Why Inventory-to-Sales Ratios Are Near Pre-Recession Lows

by: The Operations Room

By Martin Lariviere

When an article opens like this, it piques my interest:

The just-in-time approach to manufacturing, which has swept the world’s factories over the past two decades, has made a virtue out of keeping inventories lean. But some manufacturers think it has gone too far, and that having a little extra padding might be a healthier option.

The article in question is from last Friday’s Wall Street Journal (For Lean Factories, No Buffer, Apr 29). The gist of the article notes that inventory (relative to the size of the economy) has fallen pretty steadily over the last 15 years except during the recession. Here is the pretty graphic to show that:

[Click to enlarge]

As you see, the current inventory-to-sales ratio is near the historic lows we had before the recession hit. So where is the evidence that the world has changed and no one wants to have just-in-time inventory any more? Cue the anecdotes!

Even before that disaster, some companies were modifying their just-in-time approach. Heavy-equipment maker Terex Corp. (NYSE:TEX) recently cut deals with its 15 biggest suppliers to guaranteed it would buy fixed amounts of parts for three months in advance.

Since January, lawn-mower manufacturer Ariens Co. has opened four new warehouses across North America to store finished mowers. Al-jon Manufacturing LLC, a maker of machines that crush metal waste, has taken to keeping a stash of hard-to-find parts at its factory in Iowa.

So does this really show that just-in-time is on the outs? The background on these examples may suggest otherwise. Start with the Terex example.

But that flexibility showed a dark side when the economy crashed four years ago. Companies that had bought raw materials and hired workers with the expectation of selling to customers would get sudden calls canceling orders, and were left saddled with surplus products. Many companies floundered as a result, and found their customers unsympathetic. That’s why many suppliers are now resisting calls from customers to ramp up .…

“We had a supplier actually tell us a couple of days ago: ‘You guys were rough on us when the bottom fell out, so why should I help you now?’ ” says Timothy Fiore, Terex’s vice president of strategic sourcing.

Part of Terex’s response has been to “freeze” its commitments to key suppliers, in effect promising to buy specified amounts of goods over the next three months. As each month ends, the company’s commitment clicks forward another month, giving suppliers some additional security.

First of all, if relatively lean suppliers got burned when their customers abandoned them, what would have happened if they had been larded up with even more inventory and inefficient processes? Second, why is the conclusion of this that “just-in-time doesn’t work,” as opposed to that “karma is a bitch”? If a buyer mistreats a supplier, is it all that surprising that the supplier will demand better terms and greater security in the future? There have even been academic studies on this point.

What about Al-jon and Ariens?

Al-jon, a small, privately owned equipment maker in Ottumwa, Iowa, jumped on the just-in-time bandwagon long ago, trimming inventories and cutting back on the number of suppliers it used. For years, the strategy worked fine, says President Kendig Kneen.

Lately, however, Al-jon has faced growing delays. The company has seen its lead time for obtaining steel gear-reduction assemblies grow steadily over the past year; it now stands at 16 weeks. “In the past, we’d just count on a vendor having it on the shelf for us — but nobody wants to hold goods,” says Mr. Kneen .…

[Daniel] Ariens [CEO of family-owned Ariens] remains a fan of the just-in-time approach, but sees how the theory is stumbling in practice. For the past nine months, he says, he has had trouble getting enough rubber belts and tires for his machines.

“A lot of the supply chain for those things in the U.S. has moved to China,” he says, and so he has to order six weeks in advance and sometimes faces delays in getting what he needs. Recently, however, his rubber supplier moved some production back from China to a factory in Tennessee, which Mr. Ariens hopes will make it easier for him to get faster shipments.

So these stories seem much more about textbook reactions to increases in lead time. If it takes you longer to get what you need, you will hold either more inputs or more outputs or, perhaps, more of both. Again, I don’t see this as really a repudiation of just-in-time as much as an adaptation to changing business conditions.

The real interesting point behind all these stories is mentioned at the tail end of the article: A shift in power between suppliers and buyers.

J.B. Brown says just-in-time has shifted the balance of power between suppliers like him and his much-larger customers. “The whole dynamic of how companies work with suppliers has been turned on its head,” says Mr. Brown, the president of a family-owned foundry in Bremen, Ind., which produces metal parts for 250 different customers, including many multinationals.

I suspect that if you look across industries, suppliers that have survived the recessions (certainly the domestic ones) are the firms that were either really well managed to begin with or had some technological advantage. Weaker firms have been shaken out. Now suppliers face less competition, so they are asking for more. This would particularly hurt smaller buyers, since they cannot win better terms just on the size of their account. There is nothing pernicious in that, nor is it really a trend. It is just how markets work. The real question is: How long it will last?