How manufacturers win by not playing the field

Doing business with a limited number of major customers allows manufacturers to hold fewer inventories for a shorter time, according to new research by Panos N. Patatoukas, an assistant professor at UC Berkeley's Haas School of Business. Patatoukas says inventories comprise a significant part of a firm's assets -- as much as 25 percent for the average manufacturer -- and can be costly and risky to hold as inventories can become obsolete.

"The matching between suppliers and customers is a bit like dating. When a supplier firm in the manufacturing sector develops a focused, long-term relationship with a major customer, both parties tend to benefit by choosing each other," says Patatoukas.

The study, "Customer-Base Concentration and Inventory Efficiencies: Evidence from the Manufacturing Sector," co-authored by Patatoukas and B. Korcan Ak, a Berkeley-Haas PhD candidate, was published in the February issue of Production and Operations Management. Manufacturing firms typically record three types of inventories: raw materials, work-in-progress, and finished goods. The supplier-customer relationship is centered on the transfer of ownership of finished goods.

In order to examine the link between customer-base concentration and inventory efficiencies, Patatoukas and Ak analyzed more than 15,000 annual reports of U.S. manufacturers over a 30-year period obtained from filings with the U.S. Securities and Exchange Commission. Using text-mining algorithms, the researchers were able to get insights about the drivers of inventory efficiencies.

Suppliers with fewer customers also enjoy better collaboration with their major customers, the study finds. In essence, their co-dependency fosters more information sharing that facilitates better demand forecasting and more efficient production planning.

The findings also build upon Patatoukas' previous research that found a concentrated customer base benefits the manufacturer's value to stock market investors.

"Investors appear to consider relationships with a limited number of major customers as a plus for firm valuation and are willing to pay a higher premium for manufacturers with more concentrated customer bases," says Patatoukas.

The case of Walmart and its relationships with its dependent suppliers exemplifies the study's findings.

"You may think of Walmart as this big, evil behemoth that is more likely to squeeze its dependent suppliers," says Patatoukas. "The study, however, illustrates how a dependent supplier doing business with a major customer like Walmart may actually do well in terms of inventory management through enhanced collaboration along the supply chain."

Patatoukas hopes that by combining accounting and operations management research, the study will provide new managerial insights about inventory management and firm value creation.