US retailers are facing a Goldilocks problem with inventory

For two-and-a-half years now, US retailers have struggled to calibrate their inventory levels. Sometimes they have too much. Sometimes they have too little. It’s proved difficult to get it just right.

Right now, they have too much again. Cutting its profit outlook for the quarter, Target admitted this week that accumulated inventory was eating into its bottom line. Walmart said, in its earnings call in mid-May, that it expects to work through “most or all of the excess inventory over the next couple of quarters.”

Home Depot’s inventory-to-sales ratio stood at 0.61 in the first quarter of this year, up from 0.48 at the same time last year, according to S&P Global Market Intelligence. For Lowe’s, the ratio rose from 0.65 to 0.8 year-on-year.

Judging inventory is hard because retailers are being pulled in different directions. On the one hand, they’ve spent most of 2021 and early 2022 watching covid and the Ukraine war mess with supply chains. Their response, naturally, has been to stock up. On the other hand, though, the stimulus-fed consumer demand coming out of the pandemic is falling away — in part due to inflation, as Walmart executives said during their call. The outcome is inventory bloat: pallets and pallets of products that are hard to sell and expensive to store.

The pandemic has upended inventory management

In the art of gauging inventory, predictability is essential. To know how much to order this quarter, a company must know, or at least be able to estimate reasonably, how much its customers will buy next quarter. But predictability was among the first victims of the pandemic, making forecasting much more complicated.

First, in the spring of 2020, people made a run on groceries and toilet paper, leaving those store shelves bare; but the prospects for other kinds of retail seemed grimmer as fears of a recession spiked. Then, midway through 2021, as people started spending stimulus checks on retail goods and home improvement, the National Retail Federation was predicting a growth in sales of as much as 13.5% in the year. Simultaneously, the snarls in global supply chains emerged; over the year, 30% of Macy’s orders didn’t show up, Jeff Gennette, the company’s CEO, said on a call last month.

This year, other trends kicked in. As the world opened up, people spent less on products and more on experiences they’d been missing, like travel. “We didn’t expect the magnitude of that shift,” Brian Cornell, Target’s CEO, explained in May. “This led us to carry too much inventory, particularly in bulky categories, including kitchen appliances, TVs, and outdoor furniture.” Inflation rose, squeezing purchases overall. Meanwhile, supply chain problems persisted. When, this past May, Target’s first-quarter gross margins declined by about 4.3% year-on-year, higher freight and supply chain costs were responsible for more than a quarter of that decline.

Now retailers will be watching worriedly for a economic slowdown or even a recession on the horizon, particularly if the Federal Reserve acts even more stringently to curb inflation. For retailers, the will-it-won’t-it prospect of a recession is another wrench thrown into the works, making it more challenging still to know how full their warehouses need to be.

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