Inventory Report

Dec. 21, 2004
For the past decade or more, the goal to 'cut inventory' has been a key driving force in manufacturing management.

Cut inventory.

For the past decade or more, that edict has been a key driving force in manufacturing management. Inventory ties up capital, and carrying excess inventory is expensive.

In the U.S., inventory-carrying cost averages somewhere between 15% and 40% of the dollar value of the inventory on an annual basis. Economists estimate that U.S. businesses spend hundreds of billions of dollars a year carrying inventory. Well-managed companies have taken aggressive steps to minimize inventory.

In particular, they are revamping their supply chains to support smaller shipments, moved more frequently, and combined with other products in a cross docking operation -- all with the goal of eliminating inventory "at rest." But just how successful have these stock-cutting efforts been? Moderately so, with more improvement to come.

That's what a recent study by the Warehousing Education and Research Council found when it surveyed 305 U.S. companies on inventory management practices. The study, "Warehouse Inventory Turnover," conducted by Thomas Speh, director of the Warehousing Research Center at Miami University, Oxford, Ohio, and James Evans Rees, professor of distribution at Miami University, looked at inventory turnover rates for 1995 and 1998, and projected turn rates for 2000.

"The results clearly demonstrate that companies have made significant strides in improving inventory turnover since 1995, and they expect further improvements by the end of 2000," report Speh and Evans Rees. For all companies in the study, average inventory turnover rose from 8.0 to 10.4 turns between 1995 and 1998- - a 30% increase. By the end of this year, survey companies expect their turn rates to reach 13.2 -- a 27% increase over 1998. This means that, if companies realize their projections, inventory turnover will have risen an impressive 65% since 1995.

Several Factors Vary

Within the survey population, inventory turn rates vary measurably.

For example, turn rates varied by company type. Retailers reported higher average turns than did manufacturers and wholesalers for all three time periods. Inventory turns in 1998 for retailers, manufacturers, and wholesalers averaged 12.1, 11.3, and 8.1 respectively. Manufacturers, on average, experienced the highest percentage increase in turns between 1995 and 1998, and also forecast the largest percentage increase by 2000.

Turn rates differ by type of warehouse, as well. Companies using third-party warehouses reported the lowest turns for each of the three time periods, while those using a combination of private and third party warehouses recorded the highest turn rates for all three periods. Average turnover for those using the private/third-party combination in 1998 was 12.1, compared with average turns of 10.2 for private warehouses, and 7.6 for those using only third-party warehouses.

Warehouse size does not appear to affect the level of inventory movement. However, survey companies operating more than 1 million square feet of space projected the largest percentage increase in turns by 2000. The number of SKUs in the warehouse appears to impact inventory turns, but only up to a point. Survey results show that, in all three time periods, facilities handling fewer than 1,500 SKUs have higher turn rates than those with a greater number of SKUs.

For instance, survey companies with fewer than 1,500 SKUs had average inventory turns of 14.0 in 1998. This compared with 9.4 turns for firms with between 5,000 and 25,000 SKUs, and 8.2 turns for those with more than 25,000 SKUs. Food product companies turn their inventories more frequently than other kinds of firms, the study found. All types of food companies combined -- manufacturers, retailers, and wholesalers -- reported average turns of 17.0 in 1998, compared with the average turns of 10.4 for all firms in the study. Who had the lowest turn rates? Automotive and repair parts, and clothing and apparel companies garnered this honor.

Driving Change

What drives change in the rate of inventory turnover? Several factors, the study found. By far the biggest driver is "top management's emphasis on reducing inventories." Among companies reporting the greatest boost in inventory turns between 1995 and 1998, top management emphasis on trimming inventories received more than three times the mentions as any other element. Other factors included:

  • Reduced SKUs.
  • Improved sales forecasting.
  • Inventory management software.
  • Better supply chain coordination.

Interestingly, inventories still suffer at the hands of poor forecasts, despite the availability of more sophisticated forecasting/planning tools. Almost two-thirds of the survey respondents reported that sales forecast accuracy is the same or worse than it was three years ago. Nevertheless, participants are optimistic about the ability of better software and inventory management tools to improve inventory turns in coming years.

Making Improvements

Knowing your inventory turn rate is important for one reason -- to make better strategic decisions about managing your company's supply chain. Simply cutting inventory levels in a vacuum makes poor business sense. "If a firm achieves a level of turnover that falls short of competitive benchmarks," write Speh and Evans Rees, "it does not necessarily mean the firm should work feverishly to reduce inventory." The company's lower turnover may exist for several very good reasons:

  • It seeks higher fill rates.
  • It excels at providing high levels of service to customers.
  • It offers more product variety than competitors.
  • It maintains more warehouse locations in an effort to accelerate product delivery.

Each of these tactics tends to raise inventories. "Before management takes action as the result of comparing inventory turns to those of competitors," the authors caution, "it is imperative that they examine all the underlying factors correlated to the inventory turnover results. Because of the key role inventories often play in creating high levels of customer satisfaction, there is a real danger in placing unquestioned emphasis on maximizing inventory turns. Turns should always be evaluated in light of important customer requirements."

Boosting inventory turns may also have significant cost implications in other areas of the supply chain, Speh and Evans Rees point out. Such costs could include higher transportation expenditures, increased labor costs, a need for more automation, and so on. These cost implications must be weighed against the savings accrued from lower carrying costs, high asset turnover, faster cash flows, fresher merchandise, reduced pressure on markdowns, and less product obsolescence.

Inventory turnover is a key measure of effectiveness for a company's logistics and warehouse operations. It serves as a catalyst for action. But because it is such a catalyst, enterprises must ensure that their inventory turn metrics are well conceived and consistently calculated. "Only then," write Speh and Evans Rees, "can management feel comfortable in making key strategic decisions on the basis of the measures."

For a copy of "Warehouse Inventory Turnover," contact the Warehousing Education and Research Council at 630.990.0001, 1100 Jorie Blvd., Suite 170, Oak Brook, Ill. 60523-4413. Factors Driving Inventory Change What one factor will have the most impact on inventory turnover by the close of 2000? Here's how survey respondents answered the question:

  • Factor Percent of Respondents Improved systems, inventory management software, warehouse management systems (WMS) 16.2%
  • Reduced production/delivery lead time/JIT 15%
  • Improved forecasting 10.7% Application of supply chain management principles 9.6%
  • More attention to inventory management 6.6%
  • Reduction in SKUs 5.1%
  • Increased throughput 4%
  • Elimination of dead inventory 4%
  • Inventory costs 3.3%
  • Utilization of cross docking 1.5%

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