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Inventory management is a core issue in operations management as inventory is a critical buffer that matches supply and demand. Excess inventories are costs for firms and also expose firms to the inventory write-down risk. Chen, Frank, and Wu (2005) show that firms with abnormally high inventories have abnormally poor long-term stock returns. Eroglu and Hofer (2011) point that inventory performance is closely related to financial performance, and Hojung, Charles, and Minjoon (2016) find that inventory efficiency would lead to profitability in the long run. Therefore, investigating what influences a firm’s inventory efficiency is important in understanding a firm’s prospects.
Existing studies explore factors that would impact firms’ inventory efficiency. Some studies point that firm level factors could impact inventory efficiency, such as firm size, capital intensity, and gross margin (Gaur, Fisher, & Raman, 2005; Rumyantsev & Netessine, 2007), other studies show that increasing local competition and global sourcing could influence inventory efficiency (Cachon & Olivares, 2010; Jain, Girotra, & Netessine, 2014). This study brings the discussion forward by investigating the effect of supplier-base concentration on inventory efficiency. Each firm must determine how many suppliers to purchase from. Some manufacturers, such as Ford and Volvo, claimed that they would reduce their suppliers and make their supplier base more concentrated (Bolduc, 2010; Trudell, 2013). What’s the impact of supplier-base concentration on inventory efficiency? This study aims to find out whether and how supplier-base concentration influences inventory efficiency.
Using a panel data set of 1780 listed manufacturers in China as a sample, the econometric analysis reveals that manufacturers with a more concentrated supplier base hold fewer inventories and experience a shorter inventory holding period. Specifically, a one standard deviation increase in supplier-base concentration is associated with an approximate 3% decrease in inventory holding. For an average sized manufacturer in China, this improvement is equivalent to approximately 30 million RMB savings in inventory. Examining components in inventory accounts shows that the supplier-base concentration impacts inventory efficiency primarily through the raw material and work-in-process inventories, indicating firms gain improvements through replenishment and production coordination.
More interestingly, this study shows that the effect of supplier-base concentration on inventory efficiency is even stronger for smaller firms. A concentrated supplier base benefits small firms more than large firms. As shown in existing literature (see, for instance, Rumyantsev and Netessine (2007)), larger firms usually possess higher inventory efficiency because they benefit from the pooling effect, their expertise in operations management, and higher bargaining power with suppliers relative to small firms. Therefore, larger firms may not be able to increase production coordination through supplier-base concentration. By jointly considering supplier-base and customer-base concentration, the authors further find that a concentrated supply chain, defined as a high concentration in both the supplier-base and customer-base, leads to high inventory efficiency. In other words, firms in a more concentrated supply chain can match supply with demand better than those in a less concentrated supply chain can.
After identifying a significantly positive relationship between supplier-base concentration and inventory efficiency, the authors examine whether supplier-base concentration leads to a better financial performance. The efficiencies achieved through enhanced production coordination and inventory management are likely to have a positive effect on financial performance. Consistent with this prediction, the authors find a positive association between supplier-base concentration and current and future financial performance, indicating a causal relationship.