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The Big Squeeze

With debt and equity markets closing for business, it's now time for CFOs to look closer to home for capital.
Ben McLannahan, CFO Europe Magazine
August 1, 2003

Executives at Siemens Mobile were certainly no different from everyone else as they succumbed to the high-tech mania of the late 1990s. "We thought the good times were going to last forever," admits CFO Joe Kaeser with a rueful shake of the head. "We got crazy about rolling out new phones, and basically neglected demographics — there were just not enough people out there to buy them."

But it was only after a less-than-festive Christmas season in 2000 that senior executives at Siemens Mobile, the largest of 15 divisions at its parent Siemens, the E84 billion German electronics and electrical engineering giant, realized they had a big problem on their hands. Not only were vast amounts of unsold handsets languishing on the shelves of warehouses, but sloppy accounts receivable processes had left the division with mountains of unpaid invoices. By the end of the second quarter of 2001, net cash tied up in inventory and receivables had risen to €2.32 billion, or the equivalent to 4.8 asset turns (net sales/net working capital) a year. "We were in a terrible asset situation, much worse than our peers," says Kaeser, noting that the division had negative net cash from operating and investing activities of €621 million.

Three-Pronged Attack
This was when Kaeser took his cue. Until April that year, he'd been chief controller under group CFO Heinz-Joachim Neubürger, after having proved himself a turnaround expert as CEO of Siemens Microelectronics, a €1 billion California-based business. Dispatched to the troubled Munich-based division in May, Kaeser unleashed a three-pronged assault on inventory, receivables, and payables under a program called Cash Plus.

Among its features: shifting responsibility for the order-to-cash process from finance to sales; shortening the duration of network-building projects in order to receive much earlier payments; improving forecast accuracy to 85 percent by working more closely with major customers such as Vodafone and Orange; using improved forecasting accuracy to negotiate longer accounts payable terms and conditions; and reducing net inventory levels through increased use of 'No ID' production — that is, building reserves of semi-assembled handsets that can be quickly completed upon receipt of an order. The overriding aim of all those measures: to cut net working capital in half by doubling asset turns within two years.

By April this year, net working capital was down 63 percent to €855 million, equivalent to 12.1 asset turns. But Kaeser is far from finished. Having trimmed days inventory outstanding (DIO) to 12 days by the beginning of this year from 38 days in October 2001 — comfortably surpassing his initial target of 15 days — he now wants to bring DIO down to eight days. Here, the Web is likely to hold the key.

In June the CFO set up a cross-functional working group to examine the feasibility of creating an electronic marketplace where all assets and orders are visible to not only suppliers, but also customers. In doing so he reckons he can wring more cash from the firm's existing operations. "We've done it before, so we can do it again," he vows.

Cash on Demand
Kaeser isn't the only CFO in corporate Europe whose attention is fixed on working capital. Finance chiefs are honing their working capital management skills for a number of reasons. For some, it's a form of fresh funding as bank lending dries up and the capital markets become increasingly difficult to tap. "Going out and borrowing more money often just isn't feasible in this environment — there's been an incredible tightening of belts," says Ann Cairns, head of the working capital business management practice at ABN Amro in Amsterdam. Other CFOs need to free up working capital in order to please rating agencies and meet banking covenants, or to plump up dwindling pensions reserves.

CFOs are finding plenty of cash locked away in their own books thanks in large part to overdue accounts receivable, rising inventory levels, and haphazard accounts payable processes. According to REL, a working capital consultancy, western European companies have more than €600 billion trapped in inefficient cash-flow management. (CFO magazine's annual survey of working capital, prepared in cooperation with REL, will appear in the September 2003 issue.)

In some cases, releasing this trapped cash is a matter of real urgency. "It's a shortage of cash, not a lack of orders, that's at the root of most [corporate downfalls]," says Peter Ingenlath, an analyst at Gerling NCM, a Cologne-based credit management company.

Indeed, there's nothing like the prospect of a business failure to focus the mind. "The companies that learn fastest are the ones that have come closest to the flames — those that have had a brush with a liquidity crisis or a covenant breach," observes Philip Davidson, London-based head of restructuring at KPMG.

Maarten Henderson has certainly been feeling the heat. As CFO of KPN, the €13 billion Dutch telecoms provider, he had to deal with a nasty liquidity crunch in the autumn of 2001. Struggling to contain a debt mountain of around €20 billion — largely a consequence of the frenzied 3G mobile license auctions in the Netherlands and Germany — the firm sustained huge first-half losses in 2001, an 85 percent fall in its share price from January to June that year, and was picking up the pieces after a failed merger attempt with Belgacom of Belgium. Fears of a liquidity crisis were mounting as analysts drew attention to the fact that the firm had €3.6 billion of debt falling due the following year. Even with access to funds from a project finance facility and a receivables securitization program, KPN would need to find around €800 million from other sources.


The Crackdown
Two days before the September 11th attacks plunged markets into deeper turmoil than they already were, Henderson managed to secure a €2.5 billion revolving credit facility, providing KPN with a liquidity backstop for the next three years.

Once that facility was in place, Ad Scheepbouwer, former chairman of TPG, the €12 billion Dutch postal and logistics group, stepped in as the firm's new CEO and immediately set to work on a turnaround plan. As Henderson explains, a key element of that plan was to lift cash flow by squeezing working capital, and to use the freed-up cash to pay down debt. But that was clearly easier said than done. "KPN is a very old, former state monopoly, made up of many business units," he says. "Coherence between them had traditionally not been that strong."

Launching his working capital crackdown at the tail end of 2001, the CFO assembled a steering committee that included external consultants from REL, KPN's company secretary, the heads of corporate sales and billing, and representatives from all big business units. For the first year of the campaign the committee held weekly, 90-minute meetings, setting up a step-by-step plan to improve receivables, payables, and inventory management. By the end of 2002, the team freed up a whopping €765 million of working capital, leaving KPN with €2.8 billion of free cash flow generated after capex.

Combined with an asset disposal program, that helped push net debt down to €12.4 billion in 2002 from €15.7 billion at the end of 2001. Moody's response in April was to upgrade KPN's long-term debt credit rating from Baa3 to Baa2, while S&P raised KPN's outlook from stable to positive in March this year. Henderson says he was "pleasantly surprised" by the total cash extracted. "When you start something like this you know you're not perfect, but you have no firm idea of how much capital you can release."

Sunken Treasures
The largest portion — €529 million — of that total was gained by attacking receivables processes. The committee began by harmonizing the billing patterns of the firm's 8 million retail customers, who were divided into 23 billing zones around the country. Some zones were collecting monthly payments in advance, while others collected on a two-month cycle.

By year-end, those differences were history — the firm now has a standard, monthly advance-payment schedule across all zones. That means faster billing and improved account visibility.

For big corporate customers, the committee installed a disputes management database that displayed, for the first time, the amounts owed by all debtors and the reasons for each dispute. Accessible via the intranet by all registered users, and featuring key performance indicators like WART — weighted average resolve time — the system makes it easier for credit managers to home in on the largest, most stubborn non-payers, and when necessary, help calculate installment payment schedules for cash-strapped customers. The upshot, says Henderson, is that the firm could finally "get overdue debtors down, and get disputes resolved faster."

At the same time, KPN introduced what Henderson calls a "proactive collection policy" for its top 500 customers. To facilitate payments, customers are assigned their own dedicated collection officer at KPN, who puts in a reminder call to them a week before bills are due. "It's important that customers realize the clock is ticking," Henderson says.

On the accounts payable side, the firm's base of over 25,000 suppliers was reviewed to see what could be rationalized. Fewer suppliers, Henderson reasoned, would mean that there would be greater scope for standardizing and extending credit terms, and less scope for errors in the management of payments. "It's a buyer's market rather than a seller's market, so we approached all our non-strategic suppliers, telling them to either accept longer payment terms, or go somewhere else," he says. Larger suppliers were briefed on the proposed changes in person by KPN representatives, while smaller suppliers got wind of the new regime through a mailshot. The hardball approach paid off — accounts payable increased by €123 million over the year. The remainder of the working capital reduction — some €113 million — came from leaner inventories, particularly in KPN's mobile division.

Throughout the year-long campaign, the "grisly details" of the ten largest disputes — some worth as much as €3 million — were published as standard items in monthly management reports, along with other working capital indicators. They also became regular points of discussion at executive board meetings. Henderson says that relentless focus was essential in "persuading people that we were deadly serious about reducing our working capital."

Plastics Surgery
A similar story has unfolded at Borealis, the €3.7 billion Danish plastics producer. The success of its two-year-old working capital management program was based on "a direct appeal to professional pride," making the performance of individual sales managers more transparent to other parts of the organization, says CFO Clive Watson, who arrived at the firm in November 2001 just as it embarked on a debt-reduction drive.

When Watson began analyzing the aging patterns of receivables a few weeks after joining from Thorn Lighting, a €600 million division of Austrian lighting firm Zumtobel, he found that Borealis's problems were largely internal — in a nutshell, sales managers were cutting their own deals with customers, granting some of them longer periods than others to pay their bills. At the end of 2001, DSO (days sales outstanding) stood at 58 days, of which 17 were DOO (days overdue outstanding, or unpaid invoices).


What Watson wanted to avoid was ordering an across-the-board squeeze on customers or encouraging earlier payment through bigger rebates. "It's very easy to reduce DSO by trading cash for profit, but that's like getting on heroin — once you start it's very difficult to get off," he says.

His approach was a subtler one. He began by circulating a Powerpoint presentation around Borealis's sales teams every month. This contained slides charting DSO and DOO performance for all eight business units (BUs), measured against figures for 2001 and targets for 2002. The presentation was accompanied by a hefty Excel file with 11 sections that showed, among other things, the largest overdue customers (that is, those with outstanding bills of €50,000 or more) by BU — and the name of the sales manager overseeing the account. Details of changes of payment terms and conditions on invoices by BU and sales manager were also included. "These files gave everyone a clear overview of the root causes of DSO build-up," says Watson. "You could literally see, table by table, which sales managers were contributing the most to the credit losses, and who was doing the best in terms of DSO."

At the same time, Watson set the wheels in motion to change the bonus schemes of sales managers, introducing new targets based on DSO and DOO reduction. Individual schemes vary, but generally, the emphasis has shifted from volume- or profit-related targets to cash-collection targets. "Everyone's become far more conscious of [cash], so that when you go out and sell, you go out and collect bills as well," he says. After all, "a sale is a gift until the cash is collected."

Watson's combination of analysis and incentives held the key to driving down DSO from 58 days to 48 days last year, and days overdue from 17 to 4. The firm also took out some 50,000 tons of inventory, reducing DIO from 48 days to 38 days. (See " Material Whirl: Vendor-Managed Inventory" at the end of this article.)

It's also noteworthy that although 2002 was a tough year for the plastics industry, characterized by high volatility in demand, raw material costs, and sales prices, Borealis increased operating profit to €85 million from €54 million in 2001. Strong cash flow improvements trimmed the firm's net debt by €297 million to just over €1 billion. Combined with low capital expenditure, that allowed the company to reduce its gearing to 79 percent from 102 percent at end of 2001.

Loud and Clear
The trickiest challenge of any working capital crackdown, experts say, is engaging not only finance but also other parts of a firm. "The problem with working capital management is that it's fairly fragmented, in terms of responsibility across the organization," observes David Knight, a treasury consulting partner at PricewaterhouseCoopers in London. "Half the battle is getting your arms around the problem."

Over at Siemens Mobile, Kaeser came up with a nifty battle plan. To whip up enthusiasm for the Cash Plus program, he launched an internal competition that mimics European football's Champions' League. In June 2001, he divided the top 30 countries by revenue in the Siemens Mobile network into two leagues of 15 "teams" — a Champions' League and a Premier League. Every three months, Kaeser awards points to each team based on the previous quarter's performance — revenue growth gets one point, profitability gets two points, and asset reduction and cash generation get three points. The league tables are published every quarter in the internal newsletter, with a final, year-end table based on the sum of quarterly league positions. And just like in real football, the league champions are presented with trophies — an Economic Excellence Award cast in perspex — while the bottom two teams of the Champions' League and the top two of the Premier League swap places. "You wouldn't believe how competitive people get," chuckles Kaeser. "It's amazing, the momentum and the tension it creates."

And like Watson at Borealis, Kaeser links Cash Plus targets to the corporate incentive system. Subject to particular functional and regional conditions, employees can take home a bonus of up to 25 percent of their base annual salary — and that applies not only to finance staff but also to logistics, manufacturing, and sales. "You have to make sure that everyone understands that cash and asset management are not just a back-office thing," he says. "You need to create a scenario where there's something in it for everyone, from top executives to the person in the lobby."

Meanwhile, many of Kaeser's methods have been adopted at the group level. Last summer CEO Heinrich von Pierer announced plans for the entire company to increase its focus on cash flow, buying into many of the features of the Cash Plus program. "In these difficult times, cash is king," as von Pierer put it when speaking to journalists in a July conference call.

Where Now?
But the spigots of working capital management can only be tightened so far. For many CFOs who have successfully released trapped capital, the question is, where now?

The challenge for Henderson of KPN is to find even more ways to squeeze cash from existing operations. By the end of 2003, KPN expects net debt to fall to €10.5 billion from around €11 billion today and to generate about €1.5 billion of free cash flow. That'll be tough, says Rick Deutsch, head of European investment grade credit research at BNP Paribas, given that "the easier, low-hanging fruit has been picked — it's going to be a lot more difficult going forward."


Henderson is sanguine. While acknowledging that this year's working capital reduction "won't be as big as last year," he has set his sights on further improvements in purchase-to-payment systems through better deals with suppliers, and through a complete credit risk analysis of all KPN's customers. The next wave of cash, he says, is just waiting to be tapped. After all, he notes, as a result of last year's efforts working capital process improvements are now "embedded throughout the organization, with extra checks and balances. It's never just a one-off."

Ben McLannahan is a senior staff writer for CFO Europe.

Material Whirl: Vendor-Managed Inventory

Under a typical business model, when a distributor needs a product, it places an order with a manufacturer. The distributor controls the timing and size of the order and maintains an inventory plan. Under a so-called vendor-managed inventory (VMI) model, that traditional trading relationship is reversed: the manufacturer receives electronic data on the distributor's sales and inventory levels, enabling it to know about every item that the distributor carries as well as receive true point-of-sale data. That lets the manufacturer gain tighter control of the order and stocking process.

According to Maria Jimenez, a Paris-based research director at Gartner, the technology consultancy, VMI software vendors — including i2, JDA, Logility, Manugistics, Retek, and Syncra — expect their business to take off soon. The brutal inventory write-downs of the past few years are leading to "much higher degrees of collaborative planning, forecasting and replenishment," especially between retail and consumer products manufacturers. European firms already using some form of VMI include Volvo, BMW, Interbrew, Ericsson and the UK's Co-operative Retail Trading Group (Co-Op).

Borealis has also been a VMI front-runner. The €3.7 billion Danish plastics firm, which produces over 3 million tons of polyethylene and polypropylene a year, began a primitive VMI project in the early 1990s with a handful of bulk customers in the Nordic region. The firm essentially ensured material availability by assuming responsibility for monitoring stock levels on-site at the customers' premises and for placing orders.

But VMI at Borealis made great strides after the firm set up an extranet in 2001. According to Jan Roed, group head of logistics, around 20 of the firm's largest European customers are now linked to a website run by Borealis, which provides both parties with near real-time information on current stock levels and consumption rates. Also available is information on historic consumption and planning/delivery efficiency. "It's now much faster and more reliable," says Roed, who aims to bring at least another 50 customers onto the extranet. "It's really a win/win situation — customers don't have to manage their inventory, while we get the stock off our hands."

That's a relief to CFO Clive Watson, who welcomes any initiative to improve forecasting. "Inventory is tough to manage in the business we're in," he says. "Plastics is very cyclical, very volatile, characterized by our customers going through stocking and de-stocking phases." Nonetheless, he notes, VMI helped the firm to take out some 50,000 tons of inventory last year, reducing days inventory outstanding from 48 to 38 days.




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