First Thoughts
  By Dan Gilmore - Editor-in-Chief  
  November 6, 2008  
  Supply Chain News: Interesting Inventory Times    

This is an interesting time for inventory.

Just a short time ago – few months - transportation and fuel surcharge costs were through the roof, interest rates were low and money was flowing. That naturally led companies to, in aggregate, think about increasing inventory costs to reduce transportation expense. SCDigest ran several interesting articles, including analysis by MIT and ILOG’s David Simchi-Levi, on how a series of supply chain and inventory decisions might change under those conditions.

Incredibly, just a short time later, fuel costs have been roughly cut in half from their peaks, and ocean shipping rates are down even more – in some cases below the shipper’s variable cost to move the stuff. As the Baltic Dry Index, which tracks ocean rates for shipping of basic commodities, last week reached a level 90% percent below its peak, some are calling ocean shipping the greatest bubble of them all. One reader commented on that story by noting that one of his friends who ships wheat says he has recently seen rates drop from $3200 to $900. Unbelievable. It’s more astounding than the incredible rise in oil and fuel prices, which took a long time to reach their zenith in comparison to the dramatic descent in shipping rates.

All of which is just an introduction to my review of this year’s working capital survey, including inventory management performance, from CFO magazine and the researchers at REL, a division of the Hackett Group.

It was just recently released for 2007 data. That may seem a long delay, but they have to wait for the annual reports to come out in April or so, then crunch the numbers for 1000 publicly-traded companies, then have some delay between the report being finalized and the actual hard-copy publication of the magazine, etc.

I believe starting next year we are going to do something ourselves at SCDigest on this, focusing on just inventory management, versus the entire working capital spectrum, and get out a report much earlier in the year (note to self: get crack SCDigest staff working on this in early 2009.).

The CFO/REL report looks at Days Inventory Outstanding (DIO) as one component of working capital. DIO is in a sense the reverse of the more familiar inventory turns metric most supply chain practitioners use. You calculate DIO by taking a company’s year end inventory levels and dividing by total revenue and then multiplying by 365 – giving you how many days of sales a company on average holds in inventory.

Gilmore Says:

In other words, in a few years Wal-Mart has gone from inventory growth almost equal to sales growth to inventory growth that was just 12% of sales growth. That change contributed billions in free cash flow growth.

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It is close to the mirror image of inventory turns, except that most companies look at turns based on cost of goods sold, rather than the revenue used for DIO (COGS/inventory at COGS valuation). But, high levels of DIO mean low levels of inventory turns, and vice versa.

The consensus seems to be that supply chain practitioners need to be more savvy in understanding “supply chain finance” in general and the impact of inventory on working capital and other measures specifically.

It certainly is important. In 2006, Wal-Mart started to feel a lot of heat from Wall Street after letting its inventory levels rise at a much higher rate versus sales growth than it had historically. In 2005, I believe, inventory growth almost equaled sales growth.

Guess what was one of the prime messages in this year’s Wal-Mart annual report? That the company’s US stores group had “grown inventory at 0.7% versus a sales increase of 5.8%.” In other words, in a few years Wal-Mart has gone from inventory growth almost equal to sales growth to inventory growth that was just 12% of sales growth. That change contributed billions in free cash flow growth.

So now we have today’s environment. Transportation costs for a time have dropped substantially, while capital is tough to find and is expensive. Now is the time to free up working capital for the company by focusing hard on inventory management. (Note an interesting new program we saw from ToolsGroup to do just that.)

Ok, so finally on to the working capital report.

Across all sectors, inventory levels have been static for several years. DIO for all sectors excluding the auto industry was at 29.7 for 2007, an improvement of 3.5% from the 30.7 level of 2006. (Note this aggregate number includes many industries that have little in the way of inventories.) This is a little surprising to me, as I would have assumed that increasing transportation expense (and hence inventory trade-offs, such as deciding to use slower rail transport), would have led to more inventories. Maybe all that investment in inventory technology is paying off. It’s also interesting because there had been basically no improvement from 2003-2006.

The report is organized by industry sector, but sometimes in ways that make comparison difficult. For example, in the beverage sector, you have both beer maker Anheuser-Busch, with a DIO of just 16 in 2007, and spirits manufacturer Constellation Brands, with a DIO of 136, so the industry average of 23 loses a little meaning. Others are worse – home builders lumped in with appliance makers under “consumer durables.”

Having said that, looking at sector performance is interesting. Well-performing sectors in 2008 include:

  • Communications/network equipment: DIO down 15%, from 37 to 32
  • The wireless/cell phone industry: DIO down 16%, from 11 to 9
  • Specialty retailers, a very broad group, DIO down 4% from 54 to 52
  • The pharmaceutical industry: DIO down 9%, from 45 to 41
  • Metals industry: DIO down 5%, from 52 to 49
  • Life sciences/medical devices: DIO down 4%, from 43 to 41
  • Electronics: DIO down 8%, from 45 to 42
  • Internet and catalog retail: DIO down 4%, from 20 to 19

Laggards were the following:

  • Food and drug retailing: DIO up 8%, from 27 to 29
  • The consumer packaged goods sector: DIO up 5%, from 40 to 42
  • Department stores and mass merchants: DIO up 4%, from 62 to 64
  • Restaurants: DIO up 5%, from roughly 5.5 to 5.8
  • Containers and packaging: DIO up 6%, from 43 to 46

Most other groups were plus or minus 2% or less from 2006 to 2007. You can find the full report at: 2008 Working Capital Report.

We’re going to look at these numbers and some individual companies in more detail in next week’s issue of SCDigest On-Target.

Has your company started to make changes to lower inventory levels in the current environment? How so? Any reaction to the summary 2007 DIO numbers? Let us know your thoughts at the Feedback button below.

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