Reliability Breeds Inventory Reduction: 
BIG Tactic Delivers
BIG Strategy

What is the benefit of reliability? Well, size does make it relative, and in the case of Walmart, the benefit of added supply-chain reliability could be—estimating on the low side—half a billion dollars in inventory reduction. On the high side, $2 billion is possible, if not likely.

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Based on Walmart’s Return on Investment (ROI) rate of 19.3%, $500 million in inventory reduction creates $96.5 million incremental operating income, increasing operating income by 40 basis points. If they reduced inventory by $2 billion, the impact could be $386 million in additional operating income—a 160 basis-point increase. These are big moves in how the company measures its performance.

Do I have your attention now?

As many a supply chain manager will say (but perhaps not fully understand), safety stock is built into the inventory to provide “insurance” against Murphy’s Law. We logisticians, supply-chain managers, and officers live with the long list of “what can and does go wrong” every day. And when things go wrong, the result can be that the retail shelf is empty. Empty shelves in a retail store are not a good thing—we customers demand retailers to be “in stock when I want to buy,” and we will literally throw a tantrum if we can’t buy what we want when we want it.

So, there are two ways to make sure there is never an empty shelf:

  • Invest in more inventory than you sell so the shelf never goes empty—i.e., keep safety stock
  • Invest in skills and tools and create processes that ensure you replenish the inventory as it is sold

Most large box retailers do both. Some, like Walmart, will work hard to lower the cost of goods so that they can offer a lower price. The secondary benefit of the “low price” approach is that it helps lower the investment in the additional inventory, thereby lowering the cost of the safety stock.

Here is an inconvenient truth: It costs money to have that safety stock. The “cost of money” in the investment of working capital to buy the inventory is significant, but outside business pressures are creating more cost pressures in “owning” that unproductive additional inventory. Think of these ownership issues:

  • You must store the excess. That means investment and operations costs for building space, storage, and handling equipment and heating or cooling (cooling is a huge cost).
  • You must protect the excess from theft and fire loss.
  • You must count it and track it.
  • You will have to pay to dispose of it when it becomes obsolete.

The reduction of safety stock, even one day of inventory, equates to hundreds of millions of dollars of liberated working capital. Walmart on average has about $33 billion worth of inventory on hand—40 days’ supply, based on its 2010 performance. Reducing the days on hand in the US business pulls about $500 million of inventory out of the chain. Walmart likes to work with 5 percent goals, so a 5 percent reduction in days on hand is two days—about $1 billion in inventory. A billion dollars in liberated working capital could create $193 million of incremental operating income.

But wait, there’s more! These “back of the envelope” calculations do not even address the kind of return that Walmart could get from the investment of this liberated working capital into other, more profitable aspects of the business. The returns could be much greater through such redeployment of the capital. These estimates also do not address the reductions in the cost of ownership of the inventory, and increased operating efficiencies.

This kind of impact dwarfs whatever incremental cost reductions result from the improvement of fleet operations. In the long run, driving inventory efficiency is the “Mother” of the return. The Key Strategic Objective is driving the need for the inbound conversion tactic.

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