Working Capital Magic - From Customers to Cash Flow

Air Travel

Ever been in an extremely bumpy airplane ride where you thought the wings were going to get ripped off the plane?  Well, that's what I felt like today on my plane ride home from the Thanksgiving break.  The turbulence was brutal.  And you're hearing this from a guy that's probably been in over 200 airplane flights.  I used to consistently log over 110K flight miles per year.

The funny thing, in these bouncy flights, when people get nervous, they immediately look at the flight attendant to see how he or she is reacting.  They figure that if the flight attendant (who's clearly seen it all) is calm and collected, then everything should be fine.  In this case, I think our attendant was a little green, so people were a little nervous.  I guess the flight attendant is kind of a barometer of flight safety.

In any case, we safely landed back in the Bay Area. 

Collaborative Inventory Management Moves From VMI to JMI

I've been fascinated with Vendor Managed Inventory (VMI) programs for a long time.  Having managed VMI and Kanban programs for electronics suppliers in the past, I know some of the pain associated with having "demand-driven" replenishment programs.

In the past, VMI was all about the leading player in the supply chain (e.g. the retailer, big-dog OEM, etc) driving its suppliers to take more responsibility and liability for the inventory.  Under the umbrella of "short-term rolling forecasts" or "blanket Purchase Orders", the supplier was supposed to keep enough inventory in stock to ensure minimized stockout scenarios.  This was all pretty much a one-way street where suppliers were really being squeezed.

Now, it seems that there is indeed a leveling of the playing field between suppliers and buyers.  In this article on Vendor Managed Inventory Past, Present & Future, there is a clear movement towards JMI - Joint Managed Inventory.  This is the resulting scenario where entities along the supply chain share in real-time information, profits and losses.  The standards for CPFR (Collaborative Planning Forecasting & Replenishment) sure go along way to help bringing all this to fruition.

Some of the elements of JMI would be:

1. Clear delineation of contractual inventory liability - this would span from determining liability for outstanding POs, on-hand inventory, WIP, etc

2. Clearer understanding of "frozen" forecast periods.  Whether this is the typical 3-4 weeks depending on lead time or some other time period, clearly suppliers can only react to forecast or demand changes within a certain amount of time.  There has to be a clearer definition of this time period in order to make certain the JMI program and liabilities are fair to all parties

3. Segmentation of customer and inventory types:  Depending on the demand variability in different products, the Cost of Goods Sold of different SKUs, customer segmentation, etc... the Service Level Agreements that govern the management of inventory have to be defined at a granular enough level.  This helps to avoid sticky situations during quarter end when all parties need to take a look at who performed at what level and who owes what to whom.

I'm sure there are a lot others, but sorting things out during a QBR is challenging enough without having clear guidelines in the contract.

Pay the Invoice or Play the Float? The Dilemma of Accounts Payable

Managing vendor relationships is tricky enough without bringing A/P into the picture.  Typically, your purchasing or procurement department has jumped through hoops to beat down your vendors on pricing, quantity, terms, delivery, etc...  Now, it's time to take a look at the final step of procure-to-pay:  Paying your vendor's invoice.  Should you pay early and take a discount, should you pay on time or should you hang on to the gold and play the float?

I think the right answer is based on 3 things:

1.  Based on vendor segmentation, how critical is this vendor in your supply chain?  Are they a sole source, do you have competitive bids out there, can you afford to be on credit hold, etc...?  Also, how has their on time performance been?  Has their fill rate been dropping?  How about product quality?  These should all be taken into consideration in a vendor scorecard which gives you a quick glimpse into real-time vendor performance

2. What is you current cost of borrowing money?  Depending on whether its cheaper to borrow money or take a hit on the offered discount, companies should figure out when to pay invoices.  Just make sure that the invoices are reconciled with the original purchase order and goods receipt ticket.  If not, like many other companies, you just don't pay the bill until the vendor screams at your doorstep.

3.  Most of all, companies should aggressively but fairly negotiative payment terms with vendors.  Maybe in certain cases, your vendor might be willing to give you a bigger concession on discounts or volume buys than you otherwise might have been conditioned to expect.  After all, you don't get unless you first ask.  For example, if your vendor usually extends 2%net45, maybe they would be willing to extend 2.5%net30.  Or give you a higher volume discount, etc...

I have some data that I'll share on a future posting about proper procedures for float management and vendor payment portfolio management that will help your company maximize its cash flow.

And don't get me started on Evaluated Receipt Settlement.  Great for the customer, but a pain in the neck for the supplier...

Measuring the Benefits of Six Sigma

I read a recent article by Cristian Ulloa in iSix Sigma magazine that I thought was pretty interesting on measuring the benefits of Six Sigma.  As you might have figured, I liked the fact that it melded Six Sigma with Theory of Constraints.  A great statement in the article was:

"Sharing credit for the benefits of projects that have directly or indirectly contributed to increasing the total throughput of the system generates a positive impact on the behavior of the teams involved. Teams understand that, even if their project may not have an immediate impact on improving the whole system, when the final bottleneck is addressed, their project will be acknowledged for its role in the higher throughput level. This also is beneficial in motivating project teams to use Six Sigma as an effective tool for improving processes"

Talk about elevating the constraint.  In this case, the project team (and one hopes the entire company as well) is focused on the bottleneck to production and revenue.  It's probably a lot easier to believe in the statement "an hour saved at a constraint is an hour saved for the system, while an hour saved at a non-constraint is simply a mirage" if your bonus paycheck is tied to it....

Improving Working Capital: Where Should You Focus?

If the Working Capital cycle tied to cash flow is comprised of A/R, Inventory and A/P, where should companies focus their energies to get the biggest bang for their buck?  The obvious answer would be "all of the above".  But the reality of the situation is that this isn't always possible due to limited resources, time and focus.

There's been some research that points to how effectively companies think they are managing the different aspects of their working capital cycles.  Here's what I found to be interesting:

1. When it comes to Accounts Receivable management, companies tend to inherently understand that collecting their cash faster will lead to better working capital.  Pretty much common sense.  However, what's realy interesting is that when asked whether their extended terms were similar to, higher, or lower than their competitors, most companies (95%) replied that they thought they were in the same ballpark.  But, when these same companies were asked if their pricing was the same, higher or lower than their competitors, a much smaller percentage (67%) thought it was the same.  Seems to indicatethat most companies are much more aware of their pricing variations than their trade recevaibles practices.  Which is strange, beacuse although pricing is a direct part of revenue management, A/R is where revenue actually materializes.  You would think that both parts of the quote-to-cash cycle would receive equal attention.

2.  Inventory is a much talked about and (mis) understood subject.  Everybody unstands the need for it, but hates it all the same.  The question is: how much can inventory turns really be improved?  The usual benchmarks for best-in-class reduction in days of supply are around 5-30 days.  In some cases, if companies would prune their product portfolios, the upper end of this range could easily be acheived.

3. Accounts payable is the least glamorous of the working capital management process, but can really add some value.  Every company knows it's a highly manual function, but can reap some tremendous value if properly managed.  I'll be talking about how strategic float management coupled with intelligent discount-taking can really streamline the procure-to-pay cycle.  Typically, companies think that a 20-30 day extension of DPOs is possible if their is enough focus on A/P.  The trick is to do this without risking valuable vendor relationships.

The Inventory Postponement Man Always Rings Twice

Its no big secret that inventory postponement is a great strategy for many industries.  Postponement allows inventory to be stocked at a semi-finished level and only configured and further manufactured into the finished good based on actual demand coming in.  This in turn reduces the chance of excess and obsolete inventory, can reduce overall cost of goods sold, and more effectively manages working capital and asset utilization.  However, the actual implementation of a good postponement program can be a tricky thing.

For many assemble-to-order or configure-to-order industries, like computer manufacturing, the stocking level on the Bill of Material is pretty much cut and dried.  However, it's translating postponement effectively into other industries that requires some thought.

Some of the things I've picked up over the years about proper inventory postponement include the following:

1.  You have to consider the lead-time of the final assembly or manufacturing step.  If the lead time is relatively long, then fulfilling customer orders within a short time horizon can be very challenging.

2. Similarly, you have to look at capacity constraints and production costs in the final assembly (FAS) process.  If, for example, the FAS requires a lot of production to occur on bottleneck machines, you might have a problem.  The rule of thumb is not to starve a constraint, but not at the expense of throughput

3. Sometimes you have to look and see if postponement is even mechanically or chemically possible.  In the semiconductor industry, the die bank is a critical postponement point.  However, to postpone inventory further upstream can be tricky because of the long complex front-end manufcturing process which may cause futher postponement to be chemcially infeasible.  Just like in many industrial manufacturing enviroments, if you need to do a final paint and dry, postponement may not be economically feasible depending on the viability to running small lots through a painting/finishing line.

4. You also have to look at defect yields both in the processes leading up to the postponement point and after postponement.

5. Lastly, you need to also look at your distribution channel strategy and see where and if postponement makes sense.  If by postponing inventory, you are inadvertantly going to eat significant transportation costs, it may not be worth it.  You have to look at the tradeoffs of leadtime, carrying costs, and transportation costs.

It's all a matter of looking at the tradeoffs.

Deductions and Chargebacks Burning a Hole In Your Company's Pocketbook?

Everyone that sells into distribution or retail channels knows about deductions.  This is when the retailer or distributor decides to short-pay a supplier's invoice due to a myriad of authorized and unauthorized issues.  Deductions (or chargebacks as they are often called), result in a lot of revenue leakages for these companies, and drain profits.

Now these are some random thoughts, but lately I've realized that deductions and chargebacks management is a very complex problem that has multiple root causes.  I'll have a cohesive posting on these later, but having talked to numerous companies, some of the key elements I've heard are:

1. Deductions are a cross-Financial Value Chain issue: Since the reasons for deductions can range from trade promotions, logistics, non-compliance and plain mismanagement, this is really a complex problem.  Many groups may be involved, both internal and external to the company.  For example, it could be a marketing issue, a retailer's A/P issue, a concealed shipment, an unauthorized deduction, a return to vendor (RTV), etc... the list goes on and on.

This leads me to believe that business process changes, coupled with collaborative approaches can help alleviate this problem.

2. Throwing more people at the deductions problem is not the answer.  This is just plain costly and I'm not sure of the long-term viability.  You really need to influence the retailer's behavior as well as clean up your own internal processes.

3. It would make sense to work with retailers to streamline the entire quote-to-cash process, but sometimes they don't want to cooperate.  After all, retailers are the 800 lb. gorilla.  Why would they want to pay you faster? 

More on this later...Meanwhile you can also read this Business Credit magazine article on Deductions Management.

The Theory of Constraints on Laundry Day

OK, so it's been a pretty hectic couple of weeks.  After flying cross country , doing my daily commute and spending innumerable hours in the office, I've decided to clean up my place a little bit.  Not having a maid, this can actually be a big challenge that takes up my whole Saturday.

You're probably asking yourself - Who cares about this guy's weekend chores? And what does it have to with supply chain management?  Is he going to talk about his mundane errands next?

Well, doing chores is like running a manufacturing and distribution operation.  It's all about identifying the bottleneck or constraint and focusing on that to improve throughput.  In my case, just like the guy in this old but hilarious Wired magazine article, its all about doing laundry.  Keep in mind I live in a 9 unit apartment building with one washing machine and one dryer.  Talk about a capacity overload coupled with a big sequencing problem.  Everyone wants to do laundry on Saturdays. 

I think I'll just invest in a series of outfits that look exactly alike.  That way I can just wash them all together and really exploit my constraint (the dryer - it takes way too long).

So just for the record:

1. Identify the constraint - the dryer.  However, the washer is more expensive ($1.50 per load versus 75 cents in the dryer)

2. Exploit the constraint - I'll just stuff everything into the dryer - its all going to be toasty anyway.

3. Subordinate everything else to the constraint - Maybe I should just skip the washing - it adversely affects my throughput of laundered clothes.  But I think that may also affect my social life.  I suppose I could just shower fully clothed to skip a step (is this equivalent to an internal setup on the production line? Probably more like employing group technology for JIT manufacturing)

4. Elevate the constraint - I'm not going to invest in another dryer, that's my landlord's job.  I could just hang dry a bunch of clothes while the rest are in the dryer.  Not very high on the aesthetic meter as I live in an apartment. It would obstruct my view and then where would I be?

5. Don't let inertia impede throughput - Yeah, right.  I'm going to be in this exact same spot next week when I get back from Miami.  Like I said - there's probably a fortune to be made in disposable clothing...

I'll be back in the next few days with a non-jovial posting about chargebacks and deductions in the consumer goods industry.

Random Musings About Distributor Programs

I'm happy to say that this is possibly the only blog in America this week that has absolutely no commentary on the election.

Recently, I had an interesting discussion with a electronics company about their Financial Supply Chain.  This particular company deals primarily with Distributors and as a result is highly at their mercy.  The new revenue recognition rules really put the onus on suppliers to ensure that channel stuffing does not occur.  Basically, component suppliers that "sell in" to Distis can't recognize the revenue until the stock is "sold through" to the retailer or end customer. 

This is all put in place in order to prevent the supplier's salespeople from booking phantom orders and simply stuffing the distributors' warehouses, all in an effort to meet their quotas.  Sometimes, this is pure collusion between the supplier and the distributor and the Disti even charges warehouse holding costs to the supplier!

Anyway, I was looking through all the configuration of Disti programs like ship-and-debit, price protection, stock rotation, etc... and was wondering how this affected the whole quote-to-cash cycle.  Although the "sell in" is done on net 30 terms, and even though the Disti pays on time, the revenue can't be recognized until the inventory is sold thru.  In the high tech industry, where product lifecycles are very short and lead to rapid obsolescence, stock rotation programs are also pervasive.

It would be interesting to compare inventory turns (1/DSI) vs. receivables turns (1/DSO) for component suppliers.  The ratio between DSO and DSI should be a good index for looking at Quote-to-cash cycle velocity.  Tying channel inventory visibility to the quote-to-cash cycle would be pretty helpful for the high velocity demand chains in industries like consumer electronics or semiconductors.

Six Sigma: Balancing the Voice of the Customer with The Voice of the Process

I’ve been delving quite a bit in Six Sigma again, and I’ve noticed a couple of things that I missed over the last few years. First and foremost, there really is a tight correlation between the (supposed) Voice of the Customer (e.g. the requirements) and the (supposed) Voice of the Process (features).

Assuming the Voice of the Process is a stable and normally distributed process, then Six Sigma states that it should take up no more than half of the tolerance allowed by the specification limits (i.e. the Voice of the Customer). So in essence, based on QFD (Quality Function Deployment), there should ideally be a very close relationship between the two. After all, that’s the whole point of a Designed For Six Sigma process.

So the question is, if I have my requirements from a specific customer, then isn’t my Six Sigma designed process going to be firmly impacted by the variability in customer needs? What happens when customer needs change over time? What happens when they are very complex? This is where the practicality clashes with the textbook examples, in my opinion. Another example of this phenomenon for complex, engineered products can be found in the SixthSigma Blog NASA article – Beyond QFD.

And furthermore, in my opinion, once a process is under control and there is a shift in the process mean (increase in process capability), how does the Process Curve stay within tolerance of the spec limits? I’m sure that the calculation of the sigma varies to allow for this, but its not intuitive.

I know all this is very esoteric. I’ll put together some graphs to illustrate what I mean, along with a real business example. We can look at average defects in the quote to cash process.