Inventory agility upon demand shocks: Empirical evidence from the financial crisis

• Published date: 01 September 2018
• DOI: http://doi.org/10.1016/j.jom.2018.08.001
• Author: Jan C. Fransoo,Kai Hoberg,Maximiliano Udenio
• Date: 01 September 2018

Contents lists available at ScienceDirect

Journal of Operations Management

journal homepage: www.elsevier.com/locate/jom

Inventory agility upon demand shocks: Empirical evidence from the

financial crisis

Maximiliano Udenio

a

, Kai Hoberg

b,∗

, Jan C. Fransoo

b

a

Research Center for Operations Management, Department of Decision Sciences and Information Management, KU Leuven, Leuven 3000, Belgium

b

Kühne Logistics University - KLU, Großer Grasbrook 17, 20457, Hamburg, Germany

ARTICLE INFO

Keywords:

Inventory management

Empirical operations management

Financial crisis

Inventory agility

ABSTRACT

The objective of this paper is to identify antecedents of inventory agility (i.e., the capability to quickly adapt

inventories to changes in demand) upon demand shocks based on the awareness-motivation-capability (AMC)

framework and to explore the link between inventory agility and financial performance. We introduce an em-

pirical measure of inventory agility based on the deviation of relative inventories (i.e., inventory days) from their

forecasted values. We hypothesize that firms with higher awareness, motivation, and capabilities are associated

with higher inventory agility in the presence of demand shocks. We define two empirical measures for each of

the three dimensions of the AMC framework in the context of inventory agility: awareness (i.e., market or-

ientation and technology orientation), motivation (i.e., gross margin and liquidity), and capabilities (i.e., in-

ventory management capability and resource availability). In addition, we incorporate the constraining factor

model (CFM) into the AMC framework, thus allowing for complementarity among the different measures. In this

view, the influence of each of the measures on inventory agility varies according to which of the measures is the

constraining factor for a given firm. The 2008 financial crisis may have tested firms' inventory agility more than

any other crisis since the Great Depression, as an unprecedented collapse of demand coincided with a reduction

in credit availability. Therefore, for our analysis, we use firm-level empirical data from 1263 public U.S. man-

ufacturing firms for the 2005–2011 period. We find that firms' motivation and capabilities are key factors as-

sociated with inventory agility. Through the CFM, we show that identifying the constraining factors leads to a

more refined understanding of the moderating effects of the antecedents of inventory agility. In a separate

analysis, we find that inventory agility is positively associated with a number of financial performance metrics

during crisis periods. We distinguish between inventory underages and overages and find that, during the crisis,

they are both associated with lower financial performance. Furthermore, we find evidence that higher underages

(overages) magnify the effect of overages (underages). Among other managerial insights, our findings suggest

that the use of inventory reductions as a quick way to increase liquidity must be gauged against their potential

impact on other aspects of financial performance.

1. Introduction

In this paper, we identify the antecedents of inventory agility as a

response to demand shocks, i.e., the extent to which firms can maintain

relative inventory levels following demand shocks. Furthermore, we

explore the link between inventory agility and financial performance

using firm-level data from the financial crisis, and we use two theory-

based empirical frameworks–the awareness, motivation, capabilities

(AMC) framework and the constraining factor model (CFM)–to test six

hypothesis related to inventory agility. Then, we test two hypotheses

regarding the relationship between inventory overage/underage and

financial performance.

Lehman Brothers–the fourth-largest U.S. investment bank at that

time–declared bankruptcy on September 2008. This bankruptcy, the

largest bankruptcy filing in U.S. history, precipitated the worst fi-

nancial panic since the Great Depression (Ivashina and Scharfstein,

2010). The collapse of Lehman Brothers sent a shockwave through the

financial world and triggered an unprecedented decline in the global

economy (Duncan, 2008). Manufacturing industries were hit parti-

cularly hard, as aggregate sales in manufacturing declined by 39%

within three quarters of the Lehman collapse (see also Udenio et al.,

2015).

When sales decline, firms with high inventory agility can adapt their

inventories to these new realities and hold their relative inventories

https://doi.org/10.1016/j.jom.2018.08.001

Received 12 April 2016; Received in revised form 1 August 2018; Accepted 3 August 2018

∗

Corresponding author.

E-mail addresses: Maxi.Udenio@kuleuven.be (M. Udenio), Kai.Hoberg@the-klu.org (K. Hoberg).

Journal of Operations Management 62 (2018) 16–43

Available online 04 October 2018

0272-6963/ © 2018 Elsevier B.V. All rights reserved.

T

constant, thus avoiding inventory-related costs such as cost of capital

and obsolescence costs.

Fig. 1 shows the evolution of normalized relative inventories,

measured by mean and median inventory days, in the manufacturing

sector. Median inventory days at the beginning of the financial crisis

increased by 14% relative to the previous year, and mean inventory

days increased by 18%, suggesting an increase in the right skewness of

the distribution of inventory days for that period.

Although inventory days return to normal within 18 months, there

is considerable variability at the firm level, as illustrated by three firms

in the transportation equipment industry (NAICS code 336). Fig. 2

shows the sales and inventory developments of Harley-Davidson Inc.,

Dana Holding Corp., and Ford Motor Company. This industry was hit

particularly hard by the financial crisis (Van Biesebroeck and Sturgeon,

2010). While all three companies experienced a comparable collapse in

sales, they exhibited significantly different levels of inventory agility. At

Harley-Davidson, relative inventories settled at 30% above pre-crisis

levels in Q2/2010, two years after the crisis. At Dana, the inventory

surge was less pronounced and relative inventories returned more ra-

pidly to the pre-crisis level. At Ford, relative inventories decreased by

33% one year after the start of the crisis. These results suggest that each

company reacted to the crisis with a different strategy: Harley-Davidson

maintained high inventory, Dana kept inventory close to pre-crisis le-

vels, and Ford actively reduced its inventory.

These observations motivate our research. Given the importance of

inventory management capabilities in crisis situations (Steinker et al.,

2016), our objective is to investigate inventory agility in response to

demand shocks. With this study, we address three research questions:

(i) How did firms react to the significant decline in demand and align

their inventory to the new situation?, (ii) What are the antecedents of

inventory agility during the crisis? And finally, (iii) what are the fi-

nancial implications of inventory dynamics?

We leverage the AMC framework (Chen, 1996) as a theoretical lens

to investigate inventory agility. The AMC framework was originally

devised to study inter-firm rivalry. It aims to characterize a focal firm's

structural competitive tension with that of its rivals based on three key

behavioral drivers. Simply stated, a firm can respond to an action only

if it is aware of the action, motivated to react, and capable of re-

sponding (Chen and Miller, 2012). Awareness specifically refers to a

firm's alertness with regard to the market and the signals it receives

(Levinthal and Rerup, 2006;Lamberg et al., 2009). Motivation relates

to the incentives that drive a firm to undertake actions (Smith et al.,

2001). Finally, capabilities relate to the cognitive and resource-based

factors that influence the firm's ability to take action (Smith et al.,

2001). We contend that the drivers specified in the AMC framework

provide a solid conceptual basis for firm-level, theory-based constructs

regarding a firm's decision to react in an agile manner and maintain

stable relative inventories during times of crisis. We propose measures

based upon the operations and finance literature to assess each of the

AMC components. The analysis suggests that the antecedents of in-

ventory agility are consistent across the panel: A firms's motivation and

capabilities play important roles in achieving inventory agility during

the crisis.

In addition to the AMC framework, we adopt the CFM used by

Siemsen et al. (2008) to better understand how the interaction among

the AMC components affects a firm's inventory agility. By building on

the AMC framework with the CFM model, we explicitly allow for

“bottlenecks” in the antecedents of inventory agility. Using the CFM,

the effect of any of the AMC components on the agility of a given firm is

regulated as a function of its most critical component. Thus, our

methodology allows us to distinguish between, for example, the effect

of motivation on inventory agility if awareness is critical for a firm and

the effect of motivation on inventory agility if capabilities are critical

for a firm.

To assess the link between inventory agility and financial perfor-

mance, we measure the short, medium, and long-term impacts of in-

ventory dynamics on various aspects of a firm's financial performance:

profitability, market performance, and financial health. To do so, we

explicitly distinguish between inventory overages and underages. We

find that inventory overages and underages are generally negatively

associated with financial performance, and that the magnitude of this

effect varies according to the perfomance dimension under study. This

finding is consistent with, and expands upon, the empirical study of

Eroglu and Hofer (2011) that found an ‘inverted U’ relationship be-

tween inventory leanness and firm performance in numerous industries.

Our results suggest that using inventory reductions to increase liquidity

in the short term (Udenio et al., 2015;Steinker et al., 2016) needs to be

gauged carefully against the tradeoffs between different dimensions of

long-term financial performance. Our results, however, also indicate

that the marginal effect of overages (underages) is conditional on the

level of underage (overage) a firm exhibits during the period of ana-

lysis, i.e., the marginal effect of overage (underage) on financial per-

formance is larger for firms with higher underages (overages).

The remainder of the paper is structured as follows. In Section 2, we

provide an overview of the relevant literature on inventory manage-

ment in crisis situations. In Section 3, we develop a series of hypotheses

based on existing theory. Then, in Section 4, we introduce the models

and methodology used to test our hypotheses and describe the em-

pirical dataset. In Section 5, we present our results, and finally, we

conclude and summarize our findings in Section 6.

2. Literature review

Our research builds on three streams of research, namely, the em-

pirical operations management literature that analyzes firm-level in-

ventory decisions, the macroeconomic and financial literature that in-

vestigates the link between economic conditions and inventory

investments, and the strategic management literature on AMC that we

use to identify the antecedents of inventory agility.

2.1. The operations perspective

Over the past decade, research in empirical operations management

advanced considerably due to a rich stream of literature–supported by

Fig. 1. Relative inventory (normalized inventory days) in the manufacturing

sector.

M. Udenio et al. Journal of Operations Management 62 (2018) 16–43

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