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Home » Blogs » Think Tank » Inventories Shrink in Latest Logistics Report: Is That Good or Bad?

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Inventories Shrink in Latest Logistics Report: Is That Good or Bad?

July 11, 2016
Robert J. Bowman, SupplyChainBrain

Long sponsored by Penske Logistics, the State of Logistics Report was inaugurated in 1988 by the late Bob Delaney of Cass Information Systems, Inc. He was succeeded in 2004 by Rosalyn Wilson, later of Parsons Corp. In 2012, the report came under the aegis of the Council of Supply Chain Management Professionals, which tapped A.T. Kearney, Inc. to author the 2016 edition.

Inventory levels have seesawed over the years covered by the report, offering insight into key indicators such as consumer confidence and business investment. Now, the trend is once again downward. And depending on how you interpret the numbers, that’s either a good thing or a bad thing.

Between 2009 and 2015, inventory levels rose at the rate of approximately 5 percent annually, according to Sean Monahan, partner with A.T. Kearney and a co-author of the report. That number was well above gross domestic product growth. Then, in the 2014-2015, inventories went virtually flat, eking out an increase of just 0.2 percent. Inventories had also been growing as a percentage of GDP, from 13.5 percent to more than 14.5 percent, but slipped back to 14 percent in the past year. A.T. Kearney predicts a continuing decline for this year and next.

What’s it all mean? The stubbornly low interest rates of recent years have kept cash cheap, while transportation has been relatively expensive, Monahan said. With the fall in fuel prices, that dynamic has begun to shift, causing major retailers to adjust inventory levels and seek new ways of optimizing their total costs.

Interest rates remain low for the moment, so why is the cost of cash rising? For this year’s report, A.T. Kearney began looking at the weighted average cost of capital, which includes such factors as equity returns and debt to calculate the true cost of capital sitting on companies’ balance sheets. For the first time in five years, Monahan says, that number rose in the past year. As to why it happened, “we’re still trying to dig into it a bit more.”

You can spin the latest inventory trend two ways. The traditional view says it’s a harbinger of declining business confidence, and weak consumer spending in the run-up to the 2016 holiday shopping season. Indeed, a recent survey of shippers by Drewry Shipping Consultants Ltd. found 51 percent of respondents expecting volumes for the third-quarter peak season to equal those of the prior year, while 35 percent were anticipating even lower numbers. Ocean carriers appear to feel the same way, taking the unprecedented action of removing tonnage from the trades in advance of what should be their busiest time of the year.

Retailers, meanwhile, are exercising caution in the face of an uncertain domestic and global economy. (Britain’s vote to exit the European Union has only served to underscore that sense of unease.) They would rather risk a few lost sales than be stuck with excess merchandise for which they must take painful write-downs, Monahan says.

But there’s a positive side to the fall-off in inventories as well. Monahan says companies are doing a better job of optimizing their stocks, reaping gains in efficiency and productivity through sophisticated forecasting tools and a multi-echelon inventory approach. Pressures caused by the growth of e-commerce have forced distributors and retailers to deploy product closer to consumers, who are demanding rapid delivery.

One might assume that the dispersion of product over a wider network of warehouses would lead to a net gain in inventory levels. That’s not necessarily the case now. Notes Monahan: “We’re seeing a lot of retailers being smarter in how they deploy inventory, manage centralized pools and ship from stores versus distribution centers with as little working capital as possible.”

Other findings in the 2016 report paint a more negative picture. Overcapacity is present in every major mode, says Monahan. Purchases of new Class A trucks fell 24 percent this year. He quotes an estimate by Penske president Mark Althen that there are approximately 75,000 excess trucks on the road right now. Meanwhile, rail volumes, which had been growing at the rate of 5 percent per year, took a 14-percent plunge in the 2014-2015 period, as shippers abandoned intermodal services in favor of cheaper and faster trucks. For airfreight, the advent of larger passenger planes has created a glut of belly space. And on the ocean side, those new megaships are begging for business in major trade lanes, even with freight rates at rock bottom.

As if that weren’t enough, the A.T. Kearney report identifies four disruptive forces that are roiling the logistics sector. Two of them – globalization and volatile commodity prices – are beyond the ability of shippers and carriers to control. But two others – technology and operational constraints – could be effectively addressed by industry. The first concerns innovations such as driverless vehicles and the supposed “Uberization” of freight. The second includes issues such as the driver shortage, new safety regulations and the nation’s crumbling infrastructure.

If those problems are not addressed by industry and government, says Monahan, then the nation’s logistics network will encounter additional constraints, even with annual economic growth of only 2.4 percent. (That’s the Kearney report’s assumption for the next five years, down from an average of 2.6 percent since the 1980s.)

Of course, the picture can change at any time. A rise in interest rates or the price of oil could alter the logistics landscape virtually overnight. So could another natural disaster or terrorist attack. Think of the latest State of Logistics Report as a Snapchat message writ large. Still, shippers, carriers and legislators should be doing whatever they can to reduce the uncertainty that forever clouds their future.

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