Supply Chain Digest: Inventory Management Challenges Continue

Discussion
Aug 09, 2007

By Dan Gilmore, Editor-in-Chief

Through a special arrangement, what follows is an excerpt of a current article from Supply Chain Digest, presented here for discussion.

In early 2006, a look at the past several years of data from the annual CFO Magazine working capital report showed continuing upward pressure on inventory levels, despite the great focus on supply chain management improvements in most companies. This year’s report shows the same trend–average inventories across all industry sectors grew 2.1 percent in 2006.

The largest driver of this increase is generally thought to be the rise in offshoring. As a greater percentage of a company’s total sales comes from offshore sources, its inventory levels are likely to rise, as higher inventories are used to buffer the impact of the longer supply chains, increased inventory risk, etc.

I believe this issue is compounded by the relative lack of experience the average company has in managing global supply chains, an issue we analyze in detail in our report on The 10 Keys to Global Logistics Excellence. So, the inherent upward pressure on inventories from offshoring is compounded by the years it takes to really get good at the process.

I believe another factor is the increase many companies have seen in raw material prices, as commodities from corn syrup to plastic resins have seen strong increases in supply prices. If a company cannot raise its own prices in step, as many have not been able to do, it has the effect of increasing the inventory level metric, as the cost of raw materials and work-in-process inventories goes up relative to sales. There has also been some forward buying of raw materials to lock in costs of commodities expected to rise.

The CFO data, compiled by consulting firm REL, measures three elements that impact Working Capital, of which average inventory levels is one. The report actually uses Days Inventory Outstanding (DIO), which is the other side of the coin from the Inventory Turns metric used by many supply chain professionals. It is generally good if Inventory Turns numbers are increasing; the opposite is true with DIO.

Across all industry segments, the average DIO for 2006 was 31.2 days in 2006, up a little more than two percent from 2005.

So just to cover the basics, why is DIO important? For several key reasons. First, working capital tied up in inventory can’t be used for more productive purposes that could generate higher returns or growth for the company.

Second, inventory is a component of the company’s overall capital investment. Those firms that can generate a given level of profit with a lower level of investment in inventory will generate higher cash flows and better return on invested capital. Third, higher levels of inventory tend to lead to more problems with write-offs of slow, excess and obsolete inventories (SLOBs), which can hammer a company’s profit line, especially in today’s environment of rapid product lifecycles.

Just to be clear, for large companies even a small change in the number of days of inventory being held, positive or negative, can be worth tens of millions of dollars in working capital swings.

Discussion Questions: What factors do you think are driving inventory numbers up? Have we reached a plateau of performance improvement that will be difficult to break through?

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8 Comments on "Supply Chain Digest: Inventory Management Challenges Continue"


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W. Frank Dell II, CMC
Guest
14 years 9 months ago

Anytime you increase the length of the supply chain you increase the inventory required. Safety stock is driven by variability in demand and lead time. Increasing the supply chain length always increases the lead time variability.

Putting that aside, the current approach and methodology has little room for improvement. There is continued belief that accurate forecasting will solve the problem. Consumer products sales are extremely unpredictable. Competition, promotions, weather, economy, etc. all contribute to changes. It is time for the industry to first move to daily data from weekly data. Additionally, there should be a change from relying on a forecast to planned reaction to demand utilizing the slack in the supply chain to buffer extremes.

Nikki Baird
Guest
Nikki Baird
14 years 9 months ago

Globalization is definitely partly responsible for increasing (or at least flat) inventory levels. But, before you know it, localized assortments are going to put pressure on inventory levels too. The more specialized the assortment by store, the more inventory you’re going to have to carry to support that assortment.

Which says to me that inventory cannot be judged by inventory-specific measurements alone. It has to be taken in combination with what the additional inventory enables–sort of the “marginal return on inventory.” Carrying more inventory to support localized assortments is worth it if you get a boost in sales as a result. Carrying more inventory because of a longer supply chain is worth it if you get margin improvement from lower costs of supply.

But I also want to second that better planning and forecasting is not the answer. Longer supply chains and broader assortments increase risk from disruption, so the answer to that comes in flexibility in execution, not unachievable accuracies in forecasting.

Jason Radlinger
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Jason Radlinger
14 years 9 months ago

It seems that with the vast availability of either raw materials or V-A materials, the inexperience of “legacy” supply chain planners directly affects inventory levels. With increasingly higher inventory levels, companies are depleting possible investment growth while simultaneously stocking for an unknown future buying time. Dealing with backstocks, overstocks and returns, this could take a company from profitable to closed, if not closely monitored.

This continuing rise of 3PLs and 4PLs may create solutions for those whose competencies don’t lie in planning, but creating new vendor relations and watching emerging markets closely make help open avenues of possible supply, effectively balancing any price increase from current markets.

Bill Bittner
Guest
Bill Bittner
14 years 9 months ago
This is the kind of stuff I love, but unfortunately the CFO study ends up giving us another example of how “statistics lie.” I have to agree with Dan Gilmore’s observation that cross industry comparisons are meaningless. I took the time to go through the detail charts and focused on the number for the “Food and Staples Retail Industry” because that is the industry I most understand. First of all, using the median values posted at the bottom of each industry really doesn’t say much. What we really need are weighted averages or absolute values so that we can get a total industry perspective. My immediate reaction to the subject was that we would find that product diversification has forced retailers to carry more inventory. But the numbers indicate that retailers actually experienced a decline in DIO. I found that intriguing because it seemed so counter intuitive to my immediate reaction. I then looked a little closer. Among the retailers experiencing the best improvement in DIO were A&P and Winn Dixie. In A&P’s case, they… Read more »
Craig Rosenblum
Guest
Craig Rosenblum
14 years 9 months ago
An extended supply chain and increase in raw material cost certainly have an impact, however, it is the inability of retailers to be focused on THEIR go-to-market strategy, competitive point of difference, and shopper satisfaction–and not trying to be all things to all people that is wreaking havoc on inventory. The culmination of this phenomenon and the lack of one set of metrics across the entire organization are causing the train wreck between buyers’ and suppliers’ need to create demand and the supply of product. Given the ever changing trends (for example health and wellness and organics), retailers are going to be forced to continually optimize store space in order to drive sales and profits. This is going to force retailers to ensure that THEIR merchandising decisions take into account strategy, mix of product, demographics, and that their shopper insights are aggregated on a daily basis, in order to drive greater forecasting accuracy. Otherwise, inventories will continue to go up and more than likely, shopper satisfaction will go down. The ability to put the variety… Read more »
Andre Martin
Guest
Andre Martin
14 years 9 months ago

I continue to be amazed at the lack of understanding of how retail supply chains actually work. While it is true that adding offshore suppliers with longer lead times will add inventory, that is not the major culprit in rising inventories.

In the retail world, people must come to realize that everything starts and ends at the store. The store is the beginning of the information flow and the end of product delivery. The problem is retail supply chains are information disconnected and everybody is forecasting what should be calculated (forecasting at retail and manufacturing distribution centers and factories). And very few are forecasting at the only place where it really matters–THE STORE–resulting in great uncertainty up and down the retail supply chain, which must be compensated by unnecessary inventories in the form of safety stocks.

James Tenser
Guest
14 years 9 months ago
Craig and the ever-wise Andre are zeroing in on the right issues, I think. Clearly the retail consumer products supply chain itself has been significantly streamlined–to a fault it may be argued. The source of much of its remaining irrationality lies in the “black boxes” (i.e. stores) that should be providing reliable demand signals but do not–because we don’t have a plan to make it happen. In the absence of a systematic daily process for in-store implementation (that includes both physical merchandising and information capture on shelf conditions), the supply chain can never be truly optimized. RFID may one day be an element of this, but it is not the solution in and of itself. So-called “causal data” is a needed element, but it is not a solution. Algorithms that purport to derive shelf conditions from scan data are a false hope that may actually perpetuate the problem. Home store and other labor allocation practices are needed, also, but experience shows that they are not sufficient in the absence of a data-capture and communications plan.… Read more »
Mark Lilien
Guest
14 years 9 months ago

Yes, retailers are certainly importing more from overseas. What would Wal-Mart or Target or Macy’s look like if every Asian-made item was taken away? Would those stores be 85% empty?

And if you take ownership from the point of shipment (Asia) the inventory isn’t productive until it reaches the store shelf, several weeks later.

Turns also slow down when companies focus on packaging waste. A low-price item, packed 12 to a case, has a higher packaging overhead than when it was packed 24 to a case. So there’s a tradeoff between inventory investment and case pack sizes.

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