Improved Inventory Control Strategies for Farm Supply Cooperatives
Selected Paper for 2005 Annual Meeting
WERA-172
Western Coordinating Committee on Agribusiness
June 19-21, 2006
Las Vegas Nevada
Phil Kenkel
(contact author)
516 Ag Hall
Department of Agricultural Economics
Oklahoma State University
Stillwater, OK 74078
kenkel@okstate.edu
Fitri Pakiding
421 Ag Hall
Department of Agricultural Economics
Oklahoma State University
Stillwater, OK 74078
fitryanti.pakiding@okstate.edu
Improved Inventory Control Strategies for Farm Supply Cooperatives
Background
Farm supply cooperatives have large investments in inventories. A typical farm supply
cooperative has over $500,000 invested in inventories, with inventory representing over 50% of
current assets and over 25% of total assets (Wadsworth, 1994). Farm supply cooperatives have a
diverse inventory ranging from bulk products such as fertilizer, and petroleum to individual
products such as tires, hardware and animal health products.
Inventory management involves a number of activities which include the proper mix of
inventory items, inventory levels, reordering points and order sizes. The goal of inventory
management is to balance inventory holding costs with ordering costs and stock out costs. At its
most simplistic level inventory management balances the costs of holding an inventory item with
the costs of not holding an inventory item. A wide variety of analytical methods have been
applied to inventory management. Economic Order Quantity (EOQ) models determine the least
cost level of inventory under certain demand by balancing ordering and holding costs. Economic
Order Quantity models are robust have been customized for many specific industries as well as
expanded to consider stochastic demand.
Historically, most farm supply cooperatives and other agribusiness firms have not
actively managed inventory. While managers recognize the high costs of inventories, they
maintain large inventories under the assumption that any potential savings from inventory
reductions are far outweighed by economies of size in procurement and/or transportation.
Seasonality and uncertainty in demand can also leads to inventory buildups. Most managers
cannot determine the true level of sales loss from “stock-outs” and instead rely on sufficient
safety stocks.
Cooperative and agribusiness managers often base inventory decisions on simple rules.
Decisions on inventory levels, reorder points and order size are often based on historical sales
volume and truckload lot sizes. Manager may also use an “ABCD” system where products are
classified according to sales and inventory turnover. Managers attempt to always maintain stock
of high turnover items that account for a high percentage of their total sales (A items), while
applying stricter controls to classes of items with lower turnover and/or a lower percentage of
total sales.
Farm supply inventory performance is typically monitored through inventory turnover
ratios and gross margin percentages for broad farm supply categories. Under one simple
technique, termed the “turn to earn” method the product of the gross margin percentage and the
inventory turnover (annual sales divided by average inventory) is monitored in relation to a fixed
goal (usually 1 to 1.5). The basic rationale is that total inventory holding costs including
shrinkage, obsolescence and opportunity costs approach 50% of inventory value. The turn to
earn target of 1.00 is designed to ensure sufficient gross margins for each product line to cover
the inventory holding costs and leave a sufficient return to meet the business’s overall return on
asset goals. One weakness of turnover-based systems is that while they focus attention on
reducing inventory carrying costs they ignore the ordering and lost sales costs from low
inventories.
In recent years, many farm supply cooperatives have adopted automated point of sale
information systems that can track purchase and sales data on an individual item basis. While
these systems have greatly expanded information on purchases, sales and inventory levels, few
cooperatives are making full use of this information. Most cooperatives still base purchases on
general guidelines and monitor inventory performance for broad product categories.
Objectives
The overall objective of the study is to use point of sale information to examine farm
supply cooperative inventory management practices and identify improved inventory
management strategies. Specific objectives include: (1) Investigate the rate of return on
inventory items and determine the variation across product and category, (2) Estimate optimal
inventory levels for individual items based on sales patterns and holding costs, (3) Determine
potential cost savings from improved inventory management, and (4) Identify improved
category-based inventory management strategies.
Procedures
A twenty four month time series of point of sale information was obtained from an
Oklahoma farm supply cooperative. The data represented over $35M of farm supplies sales
which encompassed over 300,000 transactions involving 5,000 separate items and 33 branch
locations. The cooperative’s average monthly inventory averaged slightly under $1.5 M. Gross
margins and average inventory levels and inventory holding costs were calculated for each item
code. Sales, gross margins, gross margins percentages, and average inventory were determined
for each item code. These parameters were also summarized for eleven (arbitrarily defined) farm
supply categories (feed, seed, fertilizer, etc). The “turn to earn ratio” (gross margin percentage
times inventory turnover) was calculated for each item and each category.
The variation in
inventory performance between items and between farm supply categories was examined to
determine apparent areas for improvement.
Results and Implications
A summary of sales, profits and average sales/item for each of the eleven farm supply
categories is provided in Table 1. The table illustrates the diversity of the cooperative’s farm
supply operation. There were 244 separate items in fertilizer category which represented 46% of
the cooperatives total sales. This category also had the highest average sales per item due to the
high sales for the handful of popular bulk fertilizer items. At the other end of the spectrum there
were 849 items in the “bearings and hoses” a category which accounted for only .23% of total
sales and having an average sale per item code of only $94.
Table 1: Summary of Farm Supply Sales by Category
# Items Sales
Avg Sales
Petroleum
192 $ 11,267,109
$
58,379
Animal health
53 $
51,623
$
974
Miscellaneous
335 $
1,799,061
$
5,370
Hardware
292 $
34,887
$
119
Fence
461 $
197,357
$
428
Feed
669 $
1,075,461
$
1,417
Seed
210 $
276,104
$
1,315
Oil and
batteries
908 $
338,833
$
373
Herbicide
855 $
3,238,141
$
3,787
Bearings and
hoses
849 $
79,628
$
94
Fertilizer
244 $ 15,761,570
$
64,333
5,068
$
34,119,775
Total Profit
$ 1,331,628
$
12,787
$ 1,682,095
$
8,294
$
44,569
$
223,807
$
74,796
$
$
100,565
475,029
$
$
29,951
2,709,753
$
6,693,274
The gross margin percentages of the various farm supply categories are summarized in
Table 2. The overall gross margin percentage for entire farm supply department was 36%.
Petroleum had the highest gross margin percentage at 46% while seed and herbicide was lowest
at 26%. However there was substantial variation within the farm supply categories. For
example, within the fencing category one (possibly miss-priced) electric fence wire had a -85%
gross margin percentage while one solar electric fence charger had a 800% margin.
Table 2. Item Gross Margins by Farm Supply Category
Average
Maximum
Minimum
Gross
Gross Margin Gross
Margin %
%
Margin %
Petroleum
46%
100%
-19%
Animal health
37%
100%
-19%
Misc
38%
116%
-46%
Hardware
43%
100%
-55%
Fence
40%
800%
-85%
Feed
31%
637%
-120%
Seed
26%
163%
-322%
Oil and batteries
40%
100%
-357%
Herbicide
26%
100%
-141%
Bearings and
hoses
35%
106%
-91%
Fertilizer
29%
119%
0%
Overall Average
36%
The inventory turnover ratios (gross sales divided by average inventory) are shown in
Table 3. The overall Farm Supplies Department had an inventory turnover of 7.8 times. The
“fence” and “feed” categories had high turnover at 15.5 and 13.6 respectively while animal
health had the lowest turnover at 1.0 times. The fertilizer category which had the highest level of
gross sales had a turnover of 2.3 while petroleum which was second in sales volume had a
turnover ratio of 10.2
Table 3. Inventory Turnover Ratios (Gross sales/Average Inventory)
for Farm Supply Categories
Average
Turnover
Minimum
Maximum
Petroleum
10.2
0.15
97.0
Animal Health
1.1
0.08
6.0
Misc
1.0
0.02
32.0
Hardware
12.8
0.04
299.0
Fence
15.6
0.05
179.0
Feed
13.6
0.05
48.4
Seed
8.9
0.03
199.3
Oil and batteries
3.5
0.14
23.0
Herbicide
14.2
0.36
70.7
Bearings & Hoses
3.0
0.07
21.0
Fertilizer
2.3
0.01
27.5
Overall Average
7.8
The inventory performance as measured by the “turn to earn” ratio for the various farm
supply categories is provided in Table 4. The “turn to earn” ratio was calculated by multiplying
the gross margin percentage times the inventory turnover. The ratio therefore measures the total
contribution of the item over the course of a year to cover both inventory holding costs and to
generate a return on the business’s other assets. While there is no scientific basis for an exact
guideline most managers strive for a “turn to earn” ratio of 1 to 1.5.
The overall “turn to earn” ratio for the cooperative was a respectable 2.7. The animal
health and fertilizer categories had the lowest inventory performance while fencing materials and
petroleum had the highest. The table illustrates the interaction of gross margin and turnover in
creating profitability. The animal health and petroleum categories had similar margin levels.
However the petroleum inventory turnover over ten times as fast leading to a similar increase in
performance.
Table 4. Turn to Earn Ratios (GM% x Inv. Turnover)
for Farm Supply Categories
Petroleum
Animal Health
Misc
Hardware
Fence
Feed
Seed
Oil and batteries
Herbicide
Bearings & Hoses
Fertilizer
Overall Average
Gross Margin Inventory
%
Turnover
46%
45%
38%
43%
40%
27%
26%
40%
26%
35%
29%
36%
Turn to
Earn
10.2
1.1
1.0
12.8
15.6
13.6
8.9
3.5
14.2
3.0
2.3
7.8
4.7
0.5
0.4
5.6
6.2
3.6
2.3
1.4
3.7
1.0
0.7
2.7
Inventory performance, like its composite measures, demonstrated wide variations across
items within a farm supply category. The average, maximum and minimum turn to earn ratios
for items within the farm supply categories are provided in Table 5. Inventory performance
varied widely across items in all categories. While both gross margin percentages and inventory
turnover (the components of the turn to earn ratio) varied within each category, most of the
variation in inventory performance was due to variation in inventory turnover. It is interesting to
note that high and low performing items were found both in categories dominated by bulk
handling such as fertilizer and petroleum and in more retail dominated categories such as fencing
supplies and hardware.
Table 5. Average, Maximum and Minimum Turn to Earn Ratio Across
Items for Farm Supply Categories
Average
Petroleum
Animal Health
Misc
Hardware
Fence
Feed
Seed
Oil and batteries
Herbicide
Bearings & Hoses
Fertilizer
Overall Average
Minimum
4.7
0.5
0.4
5.6
6.2
3.6
2.3
1.4
3.7
1.0
0.7
2.7
0.07
0.04
0.01
0.02
0.02
0.01
0.01
0.06
0.10
0.02
0.004
Maximum
44.4
2.7
12.2
129.7
70.7
12.9
52.3
9.2
18.7
7.4
7.9
Conclusions and Implications
The data obtained from the case study cooperative indicates that the cooperative’s farm
supply department is attaining adequate margins, inventory turnover and inventory performance
as measured by the turn to earn ratio. However, analyzing the data for the over 5,000 item codes
handled the cooperative reveals the wide variation in profit margins, inventory turnover and
inventory performance. Cooperative managers frequently comment that specific categories of
farm supply items (example oil and batteries) have chronically low inventory performance and
are only carried as a service to the members. The data from the case study cooperative suggests
that all of the categories (with the possible exception of animal health) had adequate
performance. The wide variation in performance within categories suggests that managers can
use the item-based information now available to them to identify under performing items. In
evaluating items managers will want to consider both an items inventory performance and its
sales volume and concentrate on poor performing items which account for significant sales
volume. Future research includes more sophisticated analysis of the initial inventory data plus
expansion of the research to two additional cooperatives.
References
Wadsworth, James. “Inventory Management Strategies for Local Farm Supply Cooperatives”,
USDA Cooperative Services Rural Development Administration Service Report #41,
July 1994.