The trouble with inventories

The unprecedented disruption that the COVID-19 pandemic has wrought on global supply chains has resulted in practitioners spending time trying to better understand the functioning and structure of supply chains. Of particular interest since the onset of the pandemic has been the level of inventories available and positioned for consumption. Especially inventories held (or not held) by retailers have been problematic as shoppers can often see bare shelves where beloved items are supposed to be located.

Since the outbreak of the pandemic, consumers have shifted spending away from services and towards goods. As a result, inflation-adjusted consumer spending on goods has been at abnormally high levels. This has resulted in record demand for imports placing substantial stress on the ports, transloading warehouses, drayage providers and railroads.

However, it is likely that this goods buying bonanza will eventually wind down, especially as government stimulus programs come to an end and strong inflation continues to cut into consumers’ inflation-adjusted real personal income. There has been a growing concern that as consumer spending reverts towards the pre-COVID tend that retailers would be left with excessive inventories. Recently released government data from the Monthly Retail Trade, and the Advance Economic Indicators program, the January Logistics Managers’ Index suggest this may be occurring.

The plot below showcases seasonally and inflation adjusted sales for retail trade excluding motor vehicle and parts dealers. We exclude motor vehicles and parts dealers because the unique dynamics this sector has experienced with the shortage of semiconductors can skew conclusions. We also adjust for inflation.

Figure 1

As shown in the first plot, retail sales have spiked well above their pre-COVID trendline since June 2020 – particularly in 2021. Interestingly, there is a sharp decrease of seasonally adjusted sales in December 2021. This is partially due to consumers pulling purchases forward into October and November due to concerns about supply chain glitches near Christmas. In addition, retailers offered deals throughout the fall to smooth out spikes in demand. However, this may also be due to rising inflation sapping consumers buying power, though the sharp rebound in seasonally adjusted sales in January means it is too early to draw definitive conclusions.

In comparison, inventories showed an unprecedented spike in December 2021. Inventories generally peak in October as firms attempt to build up in anticipation of Q4 sales. Interestingly, inventories actually peaked in November in 2021 as goods were delayed due to logistics congestion. Inventories were down in December, but not as much as historical trends would suggest. The chart below of seasonally adjusted inventories, with inflation removed, shows a pronounced spike since December 2022. One open question is whether these inventories will have risen more in March given record import throughput at the Port of Los Angeles.

Figure 2

Evidence of the disparity between the value of inventories and the real level of goods on hand is apparent in readings from the last two years of the Logistics Managers’ Index (LMI) where any number greater than 50.0 indicates growth, and a value below 50.0 indicates contraction. Traditionally, Inventory Levels (blue line) and Inventory Costs (red line) move together. This relationship shifted dramatically during the pandemic.

The chart below shows movements in Inventory Levels from November 2019 to March 2022. The readings from the last three Novembers (usually near the height of Q4 inventory buildups) and Marchs (when Inventory Levels usually climb back to pre-holiday levels) are highlighted here for the purpose of demonstrating how unusual the last four months have been. From November 2019 – March 2020 Inventory Levels were 1.1 points apart, from November 2020 – March 2021 the delta was 0.5 points, from November 2021 – March 2022, we see a massive 16.9-point difference.

Figure 3

As mentioned above, sales of consumer goods were lower than expected in December due to the Omicron wave and retailers intentionally attempting to spread out sales. Durable goods sales have been suppressed through the first quarter of 2022 for a variety of reasons. Chief among them are the shift in consumer spending from goods to services as COVID restrictions ease, the drying up of COVID stimulus and the 41-year high levels of inflation in the U.S. in February and March. This drove spending on goods down even further as consumers were forced to dedicate a greater percentage of their paycheck to essentials like food and gasoline.

February and March of 2022 saw the highest rates of expansion in inventory levels in the six-year history of the LMI. This rapid growth has also pushed Inventory Costs to new highs. The reading of 91.0 is the highest in the history of the index. This is indicative of overall logistics cost growth (an aggregation of inventory costs, warehousing prices, and transportation prices) which also reached an all-time index high in March of 2022. Essentially, supply chains were expecting a continuation of the growth we saw through 2021 and then when things slowed down inventories piled up, leading to spiking costs.

Figure 4

The aggregate logistics costs score of 271.3 is only 0.2 points higher than the November 2021 reading. The key difference between what we see in November relative to March is that in November costs were high due to goods moving quickly through supply chains, dynamically utilizing available logistics capacity. In March, the costs seem to be high due to the backlog of goods building up, indicating static utilization of available logistics capacity. New capacity will take time to come online, and until then logistics costs will remain high. Through most of 2021 the increasing supply chain costs were offset at least in part by customer willingness to pay higher prices. With consumer spending now slowing down, it is unlikely these elevated costs can be passed on effectively and will eventually be unsustainable.

It will be interesting to observe the impact that this level of inventory has on the runaway levels of inflation that have been present in the U.S. and in the Eurozone through the first quarter of 2022. Firms will need to offload inventory. Off-price outlets like Ross and TJ Maxx are currently being flooded with excess inventory, it is possible that durable goods will begin to be sold off at discount prices to mitigate the high costs of storage, which could counter some of the current inflationary pressures. All we know for certain is that the uncertainty that supply chains have dealt over the last two years is likely to continue through 2022. These are strange times for supply chain managers.

Jason Miller is an associate professor of supply chain management at Michigan State University. He can be reached at [email protected].
Zac Rogers is an assistant professor of supply chain management at Colorado State University. He can be reached at [email protected].
Dale Rogers is the ON Semiconductor Professor of Supply Chain Management at Arizona State University. He can be reached at [email protected].

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