Manufacturing and distribution will be coping this year with both lower inventory to sales (I/S) ratios and more absolute inventory at the same time. That pattern will push I/S ratios down to record lows. Yet, there will actually be more inventory on hand as companies build up in anticipation of increased sales.

In fact, this pattern first showed itself last October. That's when wholesale inventories rose 0.5%. However, the I/S ratio fell from 1.20 to 1.18 because sales expanded 2.0%. This is the expected trend through mid-year. While rising inventories will be mostly finished goods, manufacturers are now adding to in-process and raw materials inventory as production increases. As a result, handling and storage operations will need to expand at the same time that they become more efficient.

For many operations managers, directives to rebuild inventory again are replacing those that most recently had them trimming inventory to bring it in line with sales. This shift is resulting from abrupt changes at the end of last year in expectations for sales and attitudes toward risk. And that's in line with a reversal in the decline of jobs and a jump of 6% in new equipment orders.

At the same time, record high labor productivity gains, capped by a 9.4% annualized rate increase in the latest quarter, have pushed corporate profits sharply higher.

In line with those shifts, materials handling equipment demand began rising last fall. October shipments from U.S. equipment suppliers were the highest in 18 months.

Inventory holding cost trends are also reversing. Credit, warehouse, insurance, labor, property tax and freight cost trends have all turned up in the last few months. So far the impact on holding costs is minor but it will become noticeable in a few months and significant by year end.

In this inventory building cycle, the supply chain will become extended for many products, especially electronics, vehicles and apparel. That will be the case because the share of imported materials, components and final goods is now higher. Meanwhile, inventory held in the U.S. may not be higher relative to final sales, but supply chain managers will be responsible for more inventory in other countries and for in-transit goods. As a result, inventory management will be more difficult and mistakes more costly in 2004.