As companies look ahead to the second half of 2023, they face continued macroeconomic uncertainty. One thing they know for sure is that they continue to face interest rates higher than at any point in the last 15 years thanks to 11 rate hikes by the US Federal Reserve since the beginning of 2022. Higher interest rates mean additional attention to cash flow management.

Retailers in many sectors have already suffered from the cutback in consumer spending since interest rates began to increase. This trend may be exacerbated as the Fed is considering raising interest at least one more time before the end of the year. For retailers with high debt loads, an improved working capital position is an essential lifeline. Even for those who have strong balance sheets, the increased carrying cost from the current interest rates could be worth $544 million across retailers in the S&P 1500 Composite.

A key measure of working capital efficiency

For any company, there are three key measures of addressing working capital efficiency: Days Sales Outstanding (Accounts Receivable), Days Payments Outstanding (Accounts Payable), and Days Inventory Outstanding. Receivables outstanding are rarely an issue for retailers, as customers typically pay in cash or with credit cards (which have very regular, on-time collections). Retailers can address Days Payments Outstanding (DPO) with the right vendor engagement approach, but these concessions often create a zero-sum proposition when negotiating against vendors. Our experience has shown that the opportunity for savings on Days Inventory Outstanding (DIO) can create more sustainable value.

Some retail sectors require more inventory than others. Inventory levels in retail are generally down since 2018 but have ticked up since last year as shown below. Home improvement retail has seen the greatest increase over this period (approximately 16% year-over-year and 2% annualized since Q1 2018). These retailers are expecting a decline in sales in 2023, which will exacerbate this issue.

Solutions for struggling inventory turnover

Below are some solutions we propose for companies that are struggling with inventory turnover. These solutions have been implemented by Oliver Wyman clients in the past and are based on the experiences of our internal retail experts.

Add the cost of inventory to merchandising reporting and incorporate into governance

What gets measured gets managed; therefore, incorporating Net Working Capital (NWC) and its drivers into merchandising reports will bring more attention to those metrics from the business. This can be accomplished either by adding these NWC metrics to existing reports or in standalone reports that are more “cash culture”-focused. Key metrics to incorporate include days of inventory outstanding, carrying cost of inventory, inventory on hand, and days of net working capital. Management will then be better informed to take action.

Identify high-inventory STOCK-KEEPING units (SKUs) for discount and service level adjustment

At nearly every retailer, we see certain SKUs accumulate excess inventory. By starting with those, we can not only unlock quick wins but also find the structural reasons causing this inventory to build up. At this point, management will work to reduce the buildup from two angles:

• Flush out stock: Management can expedite the sale of built-up stock through a combination of promotional methods (targeted offers) and changes to planogram facings (movement of slow-moving SKUs to more favorable in-store locations).
• Adjust replenishment: Any recurring orders for the high-inventory SKUs should be reevaluated to reduce either the quantity or frequency of orders.

Reduced store-level assortment through clustering

When reducing store-level assortment, it’s essential to identify “safe” candidates for delisting — those where a high percentage of lost sales for the specific product would be redistributed among other products in the same “cluster.” In the switching analysis example below, the product on the left has near substitutes that would absorb a large percentage of the sales should the product in question be delisted. The same can’t be said of the product on the right, which would result in an almost complete loss in sales if the product were removed from the inventory mix.

Pool switchable items for combined service levels

Switching analysis can also inform where products should be grouped to pool inventory in setting service levels. For highly switchable products (like the sunscreen on the left above), shared safety stock could service all of the products in that cluster, so that each product does not need its safety stock. By switching from servicing safety stock from the individual product level to the cluster level, the total amount of safety stock on hand is reduced substantially. A customer decision tree can be used to ensure that all products in the cluster are highly switchable.

Case studies — What this could be worth

Case Study: Retailer with more than $25 billion in sales (50% perishables)

The following case illustrates how a large retailer with perishables was able to reduce inventory and simultaneously optimize supplier performance.

Oliver Wyman was engaged to streamline supply chain management processes and governance. Approach and measures taken included:

• Needs-based planning for inventories, which allowed the client to reach optimal service levels
• Specific assignment of SKUs to storage locations to improve the flow of inventory — this improved the readiness of inventory for delivery by 1.4 percentage points for perishables and 1.3 percentage points for nonperishables
• Assortment review and SKU rationalization

These actions allowed the client to achieve an overall reduction in inventory of 15% (with an overall cost reduction of $25.2 million), plus an 80% reduction in process disruptions for incoming goods. The client then leveraged these wins to negotiate more variable payment terms with its suppliers, thereby improving working capital through an additional avenue (payables).

Case Study: Retailer with more than $10 billion in sales

The following case illustrates how a retail client (nonperishables) implemented inventory management solutions on a large scale. The company has a wide product mix (both slow and fast movers) that features both national brands and private labels and more than $10 billion in annual sales. As part of a wider initiative to improve internal capabilities, Oliver Wyman was tasked with reducing working capital in the business.

Solutions the client used to better manage inventory included:

• Governance: The company implemented a uniform set of managerial key performance indicators (KPIs), which gave management a more focused view of which inventories were stuck and should be moved through increased promotion and discounts.
• Clustered assortment: As described previously, Oliver Wyman grouped the client’s products into switchable clusters, which helped with SKU rationalization (and elimination) and created more manageable service levels of safety inventory.
• Supply visibility: The retailer implemented new forecasts and Material Requirements Planning (MRP) systems to better manage the inflow of inventory.

The client was able to reduce its inventory by 25% by the end of the project while improving inventory availability by 1.2 percentage points and reducing inventory shrink by 2 percentage points. Newly implemented supply controls and KPI dashboards have helped the client ensure that the improvements made have been sustainable.

Conclusion: Retailers have multiple options when it comes to working capital

In the face of increased uncertainty and higher interest rates, having more cash on hand or drawing less from a revolver is never a bad thing. For retailers to weather these conditions, they should be equipped with ample liquidity and processes that turn current assets into cash quickly. Inventory reduction and turnover improvement are ways that can have major impacts in this area, and many channels exist for accomplishing them.

Joshua Korn contributed to this article.