Inventory cycle critical to economic recovery


Just read a very interesting article at MarketWatch talking about the impact inventory has on any economic recovery.  The article states:

Every other time in the modern era that the U.S. economy has contracted more than 5% in a quarter, falling inventories have been a major reason, if not the single biggest factor. Usually, really bad recessions are worsened by the need for companies to get rid of all the stuff they made but nobody bought. Once the inventories are sold off, the economy can grow quickly again because idled workers are called back.

But so far in this recession, the inventory cycle hasn’t been a major factor, outside of the housing and auto sectors. That means that we can’t look forward to a quick reacceleration as the inventory cycle turns. This recession is rooted in a severe credit squeeze and a fundamental readjustment in consumer demand, not in the typical inventory cycle.

I fundamentally come down on the side that inventory is bad.  Despite the fact that accountants treat inventory as an asset, I believe in today’s heavily outsourced, global and rapidly changing supply chains (volatile demand, short product lifecycles, etc.) inventory is a net negative.  Yes, inventory is a part of your ability to deliver on customer satisfaction goals, but I find too many companies go well beyond this and end up with excess and obsolete inventory.  In essence, they often have the wrong thing in the wrong place at the wrong time.  And, too often, companies don’t even know where all the inventory is.

I believe these reasons are, in part, contributing to manufacturers’  inability to shed the inventory as quickly as they would like.  While the article talks about the root causes of this recession, at the end of the day demand is down in virtually all industries which will create an inventory glut unless capacity is ratcheted back and existing inventories are used up.  I’ve seen mixed reports on how quickly this is happening.  But, the implications are pretty straightfoward – the more inventories are burned off, the greater the prospect for a v-shaped recovery when things do start to come around (see more on this discussion here).

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