Posts Tagged ‘operations performance’

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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.