What's dumber than a box of hammers? For home-improvement retailer Lowe's Cos., it's the same box sitting on "high steel," the storage shelves that tower over every aisle, out of reach of customers. "If stock is on high steel, in a back room, or in a distribution center, then it's not in sellable position," says Robert Hull, CFO of the Mooresville, North Carolina–based company.
Sellable position is an obsession for Hull, who measures inventory turnover on a weekly basis. For Lowe's, as with most retailers, inventory is the most critical element of working capital. At first glance, then, it seems surprising that CFO's annual working capital survey, conducted by Purchase, New York–based REL Consultancy Group, showed Lowe's with a 10 percent increase in days inventory outstanding (DIO). That caused the retailer's overall days working capital (DWC) to soar 24 percent, to 60 days, and dropped Lowe's — one of the top performers in its sector in our previous survey — out of the first quartile of specialty retailers.
But as it turns out, Lowe's numbers are a good sign. Inventory spiked in 2004 because the company maintained historical levels of "safety stock" in its stores even as it increased the amount of products at its regional distribution centers. Lowe's did that because it didn't want any customers going away empty-handed during an initiative to increase reliance on that network of distribution centers. The initiative's goal: less backup inventory in stores, and replenishment from distribution centers in three-and-a-half days instead of seven. Ultimately, Lowe's R3 (for "rapid response replenishment") initiative will mean less inventory overall, and more of the remaining stock where customers can see it. "We manage the business for the long term," remarks Hull. "We'll take a short-term blip in a metric."
"[We] have taken a conservative approach," explained Lowe's 2004 annual report, "by adding inventory to our distribution network without lowering inventory levels in our stores." Most of that safety stock has been removed from stores since, says Hull, and inventory levels have already dropped in the first quarter of this year.
"For retailers, inventory turnover and customer service are obviously conflicting objectives," observes Stephen Payne, CEO of REL. Lowe's move, he says, "makes perfect business sense. Lowe's is using inventory as a strategic lever. It knows its initiative will drive out that excess inventory — and more — once it's up and running."
Why Working Capital Matters
Lowe's is not alone. The 2004 annual reports of many U.S. companies, including Gillette, KLA-Tencor, McGraw-Hill, and Wal-Mart, as well as European firms such as France Telecom, Saint-Gobain, and Sainsbury's, mention initiatives aimed squarely at reducing specific elements of working capital. At health-sciences firm Perkin-Elmer Inc., some 10,000 employees have received training in "compressing the cash cycle," says director of global processing Frank Giammarco.
One might ask why working capital matters when debt is cheap and companies are awash in cash. Companies these days are urged to deploy cash, not squeeze more of it out of daily operations. But even as our survey shows hints of growing capital expenditures, working capital remains top of mind for many CFOs. Indeed, continued working capital improvement — or even a controlled, temporary deterioration — can ultimately drive growth.
Zebra Technologies Corp., a manufacturer of bar-code-label printers, for example, keeps a tight grip on working capital even though it holds almost a year's worth of revenues ($663 million last year) in cash. "Working capital is important because it is the funding mechanism for future growth," explains vice president and controller Todd Naughton. "We think of ourselves as an acquirer. Managing working capital gives us the currency to do that." The company, which has no debt, has completed three cash acquisitions in the past three years and, with $500 million in revenues in 2000, bought back $100 million in stock.
Zebra does much of its business through resellers. That makes receivables the crucial working capital element. The company keeps resellers, often privately owned and thinly capitalized, on tight credit limits and terms. "We want top-line growth and we don't want write-offs," explains Naughton. "If we give a reseller a $300,000 credit limit and it pays us every 30 days, it can do $3.6 million a year [in sales]. If it pays us in 60 days, it does half that. By keeping the reseller to terms, it turns its account more frequently and we do more total business."
Likewise, he says, "when people start missing terms, accounts go bad quickly." By considering days sales outstanding (DSO) an early warning sign, he says, Zebra has kept its bad-debt expense at less than half a percent of revenue.
Naughton also argues that well-managed working capital can be a competitive advantage. "At 90 days of DSO, one of our competitors is probably at the limit of risk it can tolerate," he explains, "whereas if we are at 45 days, we can take a little risk on extended terms or extra credit limits if we have a good feel for a deal. A company stretched to the limit on its working capital can't do that."
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