What is Phantom Inventory and How to Avoid It

Efficient inventory management in any business whether big or small is a critical factor for its success. It ensures that products are available when customers need them without having to overstock or understock. 

However, in spite of careful  inventory management, a business can fall prey to phantom inventory. which can have negative implications on its inventory management, operational efficiency, customer satisfaction and the bottom line. 

Let us understand what phantom inventory is, its negative implications on a business, the underlying causes and how to avoid it.

What is Phantom Inventory?

Phantom Inventory, also known as Ghost Inventory refers to the inventory that is not physically present in the warehouse but is mistakenly recorded as being available or in stock. 

Let us understand it with an example. Suppose your records show that there are 50 units of any SKUs (Stock Keeping Units) and you accept an order of 30 units. But when your picking team personally goes to pick up the order, they find only 10 units. 

Here the remaining 40 units which is the discrepancy between your physical stock and inventory records is the phantom inventory. 

This phantom inventory which exists only on paper and not in reality, misleads about your stock levels and is a cause of concern. The greater the discrepancy, the bigger the concern. 

Negative Implications of Phantom Inventory

Let us understand what are the negative implications of phantom inventory for any business.

Financial Implications

The financial implications can be severe due to phantom inventory. Lost revenue is the most immediate effect. An item which is available only on paper but not physically for sale will not generate revenue. A few units of phantom inventory may not result in extreme losses but as the number rises, the financial loss also rises.

Phantom inventory can lead to overstocking or understocking. Overstocking  which may result in increased carrying costs such as higher storage and holding costs, rent and depreciation. Understocking may result in lost sales and dissatisfied customers.

Other financial implications include inefficient resource allocation and reduced profit margins.

Operational Issues

There are numerous operational implications as well due to phantom inventory. Searching for items that are appearing on records but not physically eats up a lot of time and energy of the employees.

Reconciling stock levels and orders due to phantom inventory leads to an increased workload which reduces productivity. Fulfilment of customer orders may be delayed and other daily business operations can be disrupted in several ways.

Customer Dissatisfaction

Any inventory is meant to be sold to customers. Due to the existence of phantom inventory, a business believes it has merchandise in stock but in reality, it does not. It leads to missed or delayed deliveries and has a negative impact on customer satisfaction. 

Any business which implements an omnichannel strategy suffers more due to phantom inventory as more than one sales channel is involved. A customer sees a product ‘in stock’ online but due to phantom inventory, the business is unavailable to ship in time. It leads to customer frustration and they are very likely to go to a competitor. 

Forecasting Inaccuracy

Discrepancies in actual and recorded inventory lead to inaccuracy in forecasting which hamper the efforts to meet customer demands. 

Let us take an example. Assume the inventory management system of a business indicates the availability of 100 units but in actuality 80 units are only available. The forecast predicts that the business needs 150 units to meet future demands. However, due to phantom inventory, the business will end up ordering only 50 units instead of 70 units leading to probable stockout later on.

Now that we know what are the negative implications of phantom inventory, it is imperative to understand the causes of phantom inventory.

Causes of Phantom Inventory

There are several reasons which can result in phantom inventory.

Poor Inventory Management Practices

Inaccurate inventory management practices are a leading cause of phantom inventory. Not carrying out regular inventory audits, failing to account for obsolete inventory, and inventory that has been lost, misplaced or out of trend can lead to discrepancies in inventory.

Human Error 

This is one of the primary reasons which can result in phantom inventory. Human error during data input can lead to inaccurate inventory records. It can happen when employees input the wrong data or mistakenly duplicate entries.

There can also be a manual error in recording sales or failure in accounting for goods that arrived damaged. In any scenario, it leads to phantom inventory which costs money to the business.

Theft and Shrinkage

Another reason for phantom inventory is due to shrinkage which is the loss of inventory due to shoplifting, employee theft, fraud and other unknown reasons. When a merchandise goes missing or is stolen, it disappears physically but is still counted in the inventory management system, leading to phantom inventory.

Mistakes on the part of the vendor which can be intentional or unintentional can also lead to phantom inventory. The vendor may send less merchandise than promised leading to unaccounted inventory. 

Misplaced Inventory

This is a leading cause of phantom inventory at store and retail levels. The inventory ends up at the wrong place or is difficult to locate when customers move products to a different part of the store after trying. 

7 Strategies to Avoid Phantom Inventory

We talked about the negative implications and the causes of phantom inventory. This leads us to discuss which are the effective strategies to implement to prevent and reduce phantom inventory.

1. Conduct Regular Inventory Audits

It is crucial to conduct inventory audits at regular intervals to identify if there are any discrepancies between inventory records and what is physically in stock. There are generally two approaches to conducting inventory audits;

• Physical counts where every piece of inventory is counted once or twice at the same time every year. It is a cumbersome manual process but an effective method to audit.

• Cycle counts which is a perpetual inventory auditing process where one category of an inventory is audited at a time rather than the entire inventory at once.

Many businesses combine these approaches and conduct cycle counts throughout the year as well as physical counts annually or biannually. 

2. Implement a Robust Inventory Management System

A robust inventory management system is the foundation for avoiding phantom inventory. It includes having an inventory tracking system which will keep an accurate account of your physical inventory and will factor in parameters such as returns and unsold inventory.

An inventory management system of the current generation uses AI and machine learning to constantly compare inventory data against historical trends and sales data.

3. Better Demand Forecasting

It is essential to ensure better demand forecasting to avoid phantom inventory which could have been caused due to overstocking or understocking. 

Demand forecasting can be enhanced by businesses through historical data analysis which makes informed predictions about future demand by studying past sales data and trends. Businesses should also engage with sales and marketing teams to gather more insights.

Inventory strategies such as JIT (Just In Time) should be implemented which reduces excess inventory and related costs. 

4. Impart Training To Employees

The employees responsible for handling inventory should be regularly and comprehensively trained in inventory management practices to minimise human and data entry errors.

Quality control measures should be in place to cross-check inventory records and whenever discrepancies are identified, corrective action needs to be taken. Employees need to be trained in quality control management as well.

5. Technology Integration and Automation

Using technology to reduce phantom inventory is highly advisable and effective. There are various technological solutions and tools which can be used to reduce phantom inventory. 

Automated Inventory Management System offers real-time tracking of inventory, accurate reporting and automated data entry. It has features such as barcoding and RFID (Radio-Frequency Identification) technology to track and record the movements of inventory. Alerts and notifications inform when inventory levels fall below predetermined thresholds.

Other tools such as demand forecasting software, inventory optimisation software, cycle counting and auditing tools and data analytics and reporting tools can be put to effective use to reduce and even eliminate phantom inventory.

6. Better Relationships with Suppliers

A collaborative and friendly relationship with suppliers plays a significant role in reducing phantom inventory and improving overall inventory management. 

Cordial and close relationships with suppliers will ensure timely deliveries which will in turn minimise the risk of phantom inventory caused by delays in the supply chain. Accurate fulfilment of orders due to good supplier relationships reduces discrepancies between received and ordered inventory.

Suppliers who share cordial relationships with businesses will also support them in their inventory strategies such as JIT, which will reduce the need for overstocking or understocking and hence avoid phantom inventory.

7. Partner with a 3PL Provider

To avoid phantom inventory, it is imperative to continuously track inventory to maintain accurate inventory records. This can be quite challenging and time-consuming without the right expertise and technology tools.

It is an advisable strategy to partner with a trusted and experienced professional 3PL provider who can reduce the risk involved with poor inventory management. A 3PL can also support your fulfilment needs.

Conclusion

Phantom Inventory is a prevalent problem that haunts businesses and can have grave consequences such as lopsided inventory management, operational issues, customer dissatisfaction and erosion in the bottom line. 

However, with a thorough understanding of its causes and with proper systems and strategies in place, it is possible to reduce or even eliminate phantom inventory. 

Businesses can implement strategies such as conducting regular audits, efficient inventory management systems, accurate demand forecasting, training employees, using technology, building amicable supplier relationships and partnering with a trusted 3PL such as PACK & SEND.