It’s the last few weeks of the quarter and the regular call goes out: cut inventory. Whatever it takes, we have to hit the number.
The underlying concern is legitimate. We’re in business to turn inventory back into cash (ideally for more than we put into it). Inventory consumes working capital and incurs costs for financing, storage, insurance, handling, deterioration, and obsolescence. High inventory may indicate that the company is making the wrong products, sales are slowing, prices are too high, or planning is disconnected from demand, none of which are signals we want to send to Wall Street.
Regardless, it does not follow that less inventory is necessarily better. A blind inventory target can be just as destructive to enterprise value as uncontrolled accumulation.
The reporting pressure is real and researchers have found that working capital does decline during the fourth quarter due to this, then rebounds early the next quarter. Across US manufacturers, inventories run 4-6% lower in the fourth quarter. It’s a self-inflicted bullwhip. Moving beyond this narrow focus on short-term financial metrics requires first recognizing what inventory actually represents on the ground.
Inventory is a physical asset: a barrel of oil, a bag of plastic resin, a railcar of intermediate product, or a finished product waiting for a customer.
Owning inventory provides a host of options.
The company can sell it today or wait. It can process it into a higher-value product. It can allocate it among plants, customers, products, or geographies. It can use the material to keep a production train operating when supply becomes uncertain.
These options have value.
Management can decide how, where, and when to exercise these options to create value as the market and production assets dictate. Thus inventory can serve as a hedge against uncertainty. Once the inventory has been produced or purchased, then it comes with a carrying cost that needs to be managed and priced accordingly.
Recent disruptions make the option value of inventory unusually visible.
Following the de facto closure of the Strait of Hormuz in early 2026, the price of Brent crude oil rose from $61 per barrel at the beginning of the first quarter to $118 at quarter-end. Petroleum flows through the strait subsequently fell from 21.6 million barrels per day in the fourth quarter of 2025 to 4.9 million in the second quarter of 2026.
A barrel already in an accessible tank was not merely a balance-sheet asset. Depending on its location and the owner’s operations, it represented the ability to sell into a tightening market, maintain refinery runs, or avoid purchasing scarce replacement supply.
The Russia–Ukraine war produced similar effects across energy, grain, and fertilizer markets. In 2022, the World Bank described the increase in energy prices as the largest since the 1973 oil crisis and the increases in food and fertilizer prices as the largest since 2008. Companies holding the right inputs could preserve production and serve customers while the economics of replenishment changed sharply.
COVID exposed the same effect in semiconductors. Chip shortages constrained vehicle production, left dealers with depleted inventories, and contributed to long wait times and elevated prices. A small quantity of the right component could unlock the value of a much more expensive finished vehicle.
But COVID also supplied the perfect counterexample.
When oil demand collapsed and available storage filled, the marginal barrel of West Texas Intermediate crude briefly traded at a negative price. Another barrel was no longer a valuable option. It was a liability with nowhere to go. The valuable asset was empty storage capacity.
The lesson is not that companies should carry more inventory because another crisis might occur. That would be hindsight masquerading as strategy.
The lesson is that the economic value of inventory depends on the state of the system: price, demand, location, specification, storage capacity, lead time, production constraints, and the alternatives available to management. A static aggregate target cannot represent all of that.
Targets aren’t wrong per se. They help provide guard rails to keep the business within normal operating parameters. However, they frequently become the decision.
A naive target does not account for lead times, freight costs, network design, demand, pricing, outages. It drives toward a number. This is Goodhart’s Law in action: when a measure becomes a target, it ceases to be a good measure. This potentially destroys enterprise value in favor of an accounting metric.
Consider the case where inventory is cut while lead times and demand are increasing for a particular product. The company is now running higher risk of stock-outs and missed orders to hit the target.
The inverse happens as well. A total that looks healthy can be padded with slow-moving or obsolete inventory, which hides shortages in the products customers actually need.
The risks may be worth it, but high-level inventory targets or back-of-the-envelope calculations based solely on average demand and cycle times don’t consider those costs or tradeoffs.
The companies with the strongest supply chain reputations do not run inventory off a static number. Where they have published the details, the pattern is consistent: inventory targets are outputs of a model that gets rerun as conditions change, not inputs handed down from finance.
Intel is the most thoroughly documented example. Starting in 2005, its channel supply organization replaced planner-set targets with multi-echelon inventory optimization (MEIO), which sets inventory levels and locations across the whole distribution network at once. One year in, total inventory was down more than 11 percent, and products planned with the model ran service levels eight points higher than products planned without it. The process now runs weekly. Planners accept over 99.5% of its targets without changes, and Intel's finance organization credits it with more than $1.3 billion in gross profit from 2014 to 2017. The combination is the tell. If lower inventory had simply meant thinner buffers, service would have fallen. It went up because the inventory moved to where it was doing work.
Schneider Electric, ranked first in Gartner's Supply Chain Top 25 for four consecutive years, came at the same problem through its planning parameters. Its safety stocks had been set with traditional methods and updated quarterly, so they lagged actual changes in sales and supply. When pandemic transport disruptions began shifting lead times week to week, Schneider moved to a system that re-estimates lead times and recommends safety stock by SKU and distribution center in near real time. The company reported six fewer days of inventory, about a 10 percent reduction, along with six days faster delivery and a 400 basis point gain in customer satisfaction.
Amazon has published less in the way of results, but it has described the approach. Its multi-echelon system computes opportunity costs for storage and flow at every fulfillment center and uses them to set inventory positions across the network in near real time, unifying buying and placement decisions that used to be made separately. That is marginal economics at scale: every unit's position has to be justified by what it is worth there against what it costs to hold.
None of these companies ignores inventory levels. Gartner's ranking itself gives inventory as a percentage of revenue a 10 percent weight. And while I can't say these companies never trim inventory ahead of a quarter close, their day-to-day policies are set by models with explicit economic objectives. That lets them weigh inventory against service, cost, and risk directly, and know whether a buffer is earned, rather than letting finance make the call.
This way of viewing inventory shifts the decision to the marginal unit.
Sell the unit today if what you get for it now exceeds what you expect it to be worth later, minus the cost and risk of holding it until then. The same logic applies to buying or producing the next unit: fund it only if its expected value exceeds the cost of carrying it.
Inventory stops being a hard target, instead, it’s a value that emerges naturally from the decision process and economics of the company and its management. It could still be that inventory needs to be cut drastically, but it could also be that you’re already running too lean and problems are just around the corner.
The purpose of inventory management is not to minimize inventory. Nor is it to maximize resilience or speculate on future prices. It is to determine which physical options are worth funding and which are not.
A target is defensible only when management can explain what uncertainty it covers, what outcome it protects, why the inventory belongs where it is, and what conditions would cause the target to change.
Inventory discipline does not mean holding less.
It means knowing what your options are and the cost to exercise them.
What's your next unit of inventory worth? Book a free working session and let's find out together.