February 25, 2024

Have inventories found their sweet spot?


Chart of the Week: Logitics Mangers’ Index – Inventory Levels, Total Business Invetory to Sales Ratio – USA  SONARLMI.INVL, TBIS.USA

Inventories appear to have stabilized after years of volatility. The Logistics Managers’ Index (LMI) Inventory Levels component hovered in slight contraction territory last year while the Census Bureau’s Business Inventory to Sales (TBIS) fell into a more stable pattern.

It has been a bumpy ride for inventory managers and procurement teams over the past five years. The combination of a trade war, supply chain snarls and erratic demand has created extreme swings in ordering patterns. 

The LMI is a measure of movement, with values above 50 indicating expansion and below 50 indicating contraction. Values farther away from 50 indicate stronger movements. So the average value of 49 over the past nine months indicates a slow drawdown in inventory levels. 

The Census Bureau’s figures are measuring more where the inventory levels are today in relation to sales. So the most recent value of 1.37 in November translates to companies averaging just over one and a third month’s worth of sales on hand. 

For context, the average TBIS value in 2019 was 1.42, when the trade war with China created a pull-forward effect. During 2021 it averaged 1.29, in the height of the pandemic spending. 

The story here lies in the recent stability of both the LMI and TBIS values. This is an indication that procurement teams are finding consistency once again in their demand forecasts. The risk is that consistency develops complacency.

While there has been a return to some degree of normalcy after the pandemic, the world remains more hostile than it was before COVID wrecked supply chains around the globe. There are now two major conflicts disrupting sea shipping patterns. And while they are not terribly disruptive to North American shipping services, they have pushed spot rates higher.

Domestic transportation capacity also remains abundant, with prices falling to their lowest levels in three years. Truckload van contract and spot rates are well below their peak 2022 values. 

If inventory levels fall too low, they are not buffered against unexpected demand. Unanticipated spikes in demand bleed into the need for transportation services, which drives transportation prices up quickly and causes severe service disruptions.  

An extreme case of this occurred in March 2020 when unexpected runs on consumer goods created severe shortages and crippled transportation networks as people were locking down. Tender rejection rates spiked from 5% to 20%, and spot rates jumped 20% in a three-week period.

On the flip side, if inventory levels are too high, companies pay the cost of holding those goods. The LMI warehouse pricing component still measured a relatively strong increase in prices to start the year, with a value of 64.2, though that was muted off the pandemic-era increases, when the index averaged an 83 from November 2020 to May 2022. 

Holding elevated inventories presents other problems, such as stagnation and pilferage. Some goods lose value over time. An argument could still be made that underserved inventories are more costly in the form of missed revenue opportunities if demand increases. 

The question is, just how reliable is the current procurement environment? There is no sign of a demand shock-type event, but there rarely is any warning. The fact that inventory levels are on the low end of the historical spectrum means that the chances of a March 2020-esque moment are more likely.


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