Posts Tagged ‘Inventory’

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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.   

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.

This morning we put out a press release announcing that Pioneer has selected Kinaxis RapidResponse for dynamic demand and supply chain management.  Pioneer is a global brand headquartered in Tokyo.  Like many companies, Pioneer is facing a more challenging supply chain management environment that requires them to better align supply and demand while reducing excess inventory and providing early detection of shortages.

######

Pioneer Corporation Deploys Kinaxis RapidResponse for Dynamic Demand and Supply Chain Management
Leading Electronics Manufacturer Chooses RapidResponse to Maximize Customer Responsiveness and Reduce Inventory Risk

Ottawa, Canada, November 18, 2008 – Kinaxis™ Inc., provider of the on-demand RapidResponse service that empowers multi-enterprise manufacturers with the collaborative and integrated demand-supply planning, monitoring, and response capabilities required in today’s complex and dynamic world, today announced that Pioneer Corporation’s Mobile Entertainment Business Group – the leading electronic manufacturer’s most rapidly growing business unit – will deploy RapidResponse.

Headquartered in Tokyo, Pioneer provides mobile entertainment products to major automotive customers in Japan, Europe and the United States from its primary manufacturing facility in Asia. Pioneer selected RapidResponse in place of an extension to its legacy supply chain planning solution, because of its ability to:

• provide multi-enterprise supply chain visibility,
• perform detailed analysis based on real-time Materials Resource Planning (MRP) calculations and
• support worldwide Sales & Operations Planning (S&OP) initiatives.

Pioneer was looking for a solution that could allow them to better align supply and demand, while reducing excess inventory and providing early detection of shortages. With deep supply chain visibility into manufacturing operations and real-time “what-if” scenario simulation capabilities, RapidResponse empowers Pioneer to determine the impact of changes within the supply chain and respond quickly and confidently, meeting both customer and corporate objectives. RapidResponse is projected to reduce both inventory and expedited shipment costs.

“As the market for mobile entertainment products continues to prosper, the stakes are high to provide on-time delivery and exemplary service to our global leading automotive customers,” said Hiroshi Tatsuta, General Manager, Production Management Department at Pioneer Corporation. “We chose RapidResponse for its unparalleled ability to enable us to keep up with ever-evolving demand patterns and in turn, better serve our customers.”

“The ability to make informed supply chain related decisions on the fly is integral to maintaining the competitiveness of a company – even more so for those industries that are experiencing rapid change,” said Randy Littleson, vice president of marketing at Kinaxis. “RapidResponse uniquely combines supply chain visibility of demand and supply within a single solution, with real-time analysis and simulation capabilities that will help Pioneer to thrive within this fast-growing industry.”

The deployment, which is expected to be completed by early 2009, is being performed in conjunction with Kinaxis partner, and leading Systems Integrator, EXA Corporation. Upon completion of a successful implementation, RapidResponse is expected to be integrated into other Pioneer divisions.

About Kinaxis
Kinaxis™ RapidResponse is a single on-demand service that empowers multi-enterprise manufacturers with collaborative and integrated demand-supply planning, monitoring, and response capabilities. RapidResponse embraces human judgment to enable planners and front-line responders to handle unpredictable changes. Global leaders such as Casio, Honeywell, Jabil, Qualcomm, and Raytheon use RapidResponse to achieve breakthroughs in sales and operations planning (S&OP), demand management, supply management, and supply chain risk management. The results are superior customer service, improved operations performance, and a competitive market advantage. For more information, visit the Kinaxis web site at www.kinaxis.com or the company’s blog at www.21stcenturysupplychain.com.

I wrote an earlier blog post titled “Supply chain lessons learned from the credit crisis” which looked at the importance of cash management and the need to understand the inventory liability in the channel in the context of cash management. The Wall Street Journal reports that Circuit City may be closing 150 stores and liquidating the inventory in an attempt to avoid bankruptcy. While the seeds of Circuit City’s lackluster performance are not rooted in the credit crisis, the Wall Street Journal does report that getting short term loans to pay for operations is proving difficult, hence their need to cut costs by closing 150 stores and liquidating up to $350M in inventory to pay for real-estate costs, such as abandoned leases.

While the fate of Circuit City is interesting, what does this mean for the Consumer Electronics companies which are Circuit City’s suppliers? How are they going to reduce their exposure not only to finished goods inventory liabilities but also to raw material purchase commitments made to satisfy anticipated demand from Circuit City? I think traditional forecasting and supply chain planning systems that rely on historical sales data are not the right solution. And speed is imperative. You can bet that all the other Circuit City suppliers are trying to solve the same problem, and many of them, especially the Consumer Electronics companies share common contract manufacturer’s and component suppliers. I suspect that customer relations principles and sound financial management, not to mention human behaviour, will mean that the first few brand owners that request a large change to supply commitments from the contact manufacturers may get a favourable response, but the ones last in line might get a different response.

What the brand owners need is a system that provides:

• multi-tier visibility to all inventory and commitments
• a collaborative environment that includes suppliers and customers
• rapid what-if capabilities, shared with their customers and suppliers, in which they can evaluate alternatives

An optimization engine run by the brand owner is not the solution. First of all the optimization engine will not be able to incorporate the compromises needed in such a situation. Second, a collaborative environment which allows all participants to understand their shared liability is likely to achieve a speedier and more widely accepted resolution than one in which only the brand owner’s needs are satisfied. They need a system in which any suggested changes can be evaluated immediately by other participants in the supply chain. Using a collaborative system as described above, the brand owner can also work with other retailers to understand how much of their finished goods they can divert from Circuit City, perhaps even running promotions to increase demand. Again speed in this context is imperative. Retailers will only be willing to run a few promotions at any one time, so being first to the table is very important in being able to shift the inventory.

Using RapidResponse, all parties along the supply chain can collaborate and immediately respond to the event and eliminate the unwanted inventory, thus cutting shipping costs, manufacturing costs, storage costs, etc.

IndustryWeek recently published an article entitled “Demand Planning: A Game of Chance or Strategy?“  A couple of things jump out when reading this article.

1. Need for better customer collaboration – They key to getting better forecast accuracy is to really understand your customer. For vendors, it’s the customer who holds the trump card … they are the ones who control what ultimately is going to happen (i.e. they are the ones that are selling your product). As a vendor you have to get into their heads and understand their business – who they sell to; how much they sell to their customers; how much you sell to them; what forecasting bias do they have; etc. It’s only by collaborating with your customer will you be able to understand them. Granted the unexpected will always happen, so having a good process in place to respond effectively and efficiently is important as well.
2. Need to break down the silos – far too often things are flung over the wall for someone else to “deal with”. For example, forecasts are flung over to the master schedulers to make happen, inventory policies are set by the inventory management group … seems tough to figure out how this type of execution can ever work. Groups need to get together and coordinate their activities.
3. Need to measure – it’s well and good to drive to the best forecast while respecting inventory policies; you have to take various measurements. For example, measuring forecast accuracy for each customer on a continuous basis allows you to adjust their forecast. In other words, it will give you a sense of their forecast bias.

Is our e-mail centric world the cause of not communicating with one another? Are we now simply content to say “I sent you an email”? Email is a great collaboration tool … the ability to communicate globally 24×7 has really extended a vendors reach. But in the end this is about collaboration – the ability to get together and solve issues … it’s not about sending something over the wall. Applications that integrate demand data, supply data and product data into a single instance and provide views that are specific for each of the groups will allow for far better collaboration – resulting in better customer satisfaction.

It would surprise me if anyone reading this blog is not aware of the financial crisis precipitated by the sub-prime mortgage lending that has been taking place over the past decade.  With a little creativity, there is a lot we can learn by extrapolating from the crisis into multi-tier global supply chains.  After all, what we are really facing is the money “supply chain” freezing up.

But let us start in the “real” world.  Over the next few months, and possibly even longer, cash is king.  Squeezing every dollar out of the supply chain ought to be high on the agenda.  The ability of a company to convert purchases into cash is best measured by their Cash-to-Cash (C2C) cycle.  The Cash-to-Cash cycle is defined as [“Days of Sales Outstanding” + “Days of Inventory” – “Days of Purchases Outstanding”].  While the contractual terms agreed with customers and suppliers are strong drivers for the C2C, the primary driver is speed with which a company converts purchased materials into products that have been sold to their customers, in other words the supply chain. In many cases the majority of DSO is accounted for by channel inventory, not only the true Accounts Receivables.  As a consequence there is a great deal that companies can do  to run their supply chains more efficiently in order to reduce their C2C.

First, understand which of your products your customer’s customer are buying.  Knowing only your “sell in”  forecast rather than your “sell through” forecast tells you nothing about your inventory liability in the channel.  Any unsold inventory in the channel is a liability regardless of payment terms because it affects your customer’s ability to pay you.  Even worse, if the channel inventory is not moving, it is unlikely that your customers will order more.  Your customers have to sell the stock at a loss, further eroding their ability to order more and pay you on time.  Channel inventory is a liability regardless if it is accounted for as Inventory or  Accounts Receivables.  Gaining visibility into which of your products your customer is selling gives you much greater control over the distribution of finished goods to your customers, increases their ability to pay you on time, and reduces the excess and obsolete inventory in the channel.  The same is true on the supply side, especially in Buy/Sell relationships with Tier 2 and Tier 3 suppliers.  Visibility into these inventories enhances greatly the ability of companies to manage their DPO and raw material inventory liabilities.

Too often we see brand owners leveraging their “muscle” to force suppliers to accept onerous payments terms, often many multiples of  the payment terms they receive from their customers.  While this will undoubtedly reduce the C2C, often making it negative, this is financial management along the lines we have seen from Wall Street, and is likely to drive some suppliers into bankruptcy during this period of tight credit.  As we have learned from Wall Street, clever financial management cannot mask poor fundamentals forever.  Instead the brand owners should be focussing on promoting and embedding superior operations performance.

Let us see if we can extrapolate from the financial supply chain to a manufacturing supply chain in order to derive lessons from the current financial crisis.  In this context I look at mortgages as channel inventory, mortgage lenders as the brand owners financing the consumers (channel partners) to build the houses by borrowing money or selling financial instruments to the banks (suppliers).  Once the market is flooded with inventory that is decreasing in value, this affects the channel partner’s ability to pay for what they have already bought let alone ordering more.  Which in turns affects the ability of the brand owner to pay the suppliers.  Once cash is tight, companies cannot invest in new products or equipment, which further erodes their ability to capture more sales.  We don’t have to look much further than Walmart to understand that most manufacturers live in a world in which the value of their channel inventory is decreasing daily. The key to being able to respond rapidly to changes in the market is to have visibility into what is happening in the market and a collaborative environment in which customers and suppliers can evaluate alternatives to reach a compromise which is of mutual benefit.  Without this level of supply chain visibility and collaboration, supply chain risk management is at best a blunt instrument.

Undoubtedly financial institutions came up with many fancy financial instruments that contributed to the current financial crises.  This is equivalent to the brand owner forcing onerous payment terms on the suppliers.  It doesn’t address the fundamental issue of superior operations performance.  Furthermore, when coupled with a lack of adequate visibility and controls to understand when things are getting out of control, we have a recipe for disaster.

I recently read our new white paper “Enabling Sales and Operations Planning with RapidResponse” that describes four capabilities required for sales and operations planning in the 21st Century.

I found this interesting because in my past life I was responsible for creating and presenting the sales and operations plan for a small division of a large aerospace manufacturer.  Recalling how that process worked, then contrasting it to what is described in the white paper makes me wish I could go back in time to leverage some of the new tools.  At that company, the process would start with pulling information from various sources; customer orders, forecast and supply orders were extracted from the ERP system.  Headcount, sick leave and vacation information was pulled from HR.  Labor allocation was provided from operations management and finally variance data was provided from finance.  All of this information went into individual Excel spreadsheets.  The sales and operations spreadsheet was a large Excel file with complex macros which pulled data from each of the individual files.   Often files were missing or were incorrectly updated.  I’d then need to track down the person(s) responsible.   Other spreadsheets were updated for the purpose of presenting key divisional metrics at the sales and operations meeting.   Once all the data was pulled together and met the sanity test, we would pull a subset of the sales and operations team together for the pre-sales and operations meeting.  The outcome of this meeting was invariably adjustments and a recalculation, often requiring a refresh of data from the ERP system.  Occasionally we required an additional pre-sales and operations meeting to get the numbers right.  Finally we were ready for the full sales and operations meeting.

Does this sound familiar?  If you have a stable sales and operations planning methodology today, you probably follow a similar process.

Total time for this process?  2-3 weeks. From my discussions with our customers, I have found that this is actually a pretty tight timeline.  Some have sales and operations cycles that last 5-6 weeks!

If your world is relatively stable, you might be able to live with 3 weeks to create a sales and operations plan.  After all it’s a monthly plan right?  But what if your world isn’t very stable?  We had a situation where we were preparing for a possible strike at our parent plant.  We had to create several versions of the sales and operations plan looking at different strategies for maintaining our inventory position while also trying to retain our highly skilled workforce.  Each version needed to be reviewed, modified and revised – not fun when the tool is Excel!

This is an aerospace example where demand is fairly constant.  What about other markets where demand is far more volatile?  Long sales and operations cycles are far less effective.  As is pointed out in the white paper, companies are starting to move to weekly sales and operations cycles, with additional meetings as required to address specific problems or opportunities.

Look at your own sales and operations process today.  How long does it take to run a sales and operations cycle?   What would it mean to your business if you could do sales and operations planning on a weekly basis?  What would it mean to your business if you could convene the sales and operations team to evaluate the impact of a significant change within hours of it occurring?  What if the decisions you make at the executive level could be instantly evaluated in terms of revenue, margin, inventory and customer service?

Sales and operations planning is moving into the next generation.  Is your sales and operations tool moving into the next generation as well?

I get a lot of requests for customer case studies.  In particular, a lot of companies that I talk to find they are struggling with inventory management best practices in the midst of their 21st century supply chains.  This is not suprising because the more globally distributed the supply chain and the more volatile demand, supply and product, the bigger the inventory management challenges are.  In many companies, it’s hard to get an accurate view of what inventory you have, and equally hard to efficiently leverage this “asset” to meet ever-changing business situations.

It just so happens that we have two customer stories that we can share that focus on these inventory management challenges.

The first is MC Assembly - a leading contract manufacturer.  Their customer spotlight has just been posted on our website.  Tom Rossi, vice president of procurement and materials says “Inventory turns have doubled and our excess / obsolete inventory is at an all time low. Our customers feel secure in knowing that we are managing the supply chain and not letting it manage us!”

There’s also a new article here in Supply & Demand Chain Executive featuring Kinaxis customer Alcatel-Lucent.  The article explains how, prior to the merger between Alcatel and Lucent, Lucent used Kinaxis RapidResponse to help reduce inventory from $6 billion to $1 billion over 3-4 years.  Arvind Ballakur, senior manager of supply chain and procurement at Alcatel-Lucent, goes on to say that “when the merger happened, we looked at various ‘what-if’ solutions that were in use at each company and selected RapidResponse as the key engine for all of Alcatel-Lucent.  Around April or May of last year, about four months into the merger, we started modeling the joint company’s in-house and outsourced operations.  By the end of this year we will have modeled 90 percent of the Alcatel-Lucent internal and external facilities, so we can provide a capability picture for all of the company.”  He goes on to say that “many people from the Alcatel side were surprised at its capabilities.  They had never seen a solution like this work company-wide.”

Charlie Barnhart has written a very thought provoking post here stating that inventory is not an asset.  This is a great topic given today’s market forces and something I’ve written about several times (see here, here and here).  Charlie has actually written a paper on this topic that you can access here.

While accounting is unlikely to change their categorization of inventory as an asset, supply chain management professionals increasingly realize that inventory is more a liability than asset.  The pace of change today is making that a reality for everyone involved in supply chain management.  Charlie has some great insights on the topic based on his years of experience in the contract manufacturing market, where inventory plays a central role.