Why We Can’t Ignore Inventory Sizing Across Industrial Sectors

Much of the narrative surrounding the appropriate adjustment of inventory levels following the overstock that developed in Q1 and Q2 2022 has been about the inventory held by retailers, particularly general merchandisers. There was good reason for this, as the seasonally adjusted inventory-to-sales ratio of general merchandisers rose sharply from December 2021 and remained very elevated through August 2022 before beginning to decline.

As inventory-to-sales ratios at general merchandise companies returned to pre-COVID-19 levels, there was some excitement that this would mean a significant increase in truckload volumes in 2024, which did not materialize. The seasonally adjusted ton-mile index of for-hire truckloads through May remains 1% lower than this time in 2023. Part of the reason for the continued weakness in truckload demand is that excess inventory has not been resolved in many sectors of the economy, especially the industrial economy.

The purpose of this article is to show that the issue of adjusting inventory sizes is not limited to parts of retail. Rather, it is a widespread problem, as inventory-to-supply ratios in numerous manufacturing sectors, such as food products, paper products, and metal products, have all risen sharply in 2022. As all of these sectors have seen weaker demand in 2023, efforts to adjust inventory sizes relative to sales have had an amplified negative impact on upstream orders due to a principle known as the inventory accelerator.

No sector in manufacturing illustrates this dynamic better than machinery manufacturing (NAICS 333). Machinery manufacturing is a huge sector in the United States, employing more than 1.1 million people and shipping about $452 billion worth of products in 2023. The chart below (permanent link here) shows inventory-to-delivery ratios on the left Y-axis, with industrial production (which measures physical unit output) on the right Y-axis. There is a clear inverse relationship; sharp increases in inventory-to-delivery ratios correspond to declines in industrial production (e.g., 1998 to mid-1999, mid-2008 to mid-2009, 2015 to 2016, 2019 to Q2 2022-present). On the other hand, inventory-to-sales ratios fall when demand is strong and production is growing rapidly (e.g., 1992-1994, 2004-2007, 2010-2014, 2017-2018). A high inventory-to-supply ratio, combined with falling industrial production, suggests that a prolonged period of inventory reduction will be necessary.

Confirming the weak demand conditions facing machinery manufacturers, machinery wholesalers are currently reporting weaker sales and rising inventory-to-sales ratios. This can be seen in the following figure, which plots seasonal and inflation-adjusted sales for machinery wholesalers on the left Y-axis as an index, where 100 = 2017, while the right Y-axis plots the inventory-to-sales ratio. An identical pattern emerges. It is worth noting that the data for recent months has shown weakening sales, coupled with rising inventories relative to sales. Given how bloated inventories are relative to sales, it will take machinery wholesalers at least two quarters (and realistically a year or more) to bring their inventories in line with sales, unless there is a sudden surge in demand for machinery (which seems unlikely until the Federal Reserve starts cutting interest rates).

About the author:

Jason Miller is Interim Chair and the Eli Broad Professor of Supply Chain Management in the Eli Broad College of Business at Michigan State University.

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