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Apple Lesson of the Day: Inventory Is Evil

By Evan Niu, CFA - Updated Apr 7, 2017 at 6:13PM

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Inventory is a delicate balancing act that Apple has mastered.

There are plenty of lessons to learn from the largest company in the world by market cap. Even though Apple (Nasdaq: AAPL) just breached the magical $500 billion mark for the first time, joining a select club of companies to have scaled to such capitalization altitudes, it's still only halfway to reaching the mythical trillion-dollar market cap.

We've already Foolishly discussed a couple of lessons that Apple has taught us so far, such as why product depth is more important than breadth and why industrial design is so important. Let's tackle another lesson that rivals should be taking note of.

Inventory is evil.

Not just evil, but "fundamentally evil"
There's good reason that Tim Cook is now Apple's CEO, after earning his stripes as Cupertino's COO for many years. Despite the fact that he's not a "product guy" like Steve Jobs was, much of Apple's operational prowess and unparalleled supply chain is directly attributable to Cook.

Cook started at Apple shortly after Jobs' return as the last millennium was winding down. Prior to his arrival, Apple's manufacturing, distribution, and supply operations were a jumbled mess. It was his call to withdraw from manufacturing in favor of using contract manufacturers, as well as to close down warehouses all over the world.

Importantly, this was around the time that Dell (Nasdaq: DELL) was making a name for itself by pioneering the build-to-order model with computer assembly, which inevitably became a model of efficiency for the whole computer industry.

Cook has always viewed inventory as "fundamentally evil." He's noted that inventory typically loses roughly 1%-2% of its value per week under normal conditions, but can depreciate faster when times are tough. He even compares it to milk that's about to go bad: "You kind of want to manage it like you're in the dairy business. If it gets past its freshness date, you have a problem."

Having inventory sitting on the books is a risk in itself, because if it's not being sold, it's bound to be written down eventually, which can be painful. Just ask Research In Motion (Nasdaq: RIMM) how it felt when it had to eat a $485 million pre-tax non-cash charge just a few months ago related to its glut of unsold PlayBooks that were sitting around collecting dust.

Can I get your digits?
Let's take this a step further with some cold, hard numbers. There are two metrics that I'll focus on: inventory turnover and days of inventory.

Inventory turnover is typically calculated as cost of goods sold divided by average inventory, and theoretically represents how many times a company's current inventory balance could be sold and replaced during the period.

In general, a higher number is better because it indicates greater efficiency with moving the company's product, which minimizes the risk that it will lose value and need to be written down. A higher figure shows that the company's inventory is being managed properly.

Days of inventory is closely related and is calculated based on inventory turnover. You get this metric by dividing the number of days in a period by the inventory turnover. It theoretically represents how long it will take to sell through the company's current inventory balance, but can also be interpreted as how much inventory a company has on hand.

In general, a lower number is better here, but not too low. If a company has an inventory shortage, then it's leaving money on the table in terms of unsatisfied demand. If it's too high, that likely means the company has too much product and runs the risk of getting hit with the aforementioned writedowns and impairments.

How does Apple stack up to some of its computer and mobile device rivals?


Inventory Turnover (TTM)

Days of Inventory (TTM)

Apple 69.4 5.3
Dell 35.7 10.2
Hewlett-Packard (NYSE: HPQ) 13.8 26.5
Research In Motion 15.7 23.2
Motorola Mobility (NYSE: MMI) 12.6 29

Source: Reuters. TTM = trailing 12 months.

In terms of efficiency measured by inventory turnover, Apple leads the pack by a large margin. Even Dell, which was once regarded as the paragon of efficiency within the PC industry, trails Apple's lead, although it bests its closest domestic competitor, HP. Looking at historical days of inventory adds additional perspective.

Apple Days Inventory Outstanding Chart

Apple Days Inventory Outstanding Chart by YCharts

Note that the figures in the chart differ from those in the table above, since the table is presented on a TTM basis while the chart is not, and the data on Motorola is limited due to its spinoff in 2011.

Apple: Inventory extraordinaire
While it can be susceptible to shortages every now and then, Cupertino has mastered the ancient art of balancing its inventory -- keeping just enough on hand to meet surging demand while minimizing impairment risk.

Most of its inventory is carried at its retail stores, and anyone who has ordered from its online store will notice that products are frequently shipped directly from the manufacturing facilities in China. In those cases, Apple never takes possession, so it never bears the risk of eating writedowns of those products.

Apple's superior inventory and operational agility are today's Apple Lesson of the Day.

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Fool contributor Evan Niu owns shares of Apple, but he holds no other position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of Apple. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. Motley Fool newsletter services have recommended writing covered calls on Dell. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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