Inventory Management

The year 2023 broke the crystal balls.

Some of the largest, most sophisticated companies in the world overbought or overproduced inventory by many millions of dollars. The reason, at its simplest, is that consumers did not behave as predicted.

Planners don’t have the luxury of blaming consumers for not acting according to their forecasts — especially when many of those customers were reacting to historic inflation in food, fuel and housing.

“Demand planning went out the door for three years,” said Rick Jordon, senior managing director with FTI Consulting. “Now they’re picking it back up, because they have all this excess inventory everywhere. And they’ve forgotten how to do it, or they didn’t do it well before.”

After three years of pandemic disruption and economic volatility, sharpening demand forecasts and inventory planning across industries seems both as imperative and challenging as it has ever been.

To get better results, companies are turning to new data sets and new technological tools like artificial intelligence to analyze them.

From spreadsheets to AI

An executive survey by McKinsey from early 2022 found that spreadsheets are still the primary planning tool for supply chain leaders, with 73% of respondents relying on them.

But, 43% said they planned to use artificial intelligence and machine learning for some planning activities. Another 17% said they planned to use AI and machine learning for most activities at some point.

A 2023 from BlueYonder, a supply chain software company, found that demand forecasting and inventory optimization are among the top uses of AI and machine learning technologies by supply chain executives

“We're moving well beyond Excel, and just moving to a more advanced tool set,” Ron Scalzo, senior managing director with FTI Consulting.

In Jordon’s view, AI technologies will at some point help remove human bias from forecasting and lead to more systematic predictions, as well as run multiple predictive scenarios at the same time.

Jordon noted that AI is needed to process through many data sets and help make sense of a company’s own internal data. “Most organizations have a lot of data,” Jordon said. “Are they using that to the best of their ability, utilizing the best technology and ignoring that noise? That’s really where the next three or four years of development will happen.”

Finding the right data to analyze the right way

At the most basic level, AI takes in data and spits out predictions. To get the best predictions, the data fed into them might matter even more than the AI tools themselves.

“There are systems pulling in data which is lying inside the company already, from across their enterprise systems, POS systems, the inventory levels from their stores and all that,” said Meher Dinesh Naroju, director of AI services at Centific. “There are very few companies that actually go outside of this box and get data from sources that are completely unstructured.”

Such data sources include things like social media, which can provide clues about burgeoning market trends. Customers are “actively engaging and leaving opinions and clues about various things they intend to do in the market or a specific category,” Naroju said.

Even images from a retailer’s store cameras might house data relevant to customer behavior in the aggregate, including reactions to certain products, brands and categories. “It’s a long shot, but it can help,” Naroju said.

Other sources, such as weather data, can provide early hints about supply chain timelines and inventory arrivals, he also noted.

Still, all of these data sets have to be put into the context of local and regional cultures and other marks of differentiation.

“It is of the utmost importance to pick and choose what data you need and very clearly segment the data you want to analyze,” Naroju said.

Once a company has the best, most refined and useful data it can get, that’s where AI tools become critical. The technology can derive insights from large pools of unstructured data that “no human being can do in so short a time,” Narajou said.

But even with the most creatively sourced data and advanced tools available, a prediction is still just a prediction.

“If you crack the code on a perfect forecast with the consumer today, you're quickly going to be the richest person in the world,” said Jake Self, vice president of operations for third-party warehousing and logistics company Smart Warehousing.

‘So much noise’

Businesses for generations have relied on the past to help them anticipate the future. That may seem outdated after the pandemic and then inflation scrambled the usual patterns, with volatile cycles piggy backing on each other since 2020.

But for many, historical trends are still the most useful forecasting data. “It’s not especially sexy, but we’ve actually philosophically been using the perspective that history is the best predictor of the future,” Destination XL Group CEO Harvey Kanter told Supply Chain Dive in an April interview.

“I think there's been so much noise in the last three-plus years that the roller coaster we’ve been on is almost impossible to predict,” he added. “I don’t know that the greatest level of AI and ML can predict what the consumer is going to do.”

Kanter went on to note that the apparel retailer still looks at pre-pandemic revenue and historical revenue contributions by day, week and month over the past 10 years, which he said has remained remarkably consistent.

Other businesses simply don’t have the budget to pay for or justify advanced technological tools. Smart Warehousing’s clients run the gamut from small brands operating out of their garages to Fortune 500 companies. For some of the smaller companies looking for replenishment and warehousing help, their forecasting process amounts to “hopes and dreams,” Self said.

For those companies, historical data is by leaps and bounds better than no data. “We've spent a lot of time on our replenishment program, really putting an algorithm in place that learns and understands based on historicals where we're going to need to be,” Self said.

Smart Warehousing can do that having invested in forecasting and replenishment technologies for more than two decades, and with an entire team of specialists dedicated to that one skill set. An algorithm for cold replenishment operations out of Missouri “looked like something out of Good Will Hunting,” Self, referring to the film that features actor Matt Damon playing an unknown mathematics prodigy.

But even with those resources, prediction is still tough in the current environment. “If you're not planning for an element of the unexpected, then you're probably not planning right,” Self said.

Dive Brief:

• Under Armour is closing in on a “normalized” inventory position, with levels down 9% year over year to $1.1 billion in its most recent reporting period, CFO Dave Bergman told analysts earlier in February.
• Inventory came cheaper, too, as cost of goods sold fell 7.8% YoY. Lower freight costs — despite some Red Sea-related spikes —  drove a 2.6 percentage point benefit to gross margin, Bergman said. The company also made progress working with vendors to lower product costs, he added.
• At the same time, the sportswear brand paid a price to shed inventory. Offsetting part of its supply chain savings was a 1.4 percentage point hit gross margin due largely to price cuts to products in its direct channel and factory stores, and to off-price buyers, to flush inventory.

Dive Insight:

Under Armour’s journey to rightsized inventories has taken longer than many of its peers in the apparel space.

By Q3 of 2022, Under Armour’s inventory was still up by about 6% YoY while rival Nike’s was down 10% and Lululemon’s was down 4.5%, according to an analysis by Telsey Advisory Group. Meanwhile, the inventories of many more other apparel brands were down by double digits.

As Under Armour struggled with lagging sales and persistently higher inventory — and with it, margin-eating price cuts — the company shuffled its c-suite, including around operations and supply chain. In June, the company announced the departure of then-COO Colin Browne. Months later it brought on Shawn Curran as chief supply chain officer.

Throughout its struggles, executives blamed an over-inventoried market overall. This time around, Under Armour management pointed to a light at the end of the tunnel on its earnings call.

“The market, we think, is coming back to normalization at this point — maybe a little bit longer to go, but pretty close,” Bergman said. “However, we are still seeing a fairly promotional environment out there, even with the inventory levels at the retailers in a lot better place.”

The company’s role as a supplier to retailers can also partly explain its struggles around inventory. Over nearly two years of lackluster demand, brands and suppliers have often been stuck with inventory overages longer than retailers, which were first to reel in their purchasing.

Retailers continue to be stingy about buying inventory, and Under Armour’s “meaningfully” (to use Bergman’s word) declining wholesale sales in the most recent quarter show it. The CFO added that, currently, “retailers are being fairly cautious and still really trying to keep clean after a year or two of obviously having more than they wanted.”

As for Under Armour’s own suppliers, executives hinted that they have given price concessions to the brand as it continues to struggle to rebuild its sales and profits.

Bergman said that the benefits from falling supply chain costs are “shifting a little bit more towards the product costing initiatives that we're working on with our vendors.” The company expects to realize those cost benefits in the coming fiscal year that begins in April.

Dive Brief:

• Crocs has been working to control the flow of unauthorized inventory to what executives label “gray market” channels, which include Amazon’s website.
• Based on the footwear company’s visibility into those channels, gray market inventory has improved since June and the company expects to be “in a substantially better position in the first-half of 2024,” CEO Andrew Rees told analysts on the company’s Q3 earnings call in November.
• Crocs is also focused on controlling inventory across its business, including wholesale channels. The company has proactively canceled prior wholesale orders to reduce inventory flows while also “supporting our wholesale partners with some inventory cleanup” through returns and company funding for markdowns, Rees said.

Dive Insight:

To control prices, margins and its brand, Crocs is controlling the flow of its inventory to every channel it can.

The company has made significant progress. Companywide inventories fell 24% year over year in the quarter, and are down 17% from the end of 2022.

“Year-to-date, we have made considerable progress in cleaning up our inventory and are pleased that our Heydude inventory ended down 41% from Q3 last year,” Reese said. CFO Anne Mehlman also noted that inventory turns continued to improve and that “we are very pleased with the health of our inventory.”

Still, the company has troubles in pockets. Rees said the company saw more carryover inventory in its legacy customers than expected, diluting Crocs’ product offerings.

Crocs has also made progress plugging the sale of unauthorized inventory.

Trailing 12-month revenue for the Crocs brand was up 11% YoY even as the brand sold 29 million pairs of shoes, down 4% from 2022. The unit decline was tied to “corrective actions” the company took last quarter to curtail “a significant African distributor that we believe was diverting goods to the U.S. gray market,” Mehlman said on the call.

Getting a handle on gray market inventory is key to Crocs’ ability to control prices across channels and markets for its products. After the company closed many of its international distributors, some of the excess inventory started to show up on Amazon, Rees said.

In the past, Crocs competed with gray market sellers on price to capture its “fair share” of sales and market share, Rees said. The company has since stopped price matching on Amazon, which has hurt revenue expectations but has increased profitability and is better for the company’s wholesale partners as well, Rees noted.

“While this will hinder sales growth in Q4, and possibly into the first-half of next year, we believe this will set us up for a much cleaner marketplace as we move throughout 2024, as well as protect the brand,” the CEO said. He added later on the call, “We're hoping that gray market inventory sells out quickly, and we can reset the digital market.”

Dive Brief:

• American Eagle Outfitters has rolled out a new artificial intelligence-based tool to aid in managing its inventory replenishment so that it can keep leaner stocks.
• “Early results are showing quicker and more accurate placement with improved in-stock levels,” COO and EVP Michael Rempell said on the company’s Q2 earnings call in September. “This is allowing us to better service demand with lower inventory across the network.”
• Inventories at the apparel seller were down 7% to $637 million YoY during the quarter while its gross margin rate was up nearly 7 percentage points. The company attributed higher merchandise margin to better inventory control and lower transportation costs. 

Dive Insight:

American Eagle’s turn to AI for inventory management follows a long period of volatility — with both stock gluts and shortages — for most of the apparel and retail industries during the pandemic era.

The company has been testing the new AI system in its stores since 2022’s holiday season. “Our pilot test this holiday proved highly successful, providing visibility into inventory availability and placement at over 99% accuracy,” Rempell said in March. “I'm very enthused about the sales opportunities, inventory productivity improvements and labor efficiencies we can unlock moving forward.”

A company spokesperson did not respond to Supply Chain Dive’s request for more detail about the new tool. 

On the whole, American Eagle company has made steep cuts to inventories. In Q2 of 2022, inventory by unit volume was up 36% — and even that was described as “significant progress” in rightsizing. 

Having cleared excess out of the system since then has paid operational dividends for American Eagle. “We were able to chase into high-demand items at a strong margin,” said Jen Foyle, president of the company’s American Eagle and Aerie banners. “With inventory at appropriate levels, promotions and end-of-season clearance were down dramatically to last year.”

CFO and EVP Mike Mathias noted that the company’s improved gross margin was largely due to better merchandise margins, which he tied to managing stocks. “Inventory discipline drove lower markdowns as we maintain our focus on healthy promotions,” Mathias said.

After years of wrestling with volatile consumer demand and supply chains, other retailers and brands have invested in technology upgrades to plan and manage their stocks.

Guess Inc. executives, for example, recently touted new planning tools that they say help the apparel company maintain discipline, boost margins and make better purchasing decisions. Discount retailer Dollar General is also planning to use part of a $25 million investment for a demand forecasting tool to support its stores and distribution centers.

Dive Brief:

• Target credited its inventory and expense discipline with a sharp spike in profitability in Q3 even as sales declined, with gross margin up 2.7 percentage points from 2022 and earnings beating the company’s own forecasts.
• Inventories were down 14% YoY, with inventories in discretionary categories down even more, at 19%. As Target heads into the holiday selling season, CEO Brian Cornell said the retailer was sticking to its conservative inventory position on “markdown-sensitive” categories.
• “This provides our team the necessary flexibility to adjust to volatile trends, something that has served us well all year,” Cornell told analysts on the company’s earnings call. “That does not mean we're backing off a newness. While we're cautious about the size or inventory commitment, we're leaning into the amount of innovation featured in our assortment.”

Dive Insight:

Target’s operations have faced “unusual and rapidly changing external conditions” since the pandemic began, outgoing Target COO John Mulligan explained on the call.

“After the onset of the pandemic, we couldn't secure enough inventory to satisfy the explosion in demand for our products,” said Mulligan, who is set to retire early 2024. “Then in early 2022, the period of rapid growth in discretionary categories suddenly reversed. We quickly moved from having too little inventory to have way too much.”

With the swing from too little to too much inventory came swings in the company’s profitability. Operating margins hit historic lows in 2022 as Target’s distribution centers and store backrooms filled up “well beyond optimal levels,” Mulligan noted.

But after taking dramatic measures to clear inventory through 2022, Target is operating more smoothly. In Q3, the company made nearly $300 million more in operating profit compared to 2022 even as its top-line sales declined by more than $1 billion.

As executives were careful to note, inventory management hasn’t just been a matter of holding levels down; the retailer is still chasing profitable sales and inventory where it sees opportunity. Going into the season, for instance, Target boasted of having 10,000 new items for the holidays.

Cornell gave some credit to the retailer’s suppliers for its ability to offer customers enticing inventory in a cautious spending environment. “After several years in which our vendors were focused on raising production volumes in the face of unprecedented demand, we’re encouraged by the focus on newness and innovation we're seeing from them,” the CEO said.

Target’s operations and supply chain have also helped the retailer meet demand when it surfaces. Even with less inventory, “the team has delivered meaningfully improved reliability and in-stock metrics this year,” Mulligan said, noting that overall in-stocks were up by nearly 1 percentage point from Q2 and up 3 percentage points YoY.

Helping to keep shelves stocked are shrinking import lead times — shorter by two weeks compared to 2022 — and a nearly 10 percentage point improvement in purchase order fill rates, according to Mulligan.

Those improvements brought benefits downstream. “With a combined benefit of a faster supply chain and a simultaneous reduction in inventory levels, all of our supply chain facilities stayed at or below our desired capacity thresholds to all 13 weeks of the third quarter of this year, compared with only three of 13 weeks in Q3 of 2022,” the operating chief noted.

Dive Brief:

• Guess Inc. cut its inventory by 2% year over year in Q3 while its sales and gross margin increased, according to executives and the company’s earnings release. That compares to 2022, when inventories soared by more than 19% YoY.
• The reduction in stocks came amid broader market uncertainty, with the apparel company’s retailer customers in its wholesale business maintaining lean inventory levels of their own, executives told analysts on a November earnings call.
• Department stores have been “very careful” with their own buying, CEO Carlos Alberini said on the call. “As a result … we are trying to be very careful in the way we manage our side of that equation to make sure that we are not left with excess inventory,” Alberini added. “The good thing is that I think our supply chain has become more dynamic.”

Dive Insight:

For well over a year, retailers have been trying to keep their inventories in check, especially in discretionary categories such as apparel. 

When demand went into rapid decline in the first half of 2022, many rushed to cancel orders. Brands and manufacturers, however, couldn’t unwind their inventory positions quite so quickly, as analysts and other industry observers have pointed out.

In 2023, retailers have been trying to stay lean while keeping their buying budgets open to chase goods in areas where they see demand pop. Guess, which sells in both wholesale and its own retail channels, operates on both sides of this equation. For its retailer customers, it has to stay nimble to meet their needs without building up excess inventory of its own — which can weigh on operations, finances and profits. 

“In some cases, even if we don't have concrete orders from those customers, we have the opportunity to really reposition inventory or orders to be able to respond to their demand if that demand has not been preplanned,” Alberini said. “And we have been doing good business using this type of business model.”

In that environment, Guess' operating margin in its wholesale business jumped by nearly 10 percentage points, which helped offset declines in its own retail business and other units. 

A “substantial reduction” in inventories, along with lower capital spending, also led to an $82 million improvement in cash flow, CFO Markus Neubrand said on the call. Executives reiterated that they expect to work inventories down by 10% YoY by the end of the fiscal year.

While aiming to have “the right product at the right price” to meet demand, Guess has tried to be “careful with how much we buy” to head off inventory excesses, Alberini said. 

“I think this is something that we pride ourselves on for now many years,” the chief added. “I think we have done a good job in managing inventories, and the key was to not buy in excess.”

But Alberini also noted the difficulty in planning amid volatile consumer demand. “Our strategy has been to continue to really watch how the consumer is responding and navigating through the current times and then acting accordingly in terms of how we position our business plans,” he said. 

To help navigate demand planning, the company tapped Salesforce’s Customer 360 for inventory planning, allocation and store transfer tools. Guess is also currently implementing a product lifecycle management system from Centric as well as a markdown optimization solution, both of which Alberini said should be completed by 2024.

Around this time in 2022, retail inventories reached their peak. For well over a year since, players in the industry have been working to bring inventory levels back in line with demand — often sacrificing profit in the short term.

In the second quarter of 2023, many retailers and brands saw their efforts bear fruit. Inventories for many — though not all — were down. Margins were up. And the combination of leaner stocks and faster supply chains allowed supply chain managers to chase trending categories through their purchasing practices.

All of that, retailers hope, means the most profitable sales possible in a lackluster demand environment. As retailers head deeper into the third quarter, here is a look at how a selection of retailers and brands measured up against each other on key operating metrics in Q2.

Walmart

What executives said: John Rainey, CFO: “The team continued to do a good job managing inventory, and we ended the quarter down 5%, including an 8% decline in Walmart U.S. We feel good about the progress we've made on in-stock levels as [the] supply chain is normalized and the composition of our inventory mix is improved. We're maintaining discipline in how we're buying general merchandise during this uncertain macro environment to mitigate future risk if demand softens.”

Target

What executives said: John Mulligan, COO: “This quarter's better-than-expected profitability was a testament to [employees’] agility and resilience as they successfully managed through multiple challenges. And while the team deserves credit for this performance, they got an assist from this year's leaner inventory position which offered more room to maneuver than a year ago when the team was dealing with excess inventory. This year, with uncluttered facilities, a renewed focus on retail fundamentals and our continued work to enhance efficiency, the team delivered an impressive increase in profitability in the face of a challenging top line.”

Kohl's

What executives said: Tom Kingsbury, CEO: “As we implement new planning and allocation processes, we're becoming more responsive to the customer's demand, operating with additional open-to-buy to chase trends and minimize risk, maintaining better in stock levels in core basics, and improving inventory flow from our distribution centers to the selling floor. Looking to the fall season, we feel good about our current inventory levels and our ability to continue to manage inventory with discipline.”

Macy's

What executives said: Jeff Gennette, CEO: “Ultimately, we ended the second quarter with inventories down 10% to last year and down 18% to 2019. We were disciplined with our approach to inventory commitments and flexed the cadence and depth of promotions and markdowns, utilizing our data-driven tools to reduce the length of seasonal clearance activity by several weeks. Promotional sell-throughs were better than expected and clearance markdowns were not as deep. Thanks to our cross-functional teams for being nimble, flexible and embracing new ways of working.

“Entering the third quarter, store floors and online are less cluttered and easier to navigate. Content is fresh and seasonally appropriate with open-to-buy and the ability to chase into areas of strength, all of which improves the omnichannel shopping experience.”

Dollar General

What executives said: Jeff Owen, CEO: “We are strategically accelerating the rightsizing of our inventory position by expanding promotional markdowns, primarily in our non-consumable products. While we expect this to result in an operating profit headwind of approximately $95 million in the back half of the year, we believe it will drive traffic and also more quickly reduce excess inventory. We believe this rightsizing supports our operating priority of enhancing our position as a low-cost operator and that it will accelerate improvement in a number of areas, including store and supply chain efficiencies as well as shrink, damages and cash flow.”

Dollar Tree

What executives said: Jeff Davis, CFO: “While inventory was below last year's level, it is elevated due to early receipt of imports. With a rapid recovery across our supply chain, seasonal imports from Asia arrived well ahead of our scheduled third quarter receipts. Moving forward, we will continue to manage our inventory and related trade accounts payable to improve free cash flow generation.”

Under Armour

What executives said: David Bergman, CFO: “I just would kind of remind us that our inventory is in a very healthy position. We don't have a lot of older products that's making up our inventory and we are normalizing against leaner days last year. So I think we're balancing the promotions and the need to move some of our inventory very well and also kind of keeping that third-party off-price liquidation channel in that 3% to 4% range of revenue, which we feel is a reasonable level.”

Nike

What executives said: Matt Friend, CFO: “Looking at inventory, we continue to feel very good about our position. Nike inventory dollars are down 10% versus the prior year. Our total inventory units across the marketplace, including Nike and our wholesale partners, are down double digits versus the prior year.

“Partner-owned inventory units are in line with the previous year, with levels planned to remain lean through our second quarter, a meaningful accomplishment after higher levels of wholesale sell-in during fiscal '23. On the whole, we are very comfortable with the level of inventory in the marketplace in relation to the retail sales that we're seeing as we begin increasing levels of wholesale sell-in in our second half.”

Lululemon Athletica

What executives said: Meghan Frank, CFO: “I would say we’ve made some significant progress. We still have some degree of elevated airfreight in our inventory balance on a cost basis. So, I would say not completely optimized, and turns are a little bit slower than history, and our goal over the longer term would [be] to get those inventory turns back to normalized historical rates. So still some opportunity, but I think the team has done a nice job in navigating what was a really dynamic supply chain and positioning inventory so that we were able to capitalize on the demand upside that we saw and experienced.”

Abercrombie & Fitch

What executives said: Scott Lipesky, CFO and COO: “The supply chain is in a good place with freight costs, shipping times and performance significantly better than last year. With a functioning supply chain, we can once again run the business the way we would like, leveraging chase to read and react and drive inventory receipts. Our inventory for the quarter was down 30% to last year, and both brands and all regions are leveraging our chase capabilities.

“We continue to expect to finish the third quarter with inventories lower than last year. At year-end, we expect to be flat to down to last year.”

American Eagle Outfitters

What executives said: Mike Mathias, CFO: “Compared to last year, gross profit dollars increased $83 million or 22% to $453 million with a gross margin rate up 680 basis points to 37.7%. The majority of the improvement was driven by better merchandise margins. Inventory discipline drove lower markdowns as we maintain our focus on healthy promotions. Additionally, we lapped $25 million of freight headwinds and $30 million of incremental markdowns related to end-of-season sell-offs last year.”

Gap Inc.

What executives said: Katrina O’Connell, CFO: “Ending inventories declined 29% in second quarter versus last year. This includes a 9 percentage point decline related to in-transit as we lap the prior year supply chain challenges and 6 points of decline related to releasing the majority of our pack and hold inventory balance. The remaining 14-point decline was driven by more efficient inventory management.

“As you know, we made significant progress on reducing inventories as we exited fiscal 2022. We remain focused in fiscal 2023 on moderating buys and utilizing our responsive levers. As a result, we are planning for year-over-year inventory to be down generally in line with year-to-date trends at the end of third quarter.”

Dive Brief:

• Off-price retailer Burlington’s inventory fell 8% year over year in Q3 to $1.3 billion as the company worked through reserve stocks it had purchased opportunistically in 2022.
• The company has been able to drive faster inventory turns by getting merchandise to stores faster, among other initiatives, CEO Michael O'Sullivan noted on a Nov. 21 earnings call.
• Executives also outlined how the company planned to gain back 3 percentage points of lost operating margin since 2019 through freight initiatives and more efficient inventory management, among other efforts.

Dive Insight:

While Burlington’s store inventory actually increased slightly, at 2% in Q3, the decline in its reserve inventory drove the overall decrease in stock levels. 

Burlington’s reserve inventory mainly includes merchandise purchased opportunistically, which the retailer waits months or until the next season to ship out to stores. 

“In the third quarter last year, we significantly built up reserve inventory,” Burlington CFO Kristin Wolfe said on the call. At the time, she explained, the company was concerned about supply chain disruptions and delays, so it brought goods in early. That also raised the levels of in-transit inventory on Burlington’s books in 2022.

“Now this year, the environment is very different, and there's been no need to bring in receipts in early,” Wolfe said. 

The retailer’s experience with the previous levels of reserve inventory today are feeding its efforts to boost its efficiency and margins. The higher use of reserve stock, together with increased buying of what Wolfe described as “closeout or true off-price” purchases, required more time to process in distribution centers.

“So we've had a significant number of learnings, and we're focused on numerous efficiency initiatives to: one, reduce labor hours and processing these buys; two, more efficiently manage the flow of goods in and out of reserves; and lastly, to minimize the number of touches in our distribution center,” Wolfe said. 

Key to increasing inventory turns and reducing markdowns is getting inventory to stores and on shelves more quickly. “Our supply chain teams are doing a great job moving goods quickly through the DCs and flowing product to stores,” Wolfe said.

Of the 300 basis point decline in operating margin in recent years, Burlington expects to add about 200 back through its inventory efforts as well as lower freight costs, with help from its transportation initiatives, according to Wolfe. In the longer term, O’Sullivan said that investments in distribution center automation could yield yet more benefits to the retailer’s profits.

In outlining a “bull case” scenario for Burlington, Morgan Stanley analysts said in an emailed research note that optimizing comparable store inventory could help drive annual gross margin expansion of around 50 basis points.

Dive Brief:

• Five Below has made “meaningful progress” optimizing its inventory as the discount retailer develops methods to “improve our ability to predict demand” and “track the movement of product through the supply chain,” CEO and President Joel Anderson told analysts in November on the company’s earnings call.

• In Q3, inventories rose 8.8% year over year. On a per store basis, however, levels fell 5.1% YoY, according to CFO Kristy Chipman. She added that Five Below strategically ordered inventory earlier to ensure strong holiday in-stock position and that management is “pleased with the level and quality of our inventory going into this holiday season.”

• The retailer has also opened an office in India, where the company has 50 sourcing factories. The office is “another example that will help us innovate,” Anderson said, having recently visited the site. “It will help us move faster. It will help us keep costing down and it really starts to spread out our supply chain to other countries.”

Dive Insight:

As Anderson explained, Five Below’s efforts around inventory are meant to drive both sales and profits, and revolve around pushing inventory productivity by using “more sophisticated processes, technology and analytics.”

Kenneth Bull, who moved from CFO to COO in 2023, noted in August that the company was working on a new merchandise financial planning system and replenishment forecasting tool.

“Using technology and data analytics, we are focused on improving inventory forecasting, ordering, replenishment and flow with a goal of increasing in-stocks and turns and improving end-to-end visibility,” Bull told analysts in August.

Asked by an analyst about where Five Below had the biggest opportunity on inventory, Bull pointed to the company’s buying and merchandising operations.

“It's all about buying better at the end of the day, making sure we've got the right inventory in the right location at the right time,” he said. “We want to make sure we have the ability to continue to place or buy those trends and put them in front of the customers appropriately. So, there's still opportunity out there. And it's going to come from process.”

Speed at various points in the supply chain has helped other retailers — including Target, Burlington and Abercrombie & Fitch, among others — keep their inventories in check by allowing them to better chase product. 

To the extent that it helps source products more quickly, Five Below’s India office could aid that effort. Anderson told analysts in August that having team members in Asia would help “drive speed and improve quality along with strengthening strategic partnerships with key suppliers in the region.” 

During 2022, Five Below sourced from about 1,000 vendors, with 60% of purchases coming from domestic vendors and no single vendor accounting for more than 5% of spend, according to the company’s 10-K.  The retailer says its low-cost sourcing and operating model helps it meet its $5 price target for products.

Nothing for retail inventory planners has been easy over the past three years. After the shortages of 2020 and 2021, the industry spent 2022 and early 2023 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 2022 trying to clear inventory. Analyzing retailers across major sectors, Telsey Advisory Group analysts found that, across segments, inventory growth averaged at 46% in Q2 2022. 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 in 2020, 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 in early 2022, 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 in 2022, 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.”