It’s getting crowded in here

During the first half of 2020 supply managers have been faced with unprecedented challenges. Forecasts and long-range plans have been cast aside as lockdowns and virus infection patterns have made planning for the future near-impossible. This uncertainty is reflected in the inventory situation many firms now find themselves in. Efficient inventory management has long been a hallmark of the most successful organizations. Firms went into the spring of 2020 expecting “business as usual,” betting on a continuation of high levels of consumer spending, and they built up inventory levels accordingly. When the economy shut down, sales dried up, and many firms found themselves holding an unprecedented level of inventory.

This is borne out in the U.S. Federal Reserve’s inventory-to-sales ratio, which measures the amount of inventory firms are carrying relative to the number of sales completed. In April 2020 this ratio hit 1.67, an all-time high in the history of this metric. Multiple sectors of the economy essentially shutdown without warning. Inventory was still flowing in when sales suddenly stopped, leading to a spike in the level of goods on-hand. 

Exacerbating this is the fact that the secondary markets that often function as release valves for over-inventoried firms are experiencing the same issues. For example, in normal conditions a firm like Macy’s may disposition unsold inventory to a discount chain like TJ Maxx or Ross Stores. But if TJ Maxx and Ross Stores are also unable to make sales (as was the case during the lockdown), they may not be interested in taking Macy’s inventory. This is the case for many secondary market firms, meaning even the sub-optimal channels of inventory disposition are closed off for many companies. 

Firms are dealing with this excess inventory in a number of ways, including cancelling orders, shifting goods around different network sites, destroying perishable goods, and having clearance sales so massive, The Wall Street Journal dubbed it “Black Friday in April”. Despite all of this, a significant percentage of inventory could not be burned off, meaning firms will need to hold onto it until normal economic activity resumes.

The largest barrier to holding so much inventory is the high cost of storing it. The Logistics Managers’ Index (LMI) measures the growth and/or contraction of key logistics metrics on a monthly basis. Figure 1 presents the LMI’s month-to-month movement for inventory levels, inventory costs, available warehouse capacity, and warehouse utilization. When interpreting this figure, any value over 50.0 (represented by the dashed, black line) indicates month-to-month growth; any value below 50.0 indicates contraction.

[Figure 1] Warehousing & inventory movement July 2019 - June 2020
Enlarge this image

Over the last year, inventory levels have steadily risen. We observe a significant spike occurring in June of 2020, when parts of the economy (perhaps temporarily) reopened. This continued inventory buildup has had a significant impact on warehousing. Available warehousing capacity had been increasing and actually trending up for a year before March 2020, when the COVID-19 lockdown began in the United States. Warehouse capacity has contracted in every month since, reaching an all-time LMI low with a reading of 41.7 (a value which indicates significant contraction) in June 2020.

As warehouse capacity has dropped, warehouse utilization has increased, as firms try to squeeze inventory into every available nook and cranny. The lack of available capacity has in turn led to a spike in the costs associated with holding inventory. Some firms are even looking beyond warehouses, utilizing intermodal rail containers to slow-roll inventory, essentially using excess transportation capacity to supplement their limited storage space. Fundamentally, firms find themselves in the unenviable position of paying more for less-desirable space in order to hold goods they had anticipated selling in April.

Unfortunately, there may not be much relief in sight. When asked to predict logistics activity over the next 12 months, LMI respondents indicated that they expect both warehousing and inventory costs, along with inventory levels, to continue to rise. 

Dealing with excess

It is likely that supply managers across multiple industries will spend the next 12 months dealing with the excess inventory built up during the initial COVID shutdown. If the reopening of the U.S. economy falters (at the time of this writing, many economists are predicting a slow-down in consumer spending due to the disruption of enhanced employment benefits), some managers may need to deal with a “double shock” in which they ordered additional inventory when the economy appeared to be reopening, but then faced a second shutdown. Supply managers, and the firms they work for, will continue to feel the financial pressure of holding high levels of inventory until the economy can permanently reopen. 

Unfortunately, not all firms will be able to deal with this pressure. Firms like J.C. Penney and Nieman Marcus have already declared bankruptcy, and it is likely that more will follow over the next 12 months. To paraphrase Warren Buffet, when the tide goes out, everyone can see who is swimming naked. In other words, firms that are not well-positioned financially or are inefficient in the way they manage their inventory will have the most difficulty over the next year. In many ways, the COVID inventory shock will act as a catalyst, speeding up the demise of the firms who were already in decline, while facilitating the ascension of others. 

Supply managers must remain vigilant, placing a premium on smart inventory management and flexibility throughout their supply chains. Managing inventory over the next 12 months will be difficult, but not impossible. The firms that are well-positioned and can make it through to the other side will likely emerge stronger and more efficient than they were before the crisis. 

Author’s Note: For more insights like those presented above, please see the monthly LMI reports, which are posted the first Tuesday of every month at www.the-lmi.com.