Negative factors, added to the existing economic recession and restricted credit markets, has resulted in an “over–inventoried” position.
Beginning in the fourth quarter of 2008, amid an ongoing economic recession and contracting credit markets, consumer confidence was further tested when several large financial institutions failed and several more were saved from failure only by intervention from the U.S. government. As these and other events culminated in significant job losses, panic and uncertainty about the immediate future of the U.S. economy, the demand for many commercial and consumer goods dropped suddenly and substantially. This essentially sparked an immediate ripple–effect of lower demand throughout the supply chains for these industries.
With the economic recovery still in its early stages, and immediate and future demand still relatively uncertain, most of these companies are negotiating with their vendors in an attempt to get the vendors to bear the burden of holding inventory longer and delivering in a more JIT (just in time) manner. Many companies that were negatively impacted by having too much on–hand inventory at the end of 2008 are unwilling to take the risk of maintaining similar inventory levels in the current economic environment. As a result, companies are attempting to shift the burden of maintaining adequate inventory levels up the supply chain, to their vendors.
Distributors who supply inventory to commercial and industrial manufacturers, such as Tier-1 and Tier–2 Automotive suppliers, must typically sign supply contracts with these customers. These agreements stipulate, among other things, the minimum supply level for each part that the vendor must maintain at all times, to help ensure that the manufacturer does not run out of materials. Material shortages can lead to line shut–downs, which tend to be very costly to the manufacturer and can result in the manufacturer not meeting obligations with their customers. Minimum on–hand quantities are typically based on actual usage quantities from prior years and tend to average one to two years of supply.
Hence, as part of normal on–going business operations, and to satisfy their supply agreements with customers, these distributors often maintain large quantities of slow–moving inventory. A combination of factors, including greatly reduced demand, customers maintaining lower on–hand inventory levels, and companies and consumers delaying major expenditures, has further exacerbated the ongoing issue of slow–moving inventory and has led to a dramatic spike in on-hand inventory levels.
From an ongoing business perspective, the sudden drop in demand has essentially had the effect of turning a one year of supply into 1.5 years of supply in a very short time frame. Inventory turnover will only return to levels consistent with those observed prior to the financial collapse of fourth quarter 2008 by companies significantly increasing their sales demand or drastically reducing on-hand inventory levels, or a combination of both.
From a collateral value perspective, distributors whose inventory levels have increased dramatically while turnover has decreased will likely experience a significant decline in collateral value versus a year or two ago, all other factors remaining constant. The aforementioned factors have led to a situation where most distributors are moderately to significantly over-inventoried, when compared to their immediate sales demand. In addition, tight credit markets and lower sales volumes have put pressure on both working capital and cash-flow.
As a result, many industries are fraught with over-inventoried companies who lack the cash or credit to capitalize on advantageous spot-buys; lack the excess warehousing capacity to store bulk purchases; lack the excess sales demand to minimize the risk in speculating on spot purchases; and, in general, lack the motivation to purchase inventories from distressed or liquidating companies, as they have their own supply and demand issues to contend with.
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