of patrons.

Vary display techniques. Displays should be a

mixture of both gondolas (shelving units) and floor

displays. Wall displays are suited to particular

products-long-handled tools and hanging items.

16
Due to the small size of most showrooms compared

with the size and scope of products carried, it helps

to place large-ticket items (e.g., lawn tractors) in a

centralized floor display. Gondolas are best for

small merchandise that can be separated into compartments or shelved separately.

Housekeeping is fundamental to proper

inventory merchandising and promotion. Dusty

merchandise, faded labels, and shopworn items

detract from sales. Keep showroom aisles clear,

lights properly working, and the floors and windows clean for shoppers’ convenience and safety.

Make regular checks to replace misplaced merchandise. Keep bin and wall hanging merchandise correctly sorted.

Showroom Layout and Display TechniquesA number of techniques should be used for

effective showroom layout and merchandise display:

l Carefully arrange merchandise. Plan placement so patrons get maximum exposure to the

merchandise displayed during their normal movements in the showroom. Strategically place special

advertised displays. For example, put seasonal

clearance merchandise in the back of the showroom. Keep sale items in their usual place and use

signs to direct patrons to those areas. Shelf signs

help patrons locate products.

l Departmentalize. Create separate departments for like categories of inventory. For instance,

manyfarm supply retail operations include departments such as hardware and hand tools, housewares, clothing, crop and livestock inputs, pet supplies, power equipment, fencing, and seasonal

merchandise. Related items are more likely to sell

in quantity when displayed near each other.

l Use open spaces. Create open areas to display floor and bulk merchandise. It allows store

personnel to spot patrons who might need help,

reduces pilferage, allows for effective display of

certain inventory items, and makes the showroom

look larger and more attractive. Gondolas should

be placed on the sides or back of the showroom.

The center showroom areas should be left open for

floor and bulk displays. Avoid using unusually

high gondolas because they obscure the view of

patrons, invite pilferage, darken inventory, and

generally are unattractive. For openness, gondola

height should be restricted to about 4 feet.

. Use store fixtures. This includes using compartmentalized shelving on gondolas, separating

bulk loose commodities into separate containers in

neat arrangements, using platforms for floor displays of bulk and big ticket items, and displaying

promotional items on end caps.

. Limit the number of displays. Patrons often

buy nothing if given too much to choose from.

. Allowing patrons to handle some products

increases their will to own them.

. Change displays regularly, especially special

sale displays usually included on end caps.

. Create special holiday displays-Christmas,

New Year’s Day, Easter, July 4th, Mother’s Day,

Father’s Day, graduation, etc.

. Keep inventory clean and up-to-date.

Regularly check expiration dates on inventory such

as animal health products.

SignsSigns increase sales. Signs should tell a story

and highlight the price of merchandise.

Information on signs should be short and specific,

describing only the major attributes of the product.

Signs also should indicate sale items.

The use of signs can enliven a showroom, but

should not distract from merchandise presentations. They should subtly draw attention and

enhance the display with additional product information.

Signs should indicate if items are on clearance,

advertised items, or special buys. Signs should also be

developed as follows.

. Include price on signs. Pricing is often more

effective when odd cents or multiples on clearance

or special buy items are used-two for $9.98 seems

less costly than $5 each.

l Limit the number of signs. Too many signs

are worse than none. Sign clutter weakens communication.

l Display major signs at about the same level

throughout the store (especially department signs).

17
l Use signs on all end caps (tables, etc.) displaying seasonal or promotional products. Signs

should provide a brief description of items and

their price. When an end cap has multiple products, a single sign should separately list individual

items and their price.

Color and LightingTwo important merchandising techniques

often overlooked involve color and lighting. Color

can help sell products. If the walls of a showroom

are painted, the colors should make the store interior a showcase for every product carried. For

instance, a light shade on walls and ceilings creates

an illusion of spaciousness. Darker colors help

camouflage objectionable areas (if there are some

that can’t be corrected). Use of color on certain

product displays helps draw attention to merchandise. Color should be used for promoting sale items

and for making attractive displays of seasonal or

special merchandise.

Correct lighting is also essential. If possible,

the showroom should not be uniformly illuminated. Lighting should be varied to attract attention to

specific items and areas. Spotlights or colored lighting on special displays attract extra attention. But

avoid being too extreme with lighting because too

much bright lighting may cause eye discomfort.

Product Promotion A part of inventory

management that can’t be overlooked is product

promotion. Advertising regular merchandise and

special sales items are effective methods for selling

merchandise faster than it would normally move.

Use of advertising and holding sales are a must.

(10) Coordinate Inventory Between

Multiple Branches

Coordination of inventory between multiple

branches of the cooperative is a typical problem. It

takes full coordination of all inventory functions to

effectively manage it. Strong coordination and

communication among branches must include both

the purchase and sale of inventory and associated

services. When one branch is low on a particular

product and another has plenty in stock, merchandise can be quickly transferred. There is no need

for one branch to reorder products when another

branch has them.

That practice results in inefficient inventory

management and higher inventory maintenance

and order costs for the entire cooperative. The

same sale would have been made had the inventory been transferred instead of reordered.

However, different branches of the cooperative

often compete with one another on sales.

Competition can be healthy because it provides

incentive for branch employees to work harder.

But, it must never conflict with the ultimate inventory goal of the cooperative-overall effective

inventory management.

Summary

The inventory management plan (figure 1)

defines a mission, sets broad goals, defines specific

performance goals, implements strategies to reach

goals, and includes a feedback loop to measure

results. Specific strategies (concepts) make up the

crux of the plan. Ten are described.

In summary, cooperatives must continually

work to: (1) attain the correct inventory mix for the

cooperative’s members and patrons; (2) maintain

efficient levels of inventory according to sales and

member (patron) demand; (3) minimize the costs of

inventory; (4) use organized and efficient methods

for ordering inventory; (5) ensure that all employees with direct contact with inventory or inventory

paperwork understand pricing, markup, and margin concepts; (6) frequently analyze inventory and

related financial statistics and conduct periodic

physical counts on inventory; (7) handle inventory

merchandise like the actual dollars it represents; (8)

merchandise the showroom and warehouse effectively and develop product promotion programs;

and (10) coordinate inventory between various

branches of the cooperative.

These interrelated strategies should be implemented as a system. For instance, attaining the correct inventory mix and maintaining efficient inventory levels are linked to minimizing costs

18
associated with maintaining inventory, ordering

efficiently, tracking inventory performance, and

making physical inventory counts. These strategies

form a solid foundation of an inventory management plan.

STRATEGIC CONSIDERATIONS

Local farm supply cooperatives need to fully

assess the consequences of using particular inventory management strategies to serve members.

Members’ view and understanding on the role of

their cooperative will often place pressure on

inventory strategies. Many members expect their

cooperative to always have what they need and

when they need it.

However, competitors’ strategic behavior can

make this expectation unrealistic and costly.

Cooperatives often need to alter their inventory

strategies or develop.alternative strategies in

response to the competitive and financial consequences that result from their current plan.

Competitive Forces and Current Strategy

Cooperatives face competitive pressure from

other businesses. Often, farm supply cooperatives

find themselves providing a market yardstick for

the other businesses in their market environment.

In other words, proprietary firms within a

cooperative’s market will often tailor their inventory management strategies (e.g., prices, product

lines, and inventory levels) to the cooperative’s

strategies. Cooperatives must be aware of their

competitors’ inventory management strategies and

be prepared to change their inventory management

plan if necessary.

Faced with a large chain competitor, the cooperative will likely experience some negative consequences if it continues following all of its

employed inventory management strategies.

Strategies must be assessed as to their effectiveness, given the change in competitive environment. This involves evaluating the cooperative’s

inventory mix and pricing and promotion strategies. Large chain competitors are often able to sell

certain items as cheaply as local cooperatives can

purchase them from their suppliers.

Cooperatives facing these circumstances must

carefully evaluate their product lines and pricing

practices and make the necessary changes to counteract any competitive pressures. Cooperatives

must differentiate themselves from the chain(s) to

retain patrons and sales volume.

Is the Cooperative Completely in the

Business?

If competitor proprietary stores (or other

cooperatives) know that a cooperative carries only

certain items of an inventory line, they can gain a

competitive advantage by carrying the complete

line.

The cooperative’s strategic response to this situation should be either to carry and promote a

comprehensive inventory line of a specific merchandise type or not to carry that line at all. The

cooperative must demonstrate that it is seriously in

the business of selling the particular merchandise

line and fully intends to serve members (patrons)

in that regard. Carrying odds and ends of a wide

array of merchandise items to meet the random

needs of select members is inefficient and says the

cooperative is not seriously interested in meeting

the needs of other patrons who regularly demand

the entire line of such merchandise.

Differentiate as a Cooperative

Perhaps the best strategy that a cooperative

can use in response to competition is to promote its

cooperative identity. This attribute, alone, differentiates the cooperative from proprietary firms.

Cooperative identity must not only be promoted to

members and farmer patrons but to other patrons

as well. Patrons who are neither farmers nor members often enjoy the fact that a farm supply cooperative is a “farm” store owned by farmer members.

Promoting the farm store and cooperative

message is particularly fitting when the cooperative is in an urban area. Constant attention and

education are needed to get the full impact of coop19
erative differentiation. The concept must be continually promoted in newspapers, flyers, radio, using

outside and in-store signs, etc. People need to be

constantly reminded that the business is a cooperative farm store that provides a wide variety of

needed merchandise lines and services.

Specialization Among Multiple Branches A

farm supply cooperative with multiple branches in

close proximity may benefit by specializing in

certain product lines at different locations. For

example, a cooperative may handle hunting

supplies at each branch but find poor sales at all

but one location.

Under this scenario, the cooperative would

benefit by consolidating all hunting supplies at the

location of greatest demand. With suitable promotion, members and patrons would know where to

go for hunting supplies and be ensured of an adequate choice and supply of merchandise and assistance from a more knowledgeable sales staff.

Product specialization among multiple

branches is an inventory management strategy. Its

potential success hinges on the type of merchandise in question and the logistics of supplying varied locations. This strategy can benefit cooperatives

in certain instances but should be used only after

careful evaluation of its implications.

CONCLUSION

Many cooperative managers tend to rely on

subjective judgement for inventory management

rather than incorporate an array of specific goals

and strategies in an explicit plan. While judgement

honed from experience is in itself an effective

inventory management tool, management of the

cooperative’s inventory can be enhanced through

the use of a plan.

Steps to follow include stating a mission,

defining broad and specific performance goals,

developing and implementing inventory management strategies, measuring results, and examining

and modifying strategies and/or goals as needed

(figure 5). Inherent in plan development is the delegation of employee responsibility to carry it out.

Figure 5 - Steps to Planning Inventory

Management

2. Define broad goals

3. Define specific performance goals

4. Develop and implement strategies

5. Measure results-feedback

6. Examine/modify strategies, goals?

(Strategic considerations)

An inventory management plan can help cooperatives.

Once a plan is in place, cooperatives need to

regularly assess the effectiveness of their overall

inventory strategy design and counteract possible

negative financial and competitive consequences.

The implications that result from using inventory

management strategies relative to serving members

and achieving financial goals must be evaluated,

given competitor presence and strategic behavior.

Cooperative managers may have developed

their own inventory management strategies and/or

found others in textbooks and other literature.

Concepts in this report can serve as a checklist to

identify features or components of an inventory

management system that are lacking or may need

improvement. The key task is to build an organized

framework for working with inventory that fits

within the cooperative’s operations and provides

for effective inventory management.

20
REFERENCES

Beard, Larry H., Al L. Hargraves, and Fred A.

Jacobs. “Managing Inventories in a Small

Business,” Business Journal, April 1983.

Brooks, Bruce L. “Inventory Management and

Control in Agricultural Marketing and Supply

Businesses,” University of Illinois at UrbanaChampaign, College of Agriculture, Cooperative

Extension Service Circular 1063,1972.

Garrison, Ray H. Managerial Accounting, Third

Edition, Business Publications, Inc.: Plano, Texas,

1982.

Grablowsky, B.J. “Financial Management of

Inventory,” Journal of Small Business Management,

July 1984.

21
Appendix table l--Selected financial data from sample of U.S. local farm supply cooperatives, 199Ol

Variable Mean Minimum Maximum Std. Dev.

All cooperatives (n=139)

Beginning inventor $487,756

Ending inventory $520,773

Average inventor $504,264

Inventory/current assets 49.4%

Inventory/total assets 25.2%

Inventory turnover ratio2 7.68

Gross margin 18.2%

Inventory management index3 1.37

Operating income/sales 2.7%

Cooperatives with less than $5 million sales (n=lOl)

Beginning inventory $297,312

Ending inventory $314,452

Average inventory $305,882

Inventory/current assets 49.5%

Inventory/total assets 25.2%

Inventory turnover ratio 7.57

Gross margin 17.7%

Inventory management index 1.32

Operating income/sales 2.2%

Cooperatives with sales of $5 to $10 million (n=31)

Beginning inventory $815,338

Ending inventory $901,093

Average inventory $858,215

Inventory/current assets 48.6%

Inventory/total assets 24.1%

Inventory turnover ratio 8.10

Gross margin 18.7%

Inventory management index 1.46

Operating income/sales 4.4%

Cooperatives with sales of $10 to $20 million (n=4)

Beginning inventory $1,839,422

Ending inventory $1,779,090

Average inventory $1,809,256

Inventory/current assets 51.6%

Inventory/total assets 31.2%

Inventory turnover ratio 6.84

Gross margin 22.0%

Inventory management index 1.41

Operating income/sales 3.8%

Cooperatives with more than $20 million sales (n=3)

Beginning inventory $3,000,146

Ending inventory $3,157,529

Average inventory $3,078,837

Inventory/current assets 49.4%

Inventory/total assets 33.0%

Inventory turnover ratio 8.04

Gross margin 24.5%

Inventory management index 2.06

Operating income/sales 3.0%

$13,683 $4,726,885

$8,558 $4,435,349

$11,121 $4,581 ,117

14.9% 81.3%

5.4% 57.7%

2.63 21.46

6.3% 30.7%

0.45 4.67

-4.9% 8.6%

$13,683

$8,558

$11,121

14.9%

5.4%

2.63

6.3%

0.45

-4.8%

$1,233,387

$1,369,385

$1,301,386

81.3%

57.7%

21.46

30.7%

4.67

8.6%

$221,099

$235,487

$228,293

28.4%

11.3%

3.32

10.6%

0.66

-0.6%

$1,747,313

$2,015,527

$1,881,420

76.0%

44.6%

21.09

24.5%

2.61

7.6%

$1,035,739

$1,110,133

$1,072,936

45.5%

21.9%

4.32

17.2%

1.20

0.7%

$2,479,373

$2,251,930

$2,365,652

62.8%

44.1%

9.98

27.8%

1.72

7.1%

$1,273,406

$1,879,708

$1 ,156,557

31 .O%

23.0%

3.94

22.2%

0.87

-0.4%

$4,726,885

$4,435,349

$4,581 ,117

67.9%

43.1%

12.14

26.7%

3.24

6.4%

$546,823

$548,630

$544,473

14.0%

9.0%

3.62/n

3.9%

0.67

2.7%

$202,606

$213,401

$205,110

14.9%

9.4%

3.60

3.9%

0.70

2.7%

$393,873

$406,926

$386,783

10.7%

7.2%

3.75

3.2%

0.55

2.0%

$735,612

$595,627

$664,874

9.0%

11.6%

2.88

5.4%

0.27

3.2%

$2,441,978

$1,807,111

$2,124,545

26.1%

14.2%

5.80

3.2%

1.67

4.7%

1 Source: U.S. Department of Agriculture, ACS farmer cooperative supplies and services data base.

* Inventory turnover ratio = average inventory + cost of goods sold; average inventory = (beginning inventory + ending inventory) + 2.

3 Inventory management index = inventory turnover x gross margin percent.

22
U.S. Department of Agriculture

Rural Development Administration

Cooperative Services

Ag Box 3200

Washington, DC. 20250-3200

RDA Cooperative Services provides research, management, and educational assistance

to cooperatives to strengthen the economic position of farmers and other rural residents.

It works directly with cooperative leaders and Federal and State agencies to improve

organization, leadership, and operation of cooperatives and to give guidance to further

development.

Cooperative Services (1 ) helps farmers and other rural residents develop cooperatives

to obtain supplies and services at lower cost and to get better prices for products they

sell; (2) advises rural residents on developing existing resources through cooperative

action to enhance rural living; (3) helps cooperatives improve services and operating

efficiency; (4) informs members, directors, employees, and the public on how

cooperatives work and benefit their members and their communities; and (5)

encourages international cooperative programs.

Cooperative Services publishes research and educational materials and issues Farmer

Cooperatives magazine. The United States Department of Agriculture (USDA) prohibits

discrimination in its programs on the basis of race, color, national origin, sex, religion,

age, disability, political beliefs and marital or familial status. (Not all prohibited bases

apply to all programs). Persons with disabilities who require alternative means for

communication of program information (braille, large print, audiotape, etc.) should

contact the USDA Office of Communications at (202),720-7808 (TDD).

To file a complaint, write the Secretary of Agriculture, U.S. Department of Agriculture,

Washington, D.C. 20250, or call (202) 720-7327 (voice) or (202) 720-l 127 (TDD). USDA

is an equal employment opportunity employer.

ti U.S. GOVERNMENT PRINTING OFFICE: 1994 300-111/00132