I was intrigued by the cover page story in The Economist this week, titled “All you need is cash”.  While fleetingly wondering if The Economist had to pay royalties to the Beatles, I was more interested in their analysis of the changes occurring currently in our attitude toward cash management, particularly the attitude toward leveraging debt. 

Over the past decade the attitude of the markets, and consequently that of Finance, has been that cash is bad.  Right now the companies most leveraged are in serious trouble to finance their operations let alone refinance their debt.  The Economist relates this attitude to cash loosely to lean manufacturing and lean supply chains, where cash is the equivalent of inventory and must be reduced to a minimum.  While from an accounting perspective inventory and cash are viewed as assets, and therefore roughly equivalent, any operations person will tell you that inventory is a liability, especially finished goods.  As I have expressed in a previous article, a negative cash-to-cash cycle is the equivalent to debt:  Finance loves it, but it increases the risk enormously, especially when it is a financial instrument rather than an operational instrument.

I posted a response to The Economist article, the text of which is below.

## My Comment ##

While there is a lot of good analysis in the article, and some in the commentary, I do want to comment on the one sentence devoted to Lean manufacturing.  There is no doubt that Lean increases the risk of shortages in times of uncertainty.  The whole point of Lean is to have a repeatable and smooth process, especially when coupled with Six Sigma.  There are well recognized ways to “right-size” inventory to accommodate variability and uncertainty, both of which have increased because of the credit crisis. 

Too often in the West we have taken Lean to mean zero inventory.  This behaviour started with the US car manufacturers forcing their suppliers to adopt VMI without ever improving processes, the result being that the suppliers had to finance large inventories while the overall system inventory did not go down.

At the same time it must be noted that buffer inventory is there to buffer against demand and supply uncertainty.  Too often inventory targets were set on a “just in case” basis.  Applying Lean principles well and across tiers of the supply chain has reduced inventory.  What better way to free up cash for operations.

However, all too often Finance has forced Operations to set inventory targets that are too low, greatly increasing the risk of supply disruptions.”

My colleague, Randy Littleson, posted an article recently about a Fortune article on Tim Cook, the COO at Apple.  While the article, in my opinion, places too much emphasis on improved financial performance based upon the reduction of inventory, it also emphasises how much operational improvement has gone hand-in-hand with the reduction in inventory, including both opening the Apple stores, thereby getting a better view of “true” demand, and of outsourcing manufacturing, thereby gaining more supply flexibility.  In the process Apple has been able to “right-size” their investment in inventories.  Without the operational improvements, the financial improvements would have been difficult to sustain.

I do still worry about the manner in which Apple uses their market presence to force payment terms on their customers and suppliers which results in a negative cash-to-cash cycle.  This is a financial instrument which forces an extra burden of cash financing on the Apple suppliers.  Not only have they had to take on more inventory liability and carrying costs, but they have to finance long payments terms.  I do not believe this to be in the long term benefit of Apple, let alone their suppliers.

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Tags: Inventory, Lean manufacturing
Posted in Supply chain management
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