Market signals now race through the supply chain - misinterpretation does, too.
If you couldn't find that Harry Potter Powercaster Playset your nephew wanted for Christmas, it may be a sign that Mattel is doing something right. The key to success for toy merchants is latching onto the year's biggest fad, then making sure stores have a little less than people will want.
It may not endear Mattel to store managers, who are forced to send customers away empty-handed, but the alternative - tons of excess inventory - is a lot worse. That's what happened to Hasbro's retailers in 1999, when they took delivery on about $625 million worth of Star Wars toys - $125 million more than they sold.
For retailers, Christmas is the big gamble of the year. For manufacturers, the risk is year-round. Every fulfilled order comes with the anxiety of whether the customer will come back; every new product line is a bet-the-company roll of the dice. And no one proved a bigger loser last year than technology manufacturers. Armed with the latest in supply-chain systems, demand-forecasting software, and decision-support applications, they misread the dotcom bubble and ended up holding the biggest inventory hot potato in history.
In April, new economy flag-bearer Cisco wrote off $2.2 billion in excess inventory. Optical networking company JDS Uniphase coughed up a $250 million inventory hairball a few months later. And in October, Nortel announced a $750 million inventory charge for its latest quarter. A far cry from 2000, when inventory was seen as a problem of the past. The frictionless business of the 21st century, the pundits said, never dirties its hands with actual physical stuff. A horde of Internet companies (think B2B exchanges) emerged and briefly flourished, seeming to prove that point.
Now lots of those frictionless firms have slipped away, and those that make things, sell stuff, and handle inventory well - think Dell - are doing better than most.
It turns out that, as with cholesterol, there's good inventory and bad inventory. The higher the turnover rate - measured as annual sales divided by the value of inventory on hand - the healthier the company. Of course, that's not new. In 1937, business prophet Ben Graham wrote in the seminal Interpretation of Financial Statements that turnover "will in many cases reveal an important competitive advantage which marks the leading companies in the group."
What is new is the disappearance of lag time. Manufacturers were forced to wait weeks or months for the information feedback they needed; in the meantime, they had to hunch their way through. Thus the inventory revolution of the last decade: Supply-chain software firms like i2 Technologies helped do away with those months of guesswork. Pallab Chatterjee of i2 offers a new metric, "propagation": how fast a product's demand signal (an order or a forecast) travels from the customer through the retailer, distributor, and manufacturer.
It works - to a point. Companies do get more immediate information about product demand. But information is only as good as the people interpreting it, and misinterpretation now travels much faster, too. These days, one bad guess can spell disaster.
Cisco, JDS Uniphase, and Nortel might not come right out and say it, but they certainly were aware of the darkening economic picture as they built up inventory; more likely, they planned to cut prices and grab market share while weaker rivals faded. It turned into a game of chicken: The network equipment makers hurtled toward the downturn, then tried to ratchet down production just in time to save themselves. But the downturn arrived a lot faster than Cisco et al. ever expected. Result: a multibillion-dollar pileup.
That spelled trouble for i2 as well. As the promise of its software turned out not to be a panacea against recession or bad corporate strategy, the company's revenues fell out, culminating in a stunning $5.5 billion loss for the third quarter of 2001, including a massive $4.7 billion charge for the ill-timed acquisition of a B2B exchange company.
So what's the lesson? That fast inventory controls are great, but they won't work if they're undermined by second guesses. The trump card, it turns out, is synchronizing human nature with instant information. Which is what humbled tech firms are now straining to do. With the help of its write-off, Cisco has improved its turnover rate from 5.4 to 7.6; JDS Uniphase sped up its turn rate from 4 to 7.
Inventory matters more than ever. But the time is past when companies can brag about their automated controls at the same time they are gaming them behind the scenes. Manufacturing is a market, and as information in it expands so does the risk of trying to outsmart it.
