Why Have We Not Reduced Inventory?

“If only I had the money that the company was supposed to save from the multiple ERP and supply chain projects. There were a myriad of projects and we are at the same place that we were when we first started. I am a skeptic. I just don’t believe it anymore when I see it on a project justification.”  CFO of a major manufacturer

I want to believe. I really do. This year supply chain leaders will celebrate thirty years of progress in supply chain management; but we have not made progress on one of the funamentals:  inventory management.  I think that it is time for us to take the litmus test and ask the hard questions, “Have our practices impacted days of inventory?  Have the early adopters of inventory optimization seen a reduction in inventory on their balance sheets?” Sadly, I think that the answer is no. Here I give my logic.

 

How I Draw this Conclusion.

I have been an industry analyst since 2001.  I have written many articles about Advanced Planning Systems (APS), Enterprise Resource Planning (ERP) and Advanced Inventory Optimization. I want to believe. I am optimistic.  However, through this period, I did not have the access to financial balance sheet data to judge if the companies that were deploying the technologies were making an impact on the balance sheet.

When I started  Supply Chain Insights I wanted to put “research” at the core of the company.  As a result, I invested in building qualitative survey capabilities and built a database of twenty years of supply chain ratio data (for more on this capability reference the research report, The Effective Frontier and check out our community). Over the past three months, we have been mining this data, and the results disturb me.

In my prior work as an analyst, I did not have access to this data. While I could get two to five years of data from the Hackett studies done for CFO magazine, I did not have the ability to look across time, test it against macroeconomic factors and supply chain maturity.  I love having this capability now.  It is eye-opening.

What I See in the Data.

This week, as I prepare for our second webinar on October 26th at Supply Chain Insights, I am working with Abby Mayer (@indexgirl) to understand the performance of discrete industries over the past decade.  We have been running an analysis for the past fifteen years on discrete industries. (We covered the process industries last month.) As we run the analysis for industry after industry, as shown in figure 1, I am hanging my head.  So far I can only find one industry that has systemically reduced inventory and working capital over the ten-year period. This industry is High-tech.  The rest of the industries have the following characteristics:

  1. In the last decade, Days of Inventory are either unchanged or have slightly increased.
  2. If Days of Working Capital have decreased in an industry, it is largely the result of changing payment terms and decreasing Days Payable. We have squeezed suppliers. It is not an improvement in Days Receivable or Days of Inventory.
  3. There is no pattern between the adoption of advanced technologies for inventory reduction and balance sheet results.  There are a few outliers (e.g., Procter & Gamble and Kimberly Clark); but for most companies that I have worked with, I see that they have purchased and implemented inventory technologies, but there has not been an impact on future years results in either Days of Inventory or Days of Working Capital.

What I Think it Means.

I am searching for the answer to this sticky question.  I find that it is “sticky wicket.” Technology vendors have pushed advanced math and new technologies into the market, and early adopters have adopted the tools. I have avidly followed this market for the last ten years. I have attended conference after conference where I have seen the obligatory slide of “We reduced X days of inventory, improved costs and driven XX% improvement in customer service.”  I know that you have seen it as well. You see it conference after conference. It is in presentation after presentation. Are these supply chain leaders telling a lie? I think not.  Instead, I think that six factors are behind the results:

  • Bias. Supply chain leaders tend to overstate business results. (I find that it is analogous to asking a woman to put down her “true” weight on her driver’s license. Supply chain leaders tend to overstate results.) The projects are successful when first implemented, but they are usually a piece of the business and the results cannot be sustained over time.
  • Increased Complexity. The supply chain is a complex system.  Business complexity has increased with an impact on inventories. Too few companies understand the impact of sales policies, product proliferation and the long tail of the supply chain on inventory.
  • Project-based Focus. Multiple projects have been implemented without an overarching road map and a clear supply chain strategy. Companies cannot achieve supply chain excellence by working discrete projects in isolation.
  • Ownership of Inventory as a Metric.  In High-tech, there is greater ownership of the “inventory metric” across the organization. It matters for all functions.  A good example of this is the culture at Samsung.  By definition, the culture is inventory adverse. Regions are held accountable for obsolescence. I think that it is because the margin of High-tech products falls so fast as the product ages.  So, the longer that it is held, the greater the loss for the company.  In High-tech, this margin curve is more extreme than other industries.
  • True Understanding of Supply Chain as a Leadership Advantage.  I believe that the high-tech industry is heads-and-shoulders better at planning than the other industries. The stakes are higher.  As a result, the executive teams have a greater appreciation of supply chain due to the margin impact of new product launch. These industries paved the way on building supply chain practices. In other industries, the margin curves have not driven similar adoption.  (e.g., Why should a pharmaceutical company get good at inventory if the margins are so high? As they face the patent cliff inventory management will matter more. )
  • Forgetting Inventory Basics.  A decade ago, the supply chain had two buffers: inventory and manufacturing. With the move to outsource manufacturing, inventory became a more important buffer.  The focus shifted from just inventory levels to form and function of inventory.  However, as many companies outsourced manufacturing, they failed to look at the impact on inventory strategies and push/pull boundaries. I was even at one company last year that had outsourced manufacturing and forgot to figure out where these outsourced manufacturing locations would “store their inventory.”  Many companies have outsourced manufacturing, but not designed the supply chain to support the outsourcing decision.

I am looking for your insights. I am trying to figure this out.  Over the course of the next three months, I will be interviewing companies that have implemented these newer technologies and tracking their claims back to their balance sheets. Let me know if you have any thoughts to share.

For more on inventory management, reference the following articles by the Supply Chain Shaman:

So Proud…

UnCorked!

Yes, I am a Contrarian

Rock, Scissors, Paper. The Pitfalls of Integrated Business Planning

Heh?

 

 

 

 

Lora Cecere

Author Lora Cecere

Lora Cecere is the Supply Chain Shaman. A shaman interprets and connects an evolving world to a group of followers. Lora does this for supply chain. As the founder of Supply Chain Insights and the author of Supply Chain Shaman, Lora travels the world to chart the course of supply chain practices and disruptive technologies. Her blog focuses on the use of enterprise applications to drive supply chain excellence.

More posts by Lora Cecere

Join the discussion 6 Comments

  • Torsten Becker says:

    Lora,

    when you take into account that the original term for Supply Chain Management should have been Integrated Inventory Management, inventory performance is really quite disturbing. I have performed a similar analysis across 70 companies in automotive suppliers, machinery and electronics. The result is quite similar: Until 2007, there was a trend towards inventory improvement based on total inventory days of supply, since 2007 the numbers are increasing and median values have increased in average over the the start date of 2004.
    My interpretation is at the moment: The benefits of supply chain management have not reached the companies, as there are only pockets of excellence and not across the company implementations. Supply Chain Management requires more than just implementing an ERP system, it requires improved processes that are adapted to the customer requirement and streamline every process step. What do you think?

  • I think many businesses fail to anticipate just how complex their supply chain is/will be. There are so many moving parts, many of which you might not even be aware of until you don’t have them or they aren’t working. One small change at one end ripples backward through the whole supply chain–what is the real end result?

  • Torsten Becker says:

    Navdeep,
    I think the issue is: If my supply chain processes are capable, they can deal with many problems, especially the disturbances. If all companies had the same performance, I would agree with your statement. In our study, we found a significant gap between average and the best companies, from which I infer, that some companies have a better mastery of supply chain than others. The difference is significant and even the performance of the best companies has decreased over the past four years.
    I will try to post something on the study in english on my blog in the next days – stay tuned…

  • Naveen Palli says:

    Lora,

    The benchmark interest rate in US currently at 0.25%. Historically this is the lowest we have seen in the past several decades (at least going back to 1971). It is interesting to note that around 1980 when the SCM principles were coming together the interest rates were around 20%. So what does this mean? For one, it means the cost of capital in the past few years has fallen to the lowest it has ever been (for the same debt/equity mix) or will ever be. Following the financial crisis, one would expect companies to invest in inventory to gain as much sales as possible. It makes sense to invest in inventory at cheap rates.

    Another big strategic imperative at the large cap companies is that growth is driven in the former ‘developing’ nations (BRIC and others). These countries have fragmented distribution infrastructures with a lot more demand and supply volatility. This would lead to higher inventory holdings to service at the same level. In any case, the mandate is to grow these markets not save up on inventory. In another 5-10 years when the shakeout happens it would be the time to right size inventory, not now.

    Taken together, it is quite understandable that inventory levels have been rising. The puzzle is why they haven’t risen more. I believe that is because these companies understand the supply chain drivers for their particular business and have optimized it around their industry, product lifecycle and strategic initiatives. The levels are where they are because companies feel comfortable at those points not because they are leaving something on the table. SCM principles, tradeoffs and limitations are well understood at these companies (at least at the Executive level). So inventory levels will follow broader macro trends (interest rates, growth areas etc.) and not because people have forgotten SCM principles.

    • Lora Cecere Lora Cecere says:

      I wish that I believed that this is a concious choice. I don’t see this trend in the historic numbers. But, if you are correct, we will see it in the future numbers. Let’s watch it together and see who is right. Thanks for responding to my blog.

  • Some excellent views so far, which go to show there is a vast difference between textbook theories and coalface realities. Twenty five years ago, SCM was heralded as the “next-big-thing” to improve ROI by implementing “Zero Inventory” management. It supported a belief that SCM overcomes the “silo mentality” that favours departmentalised gains, at the expense of corporate competitiveness and financial performance. At that time, it was alleged that raw-material-to-finished-goods-point-of-sale as well as in-and out-bound logistics would be managed by SCM to achieve the goal Lora Cecere is hoping to find by resourceful analytics.
    I believe that while there have been huge strides made in the SCM field, it only proves how difficult it is to narrow the gap between, “what is and what should be”, in meeting these challenges head-on to the extent of realising the gains purported to support real zero-inventory trading in small to huge enterprises. Having said, this one wonders what the situation would be like today if inventory was still managed by back-office despatch clerks?

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