I came across an interesting article in the McKinsey Quarterly titled “Freeing up cash from operations” that makes the argument that “companies should avoid the impulse to batten down their operations indiscriminately. Taking short-term steps and a balanced view of operations can keep cash flows healthy”.  When reading the article I wasn’t sure at first if it was a transcript of the presidential debates between Barack Obama and John McCain, or not.  (And we all know which way that went.  Just in case you missed the debate, Obama suggested reducing government cost “surgically”, while McCain suspended his campaign to fly to Washington.)

On a more practical and less esoteric note, the authors gave some good examples of bad practice and made some very good point about the benefits to the organization of a targeted approach to cost cutting. 

What a refreshing voice of reason.  Though I suspect neither the authors or I have to report to a board of directors, so we have the luxury of opinions without having to act on them.  They identified inventory and cash-to-cash cycles as two keys ways to improve cash in the current economic times.  I have identified these in one of my blogs with the caveat, which was also pointed out in the McKinsey article, that inventory targets must be “right sized” from an operational perspective.  The level of inventory reduction cannot simply be a dictate from the CFO.

Two of the biggest contributors to excessive inventory are a lack of supply chain visibility and latency in business processes, which are of course related.  The sales people might know that sales are dropping very quickly, but no-one in Operations does.  Operations are still producing to forecast.  And by the time Operations becomes aware of the change in demand, Procurement has already bought supply for the next production run.  The concept of replacing inventory with information has been around for years, but there are challenges to adoption of the concept in global, outsourced environments where little of the manufacturing capability is owned by the brand owner.  Effective communcation of information across organizational boundaries and collaborative decision making based upon the information requires a level of trust between companies (and even divisions within a company) that all too often does not exist because of adversarial cultures.  The most important KPI on which Procurement is usually measured is piece part reduction, yet they don’t usually own raw materials inventory, Operations does.  The result is that supply contracts are written without sufficient emphasis on operational effectiveness.  I am not suggesting that inventory be owned by Procurement only — that too would be an Operations nightmare — but that setting and attainment of inventory targets should be a joint responsibility of Procurement and Operations.  Similarly on the sales side for finished goods inventory.

I must commend the authors of the McKinsey article for suggesting simple and practical steps to improve accounts receivable (AR) and accounts payable (AP), such as tracking and enforcing payment terms, that are not simply financial engineering and an abuse of relationships and power.  I have strong doubts about the wisdom of using AR and AP to improve cash because I have seen too many abuses of power which may lead to a short term improvement, but in the long term the relationship with the supplier and the suppliers ability to survive are worstened.   

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Tags: Inventory
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