Inventories are at record highs: time to return to lean?

The latest manufacturing and wholesale trade data came out on Friday and there were a few headlines worth noting. In August, sales in manufacturing were down 2.0% while in wholesale trade they were up 1.4%. While inflated prices impact these figures, the trend in unit sales were similar. If you'd like a breakdown on industry and market - check out the Daily here and here.

What I'm more interested in right now is inventory. The last few years have been full of stories of shortages and as a result companies shifted their inventory policy from lean inventories to building more safety stock - the reason was the risk of lost sales outweighed the cost of holding.

So where are we now? Manufacturing inventories are up 35% over August 2019 while wholesale inventories are up 33%. So is this all sitting in increases in safety stock?

The last few years have been interesting for sure, but for manufacturers the ratio of finished goods to sales has been relatively constant - outside of the initial spike in early 2020 when orders fell temporarily.

But in wholesale we're starting to see the ratio climb which suggests that the industry has caught up to demand and is now sitting on more safety stock. The big question is whether this is planned safety stock and confidence in ongoing sales growth or misreading demand signals which could lead to a bullwhip effect.

The risk of a bullwhip effect could grow if wholesale businesses are indeed adding more safety stock than they need. The latest retail report that came out for July shows declining sales, but we will have to wait and see if the trend continues in August. Early signals we're getting from traffic and visits data suggest that activity is still high, but this might not be translating into purchasing.

If retailers are buying more in a declining sales environment and wholesale has done the same, we might see a dramatic shift in patterns and significant losses upstream. While manufacturers have not increased inventory relative to sales, if sales plummet they are still sitting on record inventories.

One more consideration is manufacturing backlogs. There is no discernable trend here since 2021 - the ratio of unfilled orders to sales has been relatively constant. But it is worth noting that backlogs-to-sales are actually lower than they were in 2019 on a relative basis.

There isn't anything to panic about in these numbers, but I suspect businesses will be more cautious on inventory policy now and into 2023 than they were a year ago. Those that aren't run the risk of getting too far ahead of the market and sitting on piles of inventory at the wrong time.