We’re stuck in a painfully sluggish economy. Stifled consumption, overcapacity in shipping, and tumbling raw materials prices all point to the kind of slow growth that doesn’t turn around overnight.
Many organizations are struggling to drive revenue — some are already seeing shrinking revenue — which naturally focuses attention on the supply chain. The knee-jerk solution would be to seek cost savings by cutting supplier costs, but in today’s economy, indiscriminately squeezing supplier margins could actually end up hurting profits in the long run.
It’s time, therefore, to look at cash as the new cost. Freeing up cash flow instead of cost cutting will allow a company to not just mitigate losses from slow revenue growth, but actually increase shareholder value through proactive measures like stock buybacks, M&A transactions, and R&D investment. The secret? Focusing on reducing days of supply and building a lean-cut yet fast-moving supply chain — one that will carry a company through any number of economic headwinds.
How Much Can You Really Cut?
Poor macroeconomic conditions cause companies to suffer unnecessarily when their supply chain isn’t optimized for action. In a constant struggle to increase profits while fighting against sluggish growth, CFOs often turn to procurement for a quick fix.
Look at Indian steel producer Tata, which in November asked for an immediate 10% price reduction from its suppliers. Earlier in 2015, Wal-Mart demanded discounts from its Sam’s Club suppliers and went on to introduce fees to vendors in its network. Traditionally, a wave of companies demanding price cuts is a sign of a sluggish economy; a quick way to free up cash. But in a down economy, as margins shrink with a company’s revenue, the organization can cut as much costs as it wants and still run out of cash.
What are the real risks of costs over cash?
Suppliers won’t make you a priority. When a customer keeps squeezing supplier margins, they will stop prioritizing that company as a customer. Some suppliers choose to end business with companies after payment terms are extended too far — others will put different clients ahead of you when it comes to last-minute asks or special requests. For example, if a department store wants to run a promotion and it’s not prepared for a sales spike in that region, it will need suppliers who will work with it on an extra push for inventory.
Disruptions will hurt more. Without a strong supplier relationship, it’ll be harder to get a response from suppliers after a big disruption floods them with calls. In situations in which a company faces massive losses due to disruptions — such as the $277 million Toyota lost in the recent slew of Kumamoto earthquakes — it helps to have built up a cooperative relationship with suppliers who could help save your operations (and your quarter).
You won’t even know you’re losing money. Excessive days of supply are by far the biggest waste of money in an operation, but it takes a psychological — and monetary — investment to analyze the supply chain and understand where the organization is holding unnecessary inventory. A single-minded focus on cutting costs just detracts attention from that holistic analysis of spending.
The Missing Cash Flow
Days of supply is one of those concepts that most people are reluctant to tackle for fear of stock-outs and missed sales opportunities, but remember: every dollar of inventory you can take out of the supply chain equates directly to a dollar of free cash flow. For a typical Fortune 100 company, this represents $50 million to $100 million of free cash for each day of supply chain saved. Take it from a company who succeeded: Flex, a global supply chain solutions company, showed savings of more than $350 million in their annual report — by taking just five days out of their 65-day supply chain. Plus, their faster supply chain allowed them to react more quickly to revenue opportunities.
So how do you reduce days of supply to free up millions in cash flow without increasing risk? Two ways: build more strategic supplier partnerships, and set up mechanisms to manage issues across the supply chain in real-time.
Many companies are reluctant to develop products with their suppliers, because they’d rather maintain complete control over their design process. And while this may offer some intellectual property protection advantages, it doesn’t bode well for the partnership. Companies that develop parts with their suppliers actually benefit the most.
Stanford Business School Professor Hau Lee spoke about the inherent value of strong partnerships: “Now, when Nike develops new products with special requirements, instead of looking to the supplier for only procurement, they look at them as a source of potential ideas and innovation. These suppliers have quick turnarounds for prototypes, meaning it’s good for them and for Nike — for the whole invention process.” Co-development means specific expertise, shared research and development costs, and more often than not, more bang for the buck.
A good way to approach suppliers, according to one automotive chief procurement officer, is to say “I want to pay this much, and I need a product that does this. How can we work together to achieve that?” By letting the supplier develop parts with you, you encourage them to take ownership of the endeavor, not only sharing the costs but also speeding technological advancements.
Real-Time Issue Management
Think about the real-time technology you use every day: new photos on social networks; updates in your professional network; real-time stock, weather, and traffic conditions. As a consumer, there’s a wealth of information at your fingertips — so why do the supply chain technologies that underlie $25 trillion of the global economy still take weeks or months to deliver information a company needs to make business decisions?
Ultimately, the best way to reduce days of supply is to utilize the wealth of data at your disposal to make your supply chain work for you in real-time. Chances are, lackluster technology is shrouding much of the chief procurement officer’s operations in the form of delayed, self-serving, or miscommunicated updates. And because supply chains typically buffer against uncertainty with inventory, poor information leads directly to an increase in days of supply.
Supply chain teams need to be organized in a way that promotes open, transparent, and real-time information sharing, so the team can stay up-to-date on both risks and opportunities (which we refer to collectively as “issues”). And the tools and processes need to be in place to contextualize and transform that communication into swift decision-making ability.
If you don’t know where your inventory is being held, and how that relates to demand spikes or disruptions, then you can’t safely remove any of it from your supply chain. Real-time issue management provides organizations with the ability to not just know faster, but act faster. That newfound agility will reduce the uncertainty and delays that bloat operations and tie up working capital.
A company’s supply chain executives want to support company growth while still meeting margin targets — and those achievements start with freeing up cash flow from the entire supply chain, rather than just cutting costs from procurement. Optimizing for fewer days of supply will allow a supply chain to run faster and with more agility, all while providing a cash boost when the company may need it the most.
Nader Mikhail is founder and CEO of Elementum, a developer of apps for managing the global supply chain.