There are strong signs companies are replacing inventories, just what the economy needs to recover.
Back in September, I wrote that businesses were no longer reducing stockpiles as aggressively as they had been earlier in 2009, and inventory growth could contribute 1.3 points to the real GDP growth rate in 2010.
Some readers scratched their heads, but now there are additional signs that inventory restocking has begun.
The turnaround is global and is the first sign of a recovery. As in past recoveries, order flows will lead to renewed confidence on the part of banks, which will ease the credit crunch. The rest of the economy, including concrete construction, should follow this growth trend.
Caterpillar is a prime example. The Peoria, Ill.-based heavy equipment manufacturer recently told its steel suppliers that it will more than double its purchases of metal this year, even if the company’s own sales don’t increase. In fact, the company has been boosting orders to suppliers for everything from big tires and hydraulic tubes to shatterproof glass.
Why? Chalk it up to the “bullwhip effect” which is reverberating across the economy. This phenomenon occurs when companies significantly cut or add inventories. It’s called a bullwhip because even small increases in demand can cause a big snap in the need for parts and materials further down the supply chain.
During the financial crisis, companies slashed $207 billion worth of inventory, helping businesses conserve cash to weather the storm. But the swing of the pendulum became visible in October when total business inventories grew by $4.1 billion, followed by an additional $5.4 billion in November.
Heavy equipment giant Caterpillar has put its suppliers
on notice that it will boost its purchasing this year.
Restocking shelves
The bullwhip has broad implications as companies rush to fill orders while also restocking warehouse shelves. It touches everyone from retailers to the industrial companies that supply all the various raw materials needed to churn out more products. The manner in which companies respond to market shifts determines which ones are the first to emerge from the slump and start growing again.
As I expected, the economy grew 5.6% in the last quarter of 2009, yet consumer spending remained muted. Most of the growth occurred because businesses stopped reducing inventories, and therefore had to produce more of what they sold.
Caterpillar thinks the inventory burn-off is over. Going forward, a big question is how well suppliers are positioned to ramp up production. Bottlenecks and other headaches may occur, as spot shortages cause unexpected price hikes and hamper the ability by many companies to meet demand.
That’s why Caterpillar took the unusual step recently of visiting key suppliers to ensure they have the resources to quickly boost output. To assure a steady flow of parts from its suppliers, the company dispatched two top executives on a four-week tour, and held meetings with 500 major suppliers around the world, traveling to Japan, China, India, and Europe.
The goal was to explain that a bullwhip was likely coming, and to ensure they were making adequate preparations. Those 500 suppliers represent 80% of all the goods Caterpillar buys. In extreme cases, the equipment maker is helping suppliers get financing.
Caterpillar says that even if demand for its equipment is flat this year, what it calls an unlikely scenario, it would still need to boost production by 10% to 15% just to restock dealer inventories and meet ongoing customer demand. That means Caterpillar’s suppliers would have to increase output 30% to 40% because Caterpillar would also be refilling its shelves.
Pierre G. Villere serves as president and senior managing partner of Allen-Villere Partners, an investment banking firm with a national practice in the construction materials industry that specializes in mergers & acquisitions. He has a career spanning almost five decades, and volunteers his time to educating the industry as a regular columnist in publications and through presentations at numerous industry events. Contact Pierre via email at pvillere@allenvillere.com. Follow him on Twitter – @allenvillere.