How to Read the Inventory Tea Leaves…

An article in the WSJ provides an interesting set of perspectives on what increasing or shrinking inventory numbers might mean in terms of an organization’s supply chain performance.  As I noted in an earlier blog, inventory is often an indicator used to measure how efficient supply chains are, as is considered a key component in the methodology used by AMR in rating its top 25 supply chains.  But the WSJ article suggests that many other factors are responsible for variance in inventory numbers.

To begin with, lean inventories can mean demand is stronger than forecast or that companies want to sell what they have on hand before ordering more goods.  Some companies are ramping up their supply chains and building up inventories in anticipation of rising demand.  It may also be an indictor that demand is tailing off, and thus inventories are creeping upwards.

One way to “read the tea leaves” is to apply the DIO metric – or “days inventory outstanding”.  This is the  number of days it would take a company to eliminate its inventory at the current pace of sales.

But there are other economic reasons as well.  For instance, some companies will hold inventory as a protection against increasing commodity prices.  Others may also boost inventory if a product is a “last time buy”, or if they perceive increased risk in the supply chain that could cause disruptions.  For instance, I wouldn’t be surprised to see companies hold larger inventories of hard drives coming out of Thailand!

Companies will also play the numbers game.  In the fourth quarter, companies try to artificially reduce inventories, to make the balance sheet look favorable.  However, the biggest item in my mind is the rise in commodity prices.  According to the Institute for Supply Management, the prices of most commodities rose in March. Building inventories now could save a ton of money later in the year if commodities and oil continue at their current clip…