Working Capital Magic - From Customers to Cash Flow

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.

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.

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.

What Does That Have To Do With The Price of Inventory In China?

The CFO conference on Working Capital in Boston had a lot of intriguing presentations. One of them was on the financial aspects of supply chain management, specifically inventory. Now, as a former manufacturing operations person, this is a subject near and dear to my heart.

I think everyone agrees that too much inventory is bad. It sucks up working capital, it dilutes your balance sheet (even though it shows up as an asset), and it goes obsolete or gets damaged without getting paid for by a customer.

The question is, how do you define the cost of too much inventory?

When it comes to working capital management, inventory is a critical component of the Cash-to-Cash Cycle. We all know that Cash-to-Cash (C2C) is defined as DSO + DSI - DPO. DSO is your Days Sales Outstanding, DSI is your Days Supply Inventory and DPO is Days Payables Outstanding. Companies are looking to shrink their Cash-to-Cash Cycle, so they look at compressing DSO, DSI and extending DPO. Pretty much common knowledge.

What Dr. Stephen Timme talked about at the conference was quantifying the carrying costs of inventory. A lot of companies arbitrarily assign a 10% carrying cost charge to inventory while they are calculating inventory stock levels, reorder quantities, and supply chain management metrics. Dr. Timme's argument is that this number needs to be looked into further.

He breaks the carrying cost charge down into its root components - things like warehousing costs, labor costs, shrinkage costs, overhead, costs of obsolescence, etc... He also talks about using a before-tax calculation of inventory costs which would use the Weighted Average Cost of Capital (WACC). Due to the modification of this formula, the inventory carrying costs could balloon up to 30% annually in some cases. This would then place a much sharper focus on inventory reduction throughout the supply chain, especially for finished goods. After all, who wants to stock up with carrying cost charges of 30% annually?

And this is somewhat consistent with my experience in high tech and chemcials manufacturing. Typically as a rule of thumb, we've used 1% inventory carrying cost per month for commodity goods. For specialty goods with a high deal of obsolescence risk, we've used 1.5% per month. Either way, this is still low, because we really haven't looked at the opportunity cost of investing in inventory. Yep, the old WACC.

The thing is, although I agree with all this and apparantly so do legions of industry experts for the last 30 years (look at JIT, Kanban, Lean Six Sigma, etc...), my question has always been about balancing carrying costs with the costs of a stockout.

It is often very diffucult to assess the costs of a stockout. How do you know the sales lost due to the fact that you didn't have a particluar brand of product on the retailer's shelves? How do you calculate the stockout loss of not having a specific ASIC ready at a bonded warehouse for your customer? This is what makes the full assessment of how much inventory to have available difficult. And then you hear from the peanut gallery: Sales people scream when there isn't enough stock on had to service that "absolutely important" order. Finance people scream about not amortizing capital equipment costs with too little throughput AND they scream about having too much cash locked up in inventory when throughput is high. Purchasing negotiates some great price breaks based on volume, but the problem is, you still end up with way more raw material inventory than you need.

Some days, you just can't win. But I'm convinced that with better supply and demand information (here I go again with RFID), you can remarkably improve this process.

As far the tea in China, that's another topic - Has outsourcing manufacturing to places on the other side of the globe increased lead times and inventory investments, or has it really cut total supply chain costs?

RFID and Trade Promotion: Using the Confluence to Influence

I was in Walgreens last night, looking to fill up on my favorite toothpaste, but I found the shelves to be completely empty. Now I know that store level replenishment is not always perfect and wasn’t created with my specific requirements in mind. After all, I should probably have stocked up in advance. But it did get me thinking about tying together RFID (or Auto-ID) and real-time trade promotion and pricing.

If the RFID revolution goes through, and retailers and CPG suppliers attain this instantaneous picture of all inventory movements down to a case/package level, one great application would be in pricing and promotion. Everyone’s heard of pull-based replenishment systems on the supply side. But how about real-time push systems for the demand management side? It might just be a quick brain-tremor, but I was thinking that if the retailer knows the in-transits, on hands and the sell-throughs, they could also provide dynamic pricing and promotion. Then, if there was a supply/demand imbalance where supply was high, pricing and bundling changes could be done in real-time. All this would be geared to hit the retailer’s (and supplier’s) revenue targets.

So for example, in a slightly overstock situation, the pricing/promotion could dynamically lower price at the store for particular SKUs and bundle it with other slow moving SKUs. I would buy another brand of toothpaste if I was also getting a bottle of mouthwash too, at a total lower price than paying for each separately. And when I pulled the stock from the shelves and bought it, a real time replenishment process could look at RFID information about in-transits, optimal stocking levels and open-to-buy quantities to decide if and when a replenishment pull signal should be sent to the supplier. I have to imagine that this would not just help sell through and increase inventory turns but also cut down on product returns to the supplier and deductions from retailers.

I probably shouldn’t be babbling on about running out of toothpaste and mouthwash – you people might get the idea that my oral hygiene is not up to par.

None of this would immediately help me in my quest for my particular flavor of Crest, but all the same, mini-applications to leverage real-time supply chain and demand information to maximize profitability would be pretty cool. More on easy-to-use replenishment algorithms later, along with Active vs. Passive RFID technology.

I chose to buy Colgate. It worked out fine.