Measuring inventory turnover efficiency using stochastic frontier analysis: building materials and hardware retail chains in Norway

Abstract

Operational efficiency in the retail business is vital in order to be profitable in a competitive environment. This paper investigates how environmental factors, firm size and time trends are linked to inventory performance. We use location data, demographic data and 16 years of financial accounting data from small and medium-sized home improvement retailers to explain inventory performance at a chain and a regional level. Traditionally a regression model could be used to assess the impact of the explanatory variables on inventory performance. We choose to use a stochastic frontier model since inventory turnover is linked to efficiency and productivity. Furthermore, we allow the model to control for key financial figures such as gross margin, capital intensity and sales growth. We find that efficiency in inventory performance varies depending on local market conditions and store location. Moreover, increased firm size tends to increase inventory efficiency, while time trend in inventory efficiency varies by retail chain affiliation. This paper provides new insights into the literature on operations- and inventory management, and suggests that retail managers should consider including environmental factors as part of their analysis when using inventory turnover as an efficiency benchmark.