The Inventory Bubble Has Arrived

Shortages are now excesses. What happened?

Johnny Miller was one of the greatest golfers of all time. His career faded in the late 80s and 90s, but his performance in the 1970s represents one of the great multi-year streaks of all time. One point of advice that Johnny often gives is “when you get into trouble, the first thing you need to do is get out of trouble.” While he was talking about what you should do when you hook your drive into the deep rough, this advice can be applied to many things in life. And, it can be applied to the current inventory position of many retailers, particularly multi-category retailers. Brian Cornell, CEO of Target, is certainly one who is currently applying Mr. Miller’s advice with a vengeance.

It seems that the limited-output garden hose of our global supply chain has suddenly sprung leaks of inventory all over the place. What happened and what can we learn from it?

That Was Then, This is Now

Last year’s headline supply chain story was continuous disruptions and a general lack of inventory across various product categories, particularly items related to staying at home, including furniture, exercise equipment, televisions, computers, electronics equipment, toys, and even Thanksgiving turkeys. Media attention reached a feverish pitch with seemingly everyone from individual companies to high level government officials questioning the design of global supply chains. While the use of the term “supply chain” had been growing for years, it is now part of the daily language of ordinary citizens. For better or worse, it seems that this will be a lasting impact of the pandemic.

Part of the discussion in all forums from media to academic circles was that years of cost cutting by companies had made supply chains “too lean.” We debunk this theory using multi-year aggregate data in the research article “Are Supply Chains Too Lean?”

Fast forward to today, June 2022. The headline story today is excess inventory.

Sometimes it’s useful to think the opposite, as George Costanza once did. Some call this “analysis of extremes.” If all the inventory you need is currently short and late, the opposite is excess and early and this opposite may be arriving right around the corner. That is a typical result of the bullwhip effect; we suggested as much in “The Whack-a-Mole Global Supply Chain.”

The industry proxies for the excess inventory situation are Target and Walmart, two of the most sophisticated supply chain operators in the retail industry. (Their combined $683B in annual revenue is roughly half the revenue of the 45 department store and discount retailers we track and roughly14% of all 242 retailers we track). Let’s examine their inventory profiles to see if we can gain any insights. This is not intended to be a critique of these fine retailers, but a view into wider retail industry dynamics.

Walmart and Target

Under very challenging conditions, Walmart and Target have both been very effective in procuring and transporting inventory and keeping store shelves stocked. In the great 2021 scramble for product, they won. Now, they, like others, are faced with the boomerang effect, likely caused by a confluence of factors. Let’s look at the magnitude of their excess inventory.

Historically, Walmart and Target run very similar seasonal inventory patterns, centered on the critical Q4 holiday season (note: the holiday season ends in calendar year Q4; both Walmart and Target have fiscal years that end on 1/31). Inventories typically build up significantly ahead of the season and then draw down equally significantly throughout the holiday and post-holiday seasons. Inventory turnover typically peaks in the post-holiday and summer quarters (indicating the lowest inventory levels of the year).

This year was different. Inventories grew to levels comparable to years past, but the holiday and post-holiday drawdown did not happen. Inventory turns fell or stayed relatively flat from pre-season to post season. Figures 1 and 2 are pictures of the inventory turnover profiles of Walmart and Target for the years 2017 to 2021. In other words, Walmart and Target aggregate inventory positions on May 1 look as if both companies are ready for Christmas all over again. (Note: Summer = August 1, Pre-Holiday = November 1, Holiday = February 1 of the following year, and Post-Holiday = May 1 of the following year. Inventory turnover (turns) here is defined as COGS for the most recently reported four quarters divided by the inventory position of the most recently reported quarter).

Figure 1 – Walmart Seasonal Inventory Turnover Pattern

Figure 2 – Target Seasonal Inventory Turnover Pattern

How Much Excess?

If Walmart were operating at its historical inventory turns for the previous five years, its inventory position on May 1, 2022, would be $13.5 billion less, or 22% less. Likewise, if Target were operating at its historical inventory turns for the previous five years, its inventory position on May 1, 2022, would be $2.8 billion less, or 23% less. These two leaders are sitting on almost identical excess inventory on a percentage basis. Put another way, Walmart would have had to have realized roughly $18 billion in additional sales to arrive at its historical inventory position; Target would have had to have realized $3.8 billion in additional sales (this uses the average gross margin for both companies; it’s possible the inventory in question has higher gross margins typical of hard goods and electronics).

If these additional sales were achieved during the holiday season, both Walmart and Target would have had to realize more than 12 percentage points of additional sales. If these sales were achieved over the course of both the holiday and post-holiday quarters, both companies would have had to realize more than 6 percentage points in additional sales.

Both Walmart and Target had excellent Q4 results (which includes the holiday season). Walmart’s sales (net of divestitures) grew 7.6% and Target’s grew by 9%. It is unlikely that both companies were planning for an additional 6 percentage points of growth in either Q4 or Q1. It’s possible that some of the inventory that was supposed to arrive in November and December arrived in January or February, meaning lost holiday sales or substitute buying. Given the holiday results, it’s hard to believe that this is a significant part of the current inventory problem.

The fact that inventory turnover at the start of the holiday season in both the Walmart and Target cases was about what it has been historically indicates that: 1) inventory kept flowing in throughout the holidays and post-holiday; and 2) there were not sales to sop it up. This is a classic overshoot situation, that on the surface, is indicative of bullwhip effect behaviors (more on this in a minute).

Now, let’s come back to Johnny Miller and Brian Cornell. The Target CEO is not just looking at his own inventory, but also the inventory of everyone else in making the decision to move quickly to get the ball back in the fairway. He’s not trying to thread the ball through some trees in the hopes of somehow pulling a par or birdie out of his hat. He’s taking his medicine, chipping out and moving on. He’ll take a bogey to avoid a double-bogey. In other words, incentives and markdowns will make it look like Christmas in June and July.

So, What Happened?

Note: this involves a fair amount of speculation.

Figures 1 and 2 indicate that inventory grew ahead of sales up to the holiday season and then kept pace with sales throughout the season. Some of this is undoubtedly due to over-ordering but it is also a reflection of shrinking lead times as port and other constraints relaxed. In other words, a four-month lead time that suddenly normalizes to a two-month lead time means goods are arriving ahead of when plans indicated. In fact, retailers could be hit with additive negative effects – some late goods finally arriving, and some other goods arriving early (or earlier than the extended lead times caused by the pandemic) due to normalization of supply chain challenges.

The other thing to consider is that lead times embedded in replenishment and other supply chain software systems are typically static; they are changed infrequently. Over the past 24 months, actual lead times have been changing weekly, if not daily. Most replenishment systems are not designed for this level of change. It is unknown whether this is part of the equation here, but it highlights the need for supply chain policies and structures to be much more dynamic. If they are not, systems (particularly those that have been tuned for scale) will operate using incorrect information.

It's also certain that inventory did not arrive for which orders were not originally issued. So, both operators knew that the inventory was going to eventually arrive. Furthermore, it’s certain that both were not projecting holiday sales to increase an additional 6 percentage points.

Sophisticated supply chain practitioners have visibility to a time-phased view of their orders, along with a time-phased view of replenishment plans at each point in the supply chain from production through distribution through retail and ultimately to the end customer. Last year, these plans were oscillating all over the place as disruptions including factory shutdowns, trucker shortages, port backups, container and other equipment shortages, and lack of warehouse capacity caused continuous changes to projected receipt times.

Continuous, floating bottlenecks made it impossible to synchronize the various assets and people in the supply chain to create reliable plans. The name of the game of late 2020 and all of 2021 was to get inventory in the door in any way possible, including chartering private vessels to circumvent port bottlenecks. Precision was temporarily trumped by brute force.