It wonÕt be easy

It wonÕt be easy

When the Federal Reserve declined last month to reduce interest rates, it wasn't a complete surprise. With short-term rates already at a 40-year low, there's little room for further cuts. Sooner or later, rates will have to move higher.

Falling interest rates have been a plus for stock prices and the dollar ? and for logistics, which is the management of inventory in motion or at rest. When interest rates are high, as they were in the early 1980s, inventory is expensive. When rates are low, as they are now, so are inventory carrying costs.

Proof of that is in the recent Cass/ProLogis "State of Logistics" report. Authors Robert Delaney and Rosemary Wilson reported that U.S. logistics spending as a percentage of gross domestic product declined to 9.6 percent last year, an improvement from 10.2 percent in 2000. Last year was the first time the figure dipped below 10 percent.

Much of the improvement was due to lower interest rates, which begs the question: What will happen when interest rates start to rise again?

Roger Urban of Urban Wallace Associates, a Cambridge, Mass., consulting firm, predicts that many companies will react by taking a hard look at their logistics practices. "Interest rates are such a substantial and high-profile part of inventory carrying costs that when rates do go up, it will be noticed," Urban said.

Actually, Urban said, obsolescence probably is a bigger contributor to inventory costs than inventory rates. Companies annually lose billions of dollars on write-offs and markdowns of outdated goods. However, because those costs tend to be dispersed throughout a company, they're less visible than a specific rate of interest.

Companies are have improved their inventory management in recent years, especially in the handling of raw materials and "work in process." But finished-goods inventory actually has risen over the last 20 years, according to a study last year by Ohio State University professors James Ginter and Bernard La Londe.

The Ginter-La Londe study was a seminal work that challenged old assumptions about inventory management. Surprisingly, it found that companies with the highest levels of inventory also tend to have the highest margins.

Urban said, though, that what the study really shows is that companies with high profits maintain high inventory levels because they can afford to do so, and because under some circumstances, high inventories boost revenue more than they raise expenses. In other words, sometimes the opportunity for extra sales justifies higher inventory carrying costs. But not always.

Therein lies the challenge for logistics managers. When rising interest rates put them back on the hot seat, they'll face pressure to slash inventory. "But you can't chop blindly," Urban said. "You have to integrate logistics with marketing, and be smart about how you manage finished goods. If you're smart, you can gain sales. If you're not, somebody ? your sales, marketing or customer-service departments, or your customers ? is going to scream."

Information technology offers the potential to improve inventory management, but it's still hampered by poor cooperation between companies, Urban said. He blames lack of standardization ? "One company will call an item an ABC fastener, another will call it a 123 paperclip."

The inter-company Tower of Babel undermines the use of logistics software to improve supply chains. Urban said a refrain of software vendors to logistics managers is, "You've got information. You don't know what to do with it. Our software will show you how." But often, he said, companies don't have information in a form that they can exchange with their vendors and customers to reduce overall supply-chain costs.

Many companies try to cut logistics costs by focusing on transportation. In the early 1980s, when interest rates were sky-high and U.S. trucking and railroads were newly deregulated, transportation savings were easy to find, particularly for trucking, which makes up 80 percent of U.S. transportation costs.

More recently, sales of transportation-management software have soared. Shippers use the software to reduce empty backhauls and to save money by switching to slower routings. Sometimes this makes sense. But again, not always. Urban said that viewing transportation costs in isolation from other logistics issues ? including the potential for lost sales ? can be an expensive mistake.

"If you're only looking at transportation costs, you will sub-optimize the management of inventory in your supply chain and produce false savings," he said. It makes no sense to shave your transportation costs by 2 percent only to lose sales because a high-margin item is not on the store shelf. Conversely, sometimes it really does make sense to use a cheaper, slower transportation.

Balancing a company's competing inventory takes sophisticated management and measurement, and not all companies are up to the job. But they'd best get ready, because interest rates won't stay low forever.

Joseph Bonney is deputy editor of JoC Week. He can be reached at (973) 848-7139, or via e-mail at jbonney@joc.com.