It's a common perception in distribution enterprises that increasing inventory turnover automatically increases an organization's profitability.

Many distribution managers focus on this measurement in making their own purchase and inventory decisions. But should inventory turnover (or “inventory turns”) carry such weight?

The meaning of “inventory turn”

Inventory turn measures how many times your inventory is sold and replenished over a certain amount of time. It’s a metric that allows you to compare your distribution enterprise to those of your industry peers.

Typically, you measure turns by dividing cost of goods sold by average inventory over a period of a year. A high inventory turn rate is often considered a strong measurement of your business' success.

However, high turn rates do not necessarily translate to higher profits. What they DO measure is return on assets (ROA)—a useful metric of liquidity and how well the business is performing as an investment.

Understand the variables.

An overall turnover rate of five to six times per year is often considered a good baseline goal for enterprises with 20-30 percent gross margins. However, there are numerous trade-offs in driving higher inventory turn rates. These include:

• Your ability to fill orders
• Disposition of obsolete or discontinued products
• Your customers’ expectations
• The competitive landscape

Generally, companies with high gross margins have lower rates of turnover. Companies that sell more commoditized products usually operate on slimmer margins and therefore expect to generate higher sales and higher rates of inventory turnover.

One tradeoff to consider is your customer’s degree of price sensitivity as compared to his need for you to fill 100% of his order. Contractors purchasing commodity type products like lumber and copper pipe have multiple sourcing options and offering the best price may be critical in retaining their loyalty. Compare those contractors with service firms that buy replacement parts they need on short notice: They are more likely to place the greatest value on a distributor’s ability fulfill orders quickly.

How did we get here?

In the 1980s, high interest rates and the availability of computer technology created an environment where both the motivation and the tools emerged to reduce the cost of carrying inventory. So buyers simplified their inventories, stocking the items they knew would sell quickly, while ordering low-turnover goods only as needed. Supply chain velocity was slower than today, and the occasional stock-out was permissible. You could say that controlling the costs of carrying inventory tended to outweigh the need to provide maximum customer service.

Fast-forward to 2018.

Modern technology and low interest rates have put pressure on the supply chain to carry more inventory to meet the growing demands of customers. In addition, Amazon and similar retailers have raised customer expectations for what "quick delivery" means. Your customers' basic expectation is that you will have the items he needs, ready to ship out and deliver to his hands at a more rapid pace than ever before.

Furthermore, service level and fill rate metrics have rapidly become the guiding principles today. There’s a popular saying among distributors: “Filling 90% of a customer’s order does not make him 90% happy.” A contractor who cannot source everything he needs is probably looking at project delays, idling workers, and slow cash flow. So when you can’t fill lines in his order, you can expect him to seek other suppliers.

Use technology to look beyond inventory turns.

Now let’s get back to our original question: Should inventory turns matter to distributors?

Yes, inventory turnover is a metric that correlates to ROA. But inventory turn rate and ROA only tell a small part of the story as far as how your business is performing.

A far more important goal is having the right inventory. Ensuring that you have the products you need, when you need them, where you need them, and in the right quantities helps to assure consistent turn rates. But more importantly, that optimized inventory enables you to provide a better level of service to your customer.

You could say the devil is in the details. Modern distribution software should have the tools to make you more agile by identifying slow moving products and by providing a process to dispose of products due for replacement or nearing obsolescence.

The right software tools can simplify this complex task. With an effective, modern distribution ERP solution, you can manage more effectively and achieve reasonable inventory turn goals while providing the level of service your customer expects.

Above all, keep your eye on your customers.

As I mentioned above, your ability to respond to and shape customer behavior can affect your ability to achieve your inventory management goals. Read my blog post “Improving Customer Loyalty with IT” to learn how software can help.