Nothing for retail inventory planners has been easy over the past three years. After the shortages of 2020 and 2021, the industry spent the past year trying to unload products as consumers cut their spending in the face of steep inflation.
Although down from their peak, many inventory positions remain elevated for current sales levels.
“I've worked at multiple apparel retailers recently that have more inventory than I've ever seen,” said Matt Garfield, managing director with FTI Consulting. “It looks like you're walking into a peak season distribution center and we were in the middle of February, March.”
Even though the era of bare shelves is not far behind the industry, many are learning to live on leaner inventories and plan to chase products as needed in 2023 and beyond.
In doing so, retailers are prioritizing cost control and margin protection over the risk of lost sales.
“A little scarcity is not a bad thing,” said Joe Feldman, senior managing director with Telsey Advisory Group.
Inventory levels have peaked. But they’re still bloated.
Last June, Target issued a mid-quarter warning that its profits for the period were in for a significant hit as the retailer worked to “right-size its inventory for the balance of the year” amid a “rapidly changing environment.” The retailer blamed intense pressure on consumer spending from inflation on necessities, including food and gasoline.
Target led the way, but discretionary retailers, with few exceptions, spent the rest of the year trying to clear inventory. Analyzing retailers across major sectors, Telsey Advisory Group analysts found that, across segments, inventory growth averaged at 46% in Q2 last year. In apparel and e-commerce, that figure was considerably higher, at 65.6% for both sectors.
“Coming out of 2021, inventory was really lean, lower than it should have been, because you couldn't get goods and everybody was chasing,” Feldman said. “I think the miscalculation was the demand level.”
Retail inventories hit their peak in October, when they were up 18% from 2021 levels. Inventories have since fallen considerably but remain well above where they were three years ago, or even a year ago.
An improving supply chain has magnified the problem, at least on paper. By February, overall schedule reliability in ocean freight was up month-over-month by 7.7 percentage points and up year-over-year by a “staggering” 26 percentage points, according to DHL.
For consumer companies, that means goods have been shipping faster and arriving earlier than a year ago, which shows up in inventory levels. Apparel sellers such as Under Armour and PVH have noted this in their earnings. At PVH, which owns the Calvin Klein and Tommy Hilfiger brands, inventory was up 34% YoY at the end of Q4.
“We have seen steady progress over the course of 2022 towards pre-pandemic production capacity and significantly improved delivery times,” PVH CFO Zac Coughlin told analysts in March. “And in the fourth quarter this year, we experienced much earlier receipts of inventory as these supply chain and logistics disruptions had eased.”
Excess is costly up and down the supply chain
The inventory story played out differently for retailers and many of the brands that supplied them. As retailers moved to cut back their positions, wholesalers were often left sitting on excess stock.
“Wholesalers really got hammered,” Garfield said.
Apparel sellers GIII Apparel Group and VF Corp, for example, both cracked 100% inventory growth last year, according to Telsey Advisory Group analysis. Nike, one of the largest apparel brands in the world, hit 44% inventory growth in the period ending Aug. 31.
“If retailers have too much inventory, they're going to stop purchasing, or slow down their purchases, or push out their purchases from their vendors,” said Joel Wolitzer, SVP and business development officer with Rosenthal & Rosenthal, which provides factoring and other financing services. “We have seen that slowdown on multiple levels.”
For merchandise suppliers, life can be made tougher by the fact many retailers don’t place firm purchase orders, which means their vendors have to place informed speculative bets on how much a retailer will purchase, informed by a retailer’s projections. Even purchase orders can be changed or delayed.
Suppliers producing private label merchandise for retailers can be put in an especially tight spot if their buyer decides to pull back on their orders.
“Those goods can only go to that retailer. Suppliers can’t sell them anywhere else,” Wolitzer said. “So they’re kind of stuck.”
For larger wholesale brands, they may have ended up with higher inventory levels than their retail partners, but that’s not necessarily the worst-case scenario if they have their own sales channels.
“It's probably better for, say, Nike or Adidas to control the way they clear through the excess inventory,” Feldman said. The alternative, he added, is to “put it out there in the market and let the retailers decide what to do with it, and just cut price and potentially impact the brand.”
For all players in the market, inventory excess is costly. Additional warehousing can get expensive. As Wolitzer noted, if companies have to borrow to pay for that warehousing, then there are financing expenses such as interest as well.
Operational efficiency and capacity also declines once a certain amount of space in a warehouse is filled, Garfield noted.
"It's a very big impact to your overall profitability — your cost per pick, cost per unit, those kinds of core profitability measures that we look at for distribution,” he said.
Have retailers learned their lesson? And which lesson?
The past two years raise fundamental questions about how to buy and plan inventory, and can yield some contradictory answers. One of the biggest is: Is it worse to have too little inventory in boom times or too much in downturns?
“Two years ago, you just had to have inventory. If you had it, there was a buyer out there,” said Oliver Timsit, founder of the apparel brand Oliver Logan. “We’ve come to terms with the fact that we can’t have something for everyone.”
With supply chain problems easing, many of the same tensions that predated the pandemic are now coming back into play. While out-of-stocks could mean the opportunity cost of a lost sale, overstocks come with financial costs of storage and financing costs.
Inventory excess also comes with opportunity costs by tying up working capital, and, perhaps most importantly, means less space for fresh products.
“Much as we all thought that the retailers learned their lesson — that they're better off ordering less, chasing demand a little bit, and having very clean, profitable sales, meaning fewer markdowns — they all fell into that trap of: ‘Oh, if we just have more, we'll sell it,’” Feldman said. “And then they got caught.”
Should demand recover, Feldman thinks retailers will have an easier time chasing inventory than they did in 2021 given normalizing supply chains.
“Those bottlenecks are gone," Feldman said. "So if you do have much more normal ramping of production on the manufacturing side, getting it here shouldn't be too much of an issue, at least in the near term. I’m hopeful these guys will be smarter about it.”
Still, retailers are unlikely to ramp up purchase orders anytime soon — even if demand does come roaring back.
“I think it’s going to be awhile before merchants and executives are really ready to place that bet for a large inventory position,” Garfield said. “Those conversations were brutal last year. The earnings — they weren’t fun calls, and I don’t think anyone wants to go back to that time.”
