Spotlight on Advanced Research: Impact of Variety and Distribution System Characteristics on Inventory Levels at US Retailers

If you manage a retail supply chain, you probably wonder from time to time how much inventory you should be carrying. Is 10 days of supply the “right” amount of inventory? Or would 40 be better? What about 100? You might want to compare your performance to your competitors, but if you have 500 stores and your competitor has 4,000, would the comparison be meaningful?

Dr. Sampath Rajagopalan, Professor of Data Sciences and Operations at the USC Marshall School of Business, has attempted to answer this question. In his paper, Impact of Variety and Distribution System Characteristics on Inventory Levels at US Retailers, he describes a model that allows US retailers to benchmark their inventory performance against their competitors, regardless of differences in store location count, product variety and several other factors.

Key Findings: High Product Variety, Store Count Drive Inventory Levels Up

Dr. Rajagopalan discovered through his research that a substantial fraction of variability in inventory levels in a given retailer segment are explained by differences in product variety, store count, gross margin, firm revenue, and demand variability. He discovered empirically that—all else being equal—greater levels of product variety, greater store count, gross margin, and demand variability lead to higher inventory levels, while greater firm revenue leads to lower inventory.

Putting the Research to Work

These findings can lend some very useful insights to a supply chain manager watching her inventory (as we should all be doing), making it possible to broadly benchmark your supply chain performance against your competitors regardless of their supply chain structure. If, for example, you carry a smaller variety of items and have fewer stores than a competitor, but you carry similar levels of inventory, Dr. Rajagopalan’s findings strongly suggest that there is an opportunity to optimize some parts of your chain to reduce inventory levels.

Further, a retailer could use this work to benchmark performance of individual stores within his chain which have different characteristics; for example, if a small format store in the chain (with limited SKU variety) has similar inventory levels as a large format store, the supply chain processes of the smaller store may be a good target for closer investigation.

The full text of the paper is available here