SCDigest: The Great Inventory Deleveraging

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Mar 31, 2010
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By Dan
Gilmore
, Editor-in-Chief

Through a special arrangement, presented here for discussion is a summary
of a current article from Supply Chain Digest.

Just as we are in an economy
where businesses and consumers are “deleveraging,” most
businesses are deleveraging inventory levels as well. Wonder why it took so
long?

Indeed, despite many stories of individual companies greatly reducing inventories
over the past years, a chart we pulled together last year from the annual CFO
Magazine
working capital study indicates not a whole lot of progress
(the lower the number, the less inventory a company holds).

Why such little progress? The iconic Bud La Londe from Ohio State University
wrote a few years ago that the data showed steep drops in work-in-process inventories,
but little or no progress in finished goods inventories over some number of
years.

SKU proliferation certainly played a role in that. I enjoyed the presentation
John Bermudez used to make when he was at AMR Research. He had had the bright
idea to begin collecting various flavors, formulas and packaging for Crest
toothpaste over the years. He’d come with a large grocery bag filled
with dozens of different SKUs collected over not that long a time frame. It
certainly drove home the point about SKU complexity, micro-segmentation and
more.

But the recession will turn out to be the real catalyst. First, inventory
levels were dramatically cut in most companies to drive cash flow. Worried
about the impact on sales, many manufacturers and retailers looked around and
said, “Maybe
the easiest way to do this is to cut back on SKUs rather than starve our best
sellers with across the board cuts,” or something along those lines.

Target is testing stores that carry 50 percent fewer SKUs to see what the
reaction is. That is an astounding, game changing concept. Frito-Lay cut SKU
counts by some 29 percent last year. Estee Lauder SKU counts were down 10 percent
at the end of last year versus 2008. Kroger is said to be testing stores with
30 percent fewer SKUs, etc.

What else is happening to drive this?


  • Continued consolidation in most markets frankly means smaller brands can
    be squeezed out.
  • Consumers and B2B customers may in some cases find less is more.
  • The “new normal” relentless focus on price by customers of
    all types means more will choose low cost over having exactly what they want.
  • Technology (e.g., inventory optimization, new store-level DRP solutions)
    is really providing some answers now.
  • There is the growth of Sales, Inventory & Operations Planning (SIOP).
  • New fulfillment models (DC Bypass, drop shipping) are merging that will
    lower inventories.

So, I may not be the first to say it, but you can bet by 2015 there will be a
substantial shift downward in the inventory levels across virtually every industry
sector. That will largely represent true supply chain progress, and it will be
real and permanent, at least to some new plateau well below where we have been
the last decade or so. As always, there will be ramifications pro and con for
companies and individuals.

Discussion Questions: Do you think we will see real drops in inventory
levels starting now and for the next few years? Why, despite the seeming
progress over the past decade, did overall inventory levels seem not to improve?
Do you think this current focus on inventory reduction will last, or again
creep back?

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13 Comments on "SCDigest: The Great Inventory Deleveraging"


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David Zahn
Guest
11 years 1 month ago

It is reasonable to expect that inventory levels will drop over the next few years as technology allows more “just in time” delivery of products, more customer/consumer specific focus in what is shelved, and general consolidation on what is to be carried and what is not to be carried through financial determinations.

What this study shows, however, is that there is a difference between different types of inventory levels. Too much product remains on the shelf/in finished goods and until that is sold through (a bit harder to do in a recession or when shoppers have decided to forgo discretionary purchases), the inventory levels will lag behind what is waiting to “replace” those products. The manufacturers/suppliers are slowing down their production and so there will be less product being pushed out, and less demand from retailers for the same levels of product.

Paula Rosenblum
Guest
11 years 1 month ago

I agree with some points and disagree with others. For one, I don’t see the “relentless focus on price” on the part of consumers. Value yes, price no.

The main reason inventory will decline somewhat across many retail sectors is the new-found ability to treat it as a shared resource across channels and stores. RSR’s research shows that distributed order and fulfillment management helps retailers reduce inventories, increase turns while improving fulfillment levels across the enterprise.

However, implementing DOM is not as simple as snapping your fingers, so it will take retailers some time to get these applications in place, and an even longer time to realign merchandising organizations to accommodate new strategies.

But it will happen. Every retailer who has implemented DOM has achieved phenomenal results. And others will take notice.

Roger Saunders
Guest
11 years 1 month ago
Manufacturers have the same concern about inventories as retailers. They’ll drive their engines to coordinate product movement with consumer usage. Just-in-time merchandise will control flow, but the shelves still have to be filled at the retail level. A couple of other key factors for retailers that hold inventory (SKU) at the store level at higher points: 1. Retailers have bigger boxes/shelf space to fill. 2. Products are smaller — examples include flat screen TVs that are different than versions of 10 years ago; detergent is delivered in different packaging than 15 years ago. 3. Everyone is trying to control costs and do their part in ‘Green Movements’ to cut down on packaging. 4. Retailers have made significant moves to their generic brands; perhaps they have taken manufacturers’ goods off the shelf, but now they have their own ‘rice bowls’ that they don’t want to tip over. Inventories have to be controlled at all points in time — good economies or bad. The fact of the matter is, we have built some retail boxes that have… Read more »
Gene Detroyer
Guest
11 years 1 month ago
It is interesting, if not misleading, that the chart combined Mass Merchants and Department Stores. Mass Merchants have among the highest turns in retail while Department Stores have the lowest. It is likely that the MM DIO is in the high-30’s while the Department Stores are struggling to get below 100. In any case, inventory is a huge operating cost, one that has not been addressed for decades. There has been a mindset that all a retailer had to do to increase sales was to buy more merchandise. The result of that has been the constant pressure on moving goods out and out-sized price promotion that over time ruined the integrity of pricing. Unless the management mindset changes, the economic upturn will bring back the same misapplied strategy. However, the success of online retailing will change the total inventory dynamic and hurt retailers with old style management. Inventory costs. The more locations that are operated, the more it costs. It is hugely more expensive to service customers out of 7,000 stores across the country than… Read more »
Bill Bittner
Guest
Bill Bittner
11 years 1 month ago
There are four costs associated with carrying inventory: Shrink (caused by damage, spoilage, theft, etc.), Obsolescence (seasonal changes, style changes and updated products), Opportunity cost (storage cost, cost of financing, etc.) and Deflation. With interest rates low, the biggest concerns have been Shrink, Obsolescence and Deflation. Opportunity costs have not been a big factor. I agree that product variation has been the biggest inhibitor to inventory reduction, but case packs are also important because no one wants to handle partial cases. As product variations have increased without changes in case packs, retailers have been forced to increase shelf allocations or handle partial cases. The result has been more space allocated to big brands who offer a large variety. This has given the consumer more variations but fewer alternatives. They can have the purple Kleenex, but there will be fewer brand alternatives. I think there is a great opportunity here for retailers to remake themselves. Think of the store like the results from a Google search query. The consumer is shopping a particular type of retailer… Read more »
Dan Gilmore
Guest
Dan Gilmore
11 years 1 month ago

For the record, mass merchants and large department stores are combined in the original data set from CFO magazine and its partner in this, Hackett Group, in a category they call “Multi-line retail.” It does not include specialty stores, which is basically everything else, from apparel to office products and auto parts.

For some reason Walmart is not included, but here are some other retailers in the multi-line group group.

Target: DIO = 38
Sears: DIOO = 69
Kohl’s: DIO = 62
Bon-Ton: DIO = 75
Nordstrom: DIO = 38
Family Dollar: DIO = 53

The bigger point though is that, in general, however you group it, in retail and consumer products sectors, we simply have not seen the inventory needle move for 5-10 years.

But you will see it start to move now and continue to do so, for the reasons above.

Bill Emerson
Guest
Bill Emerson
11 years 1 month ago
There is one key macro challenge to effectively reducing inventory that has not been considered, which is the excess number of stores and selling space relative to aggregate demand. As discussed in a recent post (Welcome to the Ghost Town Mall – the future of 4-wall retailing) on my blog site, the number of stores and retail selling square footage, driven by easy credit, has been growing at a multiple (in some cases 4-6X) of population growth for the last 40 years. This growing imbalance was masked by an equivalent rise in consumer debt and a precipitous drop in household savings, which in turn created an artificially high level of aggregate demand. The credit bubble has collapsed, household savings are rising, and demand is moving towards a more rational level. The supply/demand imbalance created by 40 years of growing retail square footage faster than population growth has created a tremendous glut in stores and selling space. To put this in perspective, according to the International Council of Shopping Centers, there is now 46 square feet… Read more »
angiretlwire dixon
Guest
angiretlwire dixon
11 years 1 month ago

I have a question for Dan Gilmore.

How is the calculation for “DIO” different than a term I’m more familiar with called “Weeks of Supply” (or to compare apples to apples “Days of Supply”)?

Dan Gilmore
Guest
Dan Gilmore
11 years 1 month ago

Per question above:

As in much of life, there are different answers.

The CFO study calculates DIO like this:

DIO = Inventory/(total revenue/365)

In other words: year-end inventory divided by one day of average revenue.

So, a decrease is an improvement, an increase a deterioration.

Many argue, I believe correctly, that it is better to use cost of goods rather than revenue for the calculation. But the numbers in my chart represent summary of CFO’s numbers, which use revenue.

Also, I believe it is best to use “average inventory” not the year-end number, which obviously is just a point in time and subject to gaming. However, average inventory is not usually available in public filings, whereas year-end is, so that’s what they are used. You could, in theory, average the totals at the end of each quarter, which is available but would be a lot more work.

Hope that helps. It is obviously very similar to Days of Supply, which has the same questions about which numbers to use.

Richard Kochersperger
Guest
11 years 1 month ago
The chart displayed shows average inventories and doesn’t tell the real story. We don’t have enough information to fully understand what is actually occurring. For example, in the food industry, there are multiple types of inventory: turn inventory and forward buy/investment/ROI inventory. It is important to consider both. A decade ago, over 70% of a food distributor’s inventory could be investment buy, which is not the case today. Item counts: In the past five years, item counts at store level have increased significantly as variety has exploded. What used to be a single SKU is now 16 due to flavor, color or fragrance enhancements. More items mean significantly more inventory. Formats: The number of retail formats selling food has also increased, with many of the formats demanding their own unique pack and size which significantly increases inventory for the manufacturer. It is so challenging that often a manufacturer has to make a unique SKU for Wal-Mart, Target, Kroger, etc. even though the product is exactly the same. The real issue is the cash to cash… Read more »
Mike Spindler
Guest
Mike Spindler
11 years 1 month ago

Interesting and, in my opinion, correct views on both the roles that case-pack and the store universe have to do with this issue. The over-stored issue has been mitigated a bit with the 200,000 closings since the beginning of the downturn. And there is an echo-impact from those closures that has to do with the purchase displacement from the un/under-employed resulting from the closures.

SKU proliferation, in the form of new products and line extensions (many from private label folks) are once again on the rise and the rate we will see in 2010 will mimic 2007.

These changes will no doubt cause some very interesting innovation over the next 12 months … much of which is already on the move. This will include some new channel models not far from what Bill B. has described.

Dennis Serbu
Guest
Dennis Serbu
11 years 1 month ago
Much of the fanfare about inventory reduction and reduction of assortments is a knee jerk reaction to the economy. Political preferences aside, this situation won’t last forever and Americans will resume spending. The damage done by retailers to themselves may take a long time to repair. I was impressed that Wal-Mart is restoring hundreds of SKUs they dropped back in the spring and summer of last year. Supervalu apparently didn’t get the memo and is still charging full steam ahead with major SKU reductions and expansion of private label which appears to be flattening in growth. What may appear to be a good decision because of improvements in inventory performance and profit, may amount to eating the Golden Goose. Many “slow” SKUs which were dropped were purchased by the premium customers, the 10% of the customer base that generates 40% of sales. The repurchase cycles on slower SKUs is fairly long and it may be a while before this customer realizes that their favorite store no longer carries her preferred brand of whatever. She shops… Read more »
Doron Levy
Guest
Doron Levy
11 years 1 month ago

Limited resources mean smaller investment in inventory on the shelf. Another side could be that innovation in logistics are keeping shelves looking full while maintaining the fewest units possible.

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