Rising Inventories Pose A Threat To Businesses And The Economy
I decided to become an economist at age 16, but I also started reading my grandmother’s used copies of Forbes. After getting a Ph.D. from Duke and working for three years as a professor, I found my calling in the business world. I began as a corporate economist (PG&E, Nerco, First Interstate Bank) before entering consulting, helping business leaders connect the dots between the economy and business decisions. I wrote Businomics: From the Headlines to Your Bottom Line—How to Profit in Any Economic Cycle to help corporate executives and small business owners understand how the economy impacts their companies. I’m the longest-tenured member of the Oregon Governor’s Council of Economic Advisors, chairman of the board of Cascade Policy Institute and senior fellow at the National Center for Policy Analysis. My friends and fans love their monthly fix of economic charts, a 60-second scan of the economy. The latest edition is always up at www.conerlyconsulting.com/charts.php.
The author is a Forbes contributor. The opinions expressed are those of the writer.
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Opinions expressed by Forbes Contributors are their own.
Inventories are rising—and that’s scary. After a very long-run trend of leaner inventories, companies are now holding significantly more than they did just four years ago. Excess inventories are an easy way to go bankrupt, so this movement deserves attention.
At the end of 2011, companies held $1.26 worth of inventory for every dollar’s worth of monthly sales. Their holdings now amount to $1.38. (Inventory data.) As an economist I cannot know what the right level of inventories is. Careful decisions don’t bother me, but I’m not convinced that careful is more common than complacent.
Companies have been trimming inventory levels for many years. Twenty years ago businesses held $1.49 of inventory for every buck of monthly sales. With improved technology, companies today know what is in the store, what’s in the warehouse, when new supplies will be delivered, and what’s delayed in shipment. Walmart gets—and deserves—a lot of credit for better inventory management, but good practices have spread across the entire economy. So why the recent reversal?
Inventories spike up whenever the economy goes soft, but that’s not really the case in the last four years. The recent upward trend is present at all levels: manufacturing, wholesale and retail.
Maybe companies went overboard in lean inventories after the last recession. Possibly they figured that they were losing sales and have made a conscious decision to have more stock available. In fact, I wrote about companies losing sales due to low inventory back in 2009.
More likely is that inventories have risen because of complacency. Sales have grown at a moderate pace, not great but not bad. Few businesses are in crisis. Interest rates are low, so it does not cost much to tie up working capital in inventories. This is a breeding ground for complacency.
If the economy does stutter, the inventories will have negative effects on individual companies and the overall economy. At the company level, a weak economy will reduce cash flow, making companies wish that their inventories consisted of cash rather than goods. At the economy level, businesses with excess inventories will stop ordering more materials from their suppliers, triggering a more severe turndown that otherwise would have occurred.
I have been recommending to my clients who hold inventories that they do two things. First, review their replenishment rules. It’s common to set up rules and then not revisit them. This is a good time to examine the rules in place. Second, see if your company is really following its rules. Sometimes procedures are set up and ignored. If that’s the case, turn your attention to your purchasing practices right away.
At the end of 2011, companies held $1.26 worth of inventory for every dollar’s worth of monthly sales. Their holdings now amount to $1.38. (Inventory data.) As an economist I cannot know what the right level of inventories is. Careful decisions don’t bother me, but I’m not convinced that careful is more common than complacent.
Companies have been trimming inventory levels for many years. Twenty years ago businesses held $1.49 of inventory for every buck of monthly sales. With improved technology, companies today know what is in the store, what’s in the warehouse, when new supplies will be delivered, and what’s delayed in shipment. Walmart gets—and deserves—a lot of credit for better inventory management, but good practices have spread across the entire economy. So why the recent reversal?Inventories spike up whenever the economy goes soft, but that’s not really the case in the last four years. The recent upward trend is present at all levels: manufacturing, wholesale and retail.
More likely is that inventories have risen because of complacency. Sales have grown at a moderate pace, not great but not bad. Few businesses are in crisis. Interest rates are low, so it does not cost much to tie up working capital in inventories. This is a breeding ground for complacency.
I have been recommending to my clients who hold inventories that they do two things. First, review their replenishment rules. It’s common to set up rules and then not revisit them. This is a good time to examine the rules in place. Second, see if your company is really following its rules. Sometimes procedures are set up and ignored. If that’s the case, turn your attention to your purchasing practices right away.
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