Leaner inventory has been a key topic across several consumer-facing industries—including automotive, retail, consumer products, and others—with companies paring back excess stock in the face of lower sales or gloomy forecasts.
These reductions help operators instill a sense of balance amid turbulent conditions, boost productivity, and improve cash flow. At the same time, discounting to dispose of excess inventory can take a bite out of gross margins.
Why the big focus on inventory?
Consumer activity has remained strong in recent quarters, but recent signals point to cooling. Spending at retailers declined in February, and consumer sentiment fell in March, adding to uncertainty driven by inflation, interest rate hikes, and recession fears.
There are three key reasons companies respond by tightening inventory levels:
1. Cash is king
Inventory reduction is an immediate lever managers can pull to improve cash flow amid high interest rates. If a significant economic slowdown is in the cards, dry powder will be necessary to finance growth and fund daily operations.
2. Ease of change
There is no single way to more effectively free working capital than properly managing inventory. With efficient planning and optimization, this is something leadership teams should be able to control reliably.
Here’s how it works:
Working capital = accounts receivable + inventory - accounts payable
- Changing accounts receivable terms requires customers to make adjustments
- Changing accounts payable terms requires suppliers and vendors to make adjustments
- Changing inventory requires disciplined focus and timing of when POs are sent so that they optimize behavior.
3. Margin
Discounting excessively impacts profitability, but it’s not the only cost to consider. Surplus inventory leads to excess labor, transportation, and warehousing expenses – all of which have direct impact on margin and profitability in future quarters.
Listen to the customer. Ensure visibility.
Of course, inventory management requires a well-designed game plan built on the following priorities:
Customer experience. Customer demand is changing as lines between in-person and virtual shopping blur. Companies need to worry about more than just stocking the shelves.
Mastering the balancing act between a customer’s demand for in-store experience availability and online-shopping efficiency is essential. Which stores or channels do potential customers purchase from? How much do customers order from each outlet? Answering these questions helps optimize inventory in warehouses vs. carrying excess inventory in stores, especially when shipping direct from the store is an increasingly available tool in the distribution toolbox.
Demand preference. The Metail mindset dominates, and consumers are gaining disproportionate leverage. Those who stay ahead understand that winning in Metail means never sitting still.
A truly dynamic supply chain team closely aligns with merchandising teams. To keep the value chain agile, the entire organization needs to be listening and responding to customers in lockstep.
Storage and labor. Increasing inventory requires space and handling. Currently, the industry has issues in both areas - high turnover in labor and a limited amount of warehouse space. With many SKUs stored in each location, it increases the burden on employees to pick and pack efficiently.
Organizations need to understand current capacity levels and prioritize inventory based on the space available. Stick to the basics of enhancing the warehouse layout and improving productivity.
Clarity on supply. Out-of-stock components can freeze production lines. At the same time, companies face a potential “bullwhip” effect where inventories quickly bloat. Supply chain visibility is essential for aligning inventory with demand needs.
Mapping out a supply chain with Tier 1, Tier 2, and other suppliers can help visualize the supply chain and build an optimized inventory stocking plan with ample flexibility. Coupling this with advanced analytics and modeling helps companies track the production of goods.
Take a holistic approach
There is no way to anticipate structural demand changes far enough in advance to avoid inventory builds. However, building a more flexible supply chain will reduce erratic and potentially damaging swings in inventory.
The key to building flexibility lies in holistic inventory management. This goes beyond rationalizing inventory by improving critical supply chain performance drivers.
In a world where the CEO is focused on building the vision and investing for the future, it is important to free up cash through inventory levers. An effective approach will:
- Address reliability of supply and lead times, while compressing lot sizes.
- Optimize the business model via a focus on differentiated service levels, optimized manufacturing, strong supplier partnerships, and a smart logistics footprint.
Winning will require a cross-functional strategy and discipline to periodically review inventory levels. Assemble or strengthen the team that quantifies optimal inventory levels; validates opportunities; prioritizes opportunities; and develops implementation plans.