Who Is Spending Your Cash?

“Cash is king,” we hear.  I have seen this in the core values of major, multi-national corporations.  If you travel for your company, you likely face restrictions on the amount and/or cost of travel which you can book without very senior level approval.  I know of one company with revenues of about $15 billion in which the CFO has mandated approval of any air fare over $500, even for employees who routinely must book and re-book travel on short notice due to the nature of their duties.  I do not debate the wisdom of such policies.  I only use them to illustrate how carefully the expenditure of cash is scrutinized in many cases.  Capital expenditures require even greater examination and multiple approvals, perhaps even from the board of directors.  Despite these procedures, I pose this question:  “Do you really know who his spending your cash and how they are doing it?”

Consider where most of the cash is spent and who spends it.  In most manufacturing firms, the largest single expenditure of cash is for the acquisition of raw materials and their transformation and distribution, namely, the cost of goods sold.  What is not sold remains on the balance sheet as inventory.  A manufacturer with 40% gross margin is doing very well in most industries, although there are notable exceptions in pharmaceuticals and a few other manufacturing industries.

A 40% gross margin would mean that 60% of the cash inflow from sales is spent on inventory – inventory that is either sold or stored.  In fact, manufactured product (or at least the raw materials, components or intermediates/work-in-process) in every manufacturing operation is stored at some point before it is shipped to a customer.  That is why inventory turns or days in inventory (both relating inventory to sales through the cost of goods sold) are the most appropriate kinds of metrics for inventory rather than the absolute amount.

So, given the relative proportion of cash flow in the majority of manufacturing firms that is spent on inventory of one kind or another, compared to, say, the proportion of cash flow spent on travel, one might assume that the level of scrutiny and approval required for spending on inventory would be extraordinary and performed at the most senior level of the firm.  Is that true in your company?  Of course not.  Manufacturing and distribution operations would be paralyzed, and servicing customers effectively would be precluded by such a bureaucratic approach.

Supply chain planners or buyer/planners are people who must determine how much should be procured, when, and where.  Purchasing or sourcing professionals, whose mission is to make sure that the purchase price is minimized, support the planning function, but purchase orders are issued by buyer/planners.

Even if “buying” is separate from “planning”, it is the planner who decides how much is needed when and where.

Planners do not rank among the highest paid employees, yet they are pulling the lever to spend the majority of the company’s cash flow.

Most planners today have access to advanced planning and scheduling (APS) tools which embed material requirements planning (MRP – I know this should be “little mrp”, as opposed to “big MRP” for manufacturing requirements planning, but allow me this convention here for visual ease) and distribution requirements planning (DRP) calculations to aid them in determining how much to purchase.  These tools are very helpful.  They are particularly helpful if the forecast is exactly right, if forecast error is always normally distributed, if stated transit lead times are always reality, if yields are constant, if service from one internal manufacturing or distribution point to another is always constant and known.  However, almost none of these conditions are ever true, and they are never true all at the same time.

So, not only do planners have to ultimately determine what to move, make and buy for every item in the bill of material (or formula/recipe) at every location in every future time period in the planning horizon, they must do so in an environment with many unknown inputs.

(At this point, I will include a plug for recruiting, training and retaining the very best planners – not vp’s of planning or directors of planning, but planners themselves since they are likely spending most of your cash!)

This problem is called multi-echelon, inventory optimization (MEIO)  MEIO is fast becoming a best practice requirement.  MEIO optimizes the answer to the very challenging problem of how much extra inventory a planner should plan to have at each location, for every item, at every level, given the many other unknown factors as well.  Put differently, “What is the inventory safety stock level that should be targeted for every item at every location, such that the cost of holding inventory for achieving a given service level for the end customer is minimized.”  This question must be answered across all nodes while considering all of the unknown factors mentioned above.

When solved, the result is a lower required buffer inventory than could be planned with just MRP or APS in order to achieve an optimal service level.  That means more available cash and more revenue and profits.

Solving the MEIO problem remains a massive challenge for which many planners still do not have sufficient tools at their disposal.  However, algorithms have been developed and can be implemented through commercially viable software.  It’s also increasingly possible to build your own on an advanced analytics platform.  As MEIO continues to be adopted, more planners can go about their normal planning process of determining what to move, make and buy, but with a much better starting point, namely the amount of inventory buffer required at each item, location.  This buffer, or safety stock, already a standard row in a supply planner’s gross-to-net calculation in his or her advanced planning system, allows planners to perform their work without disruption while achieving significantly better results for the cash management of their firm – when populated through MEIO.

Questions:

1)      How do your planners account for the unknown factors in determining how much cash to spend on which inventory in which locations and when?

2)      Are you thinking about evaluating MEIO?  If not, why not?

3)      Can you afford not to pay more attention to where the majority of your cash flow is going?

A Handy List of Keys to Careful, Comprehensive Inventory Management

I’m sure there are a lot of ways to summarize a careful, comprehensive approach to inventory management.  You may even be able to add to this list below or create your own, but this may be one handy way to think about it.

It might seem a little “corny”, but as a memory aid, I call this approach 5A6σ. 

  1. Anticipate market requirements
  2. Account for your actions
  3. Accurately calculate safety stock
  4. Access information and use it instead of inventory
  5. Accelerate by continuously reducing lead times and lot sizes
  6. Leverage the techniques of process control to reduce variation

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Anticipate – anticipate market requirements

The more you are able to accurately anticipate the demand from your end customer in the marketplace, the more you will be able to move, make, buy, and store the inventory that will sell quickly.  This may seem like a self-evident axiom, but this is not easy, and the benefits of incrementally better anticipation go directly into additional revenue as well as more efficient inventory and use of cash.

Large bodies of knowledge have been built around this subject from rigorous quantitative models for forecasting to methodologies for collaborative forecasting, both within an organization and across organizations.  The point of diminishing returns can be reached fairly quickly, but if you are not there yet, it may be your most significant point of leverage for improved supply chain performance.

Account – for your action

This is perhaps the simplest, but yet most difficult aspect of careful, comprehensive inventory management. 

When different functions of the business such as sales and manufacturing do not have harmonized goals, then inventory efficiency will suffer.  For example, if manufacturing is rewarded only for efficiency and overhead absorption, while sales is only rewarded for volume or even total margin dollars, and purchasing is rewarded for lowering per unit costs, then inventory is left to someone who does not have the ability to fully influence it. 

This is one of the benefits of a functional Sales and Operations Planning or Integrated Business Planning process that is supported by shared and consistent metrics across business functions.

Accurately – calculate safety stock

We cannot know for certain what demand will be tomorrow.  Even organizations dedicated to consumption-based replenishment of “true demand” cannot know exactly how much will be required of which products, at which locations, and at which times.

Make-to-order businesses have an easier time of this, but, even then, orders can change and often do.

So, demand varies, but so does the lead time to meet the demand which is affected by several factors:

  • Variation in the ability of manufacturing to respond in a timely and accurate fashion, driven by batch sizes and setup times, variation in the conversion process, and by other factors
  • Variation in the transportation operation (caused by traffic volume or accidents, road construction, weather, illness, and any number of other factors)
  • The capability of warehousing to know what is exactly where and pick, pack and ship it in a timely and efficient way.

For these reasons, you must have more inventory than you will actually be needed if everything goes perfectly.

Any other approach implies the intentional loss of revenue.  Done poorly, this can put you out of business.

Fortunately, there are techniques for doing a good job of this through optimization.  Do a bit of research to identify the technique that fits the structure of your operations (single-tier distribution or multi-tier manufacturing, for instance) and get the analytical and software support (if necessary) to embed that technique into the normal planning process.  This can often yield a step-function improvement in both reducing the necessary investment of working capital in inventory as well as in improving customer service.

Combined with the set of decisions around supply chain flexibility with which inventory decisions are interdependent, decisions about inventory are essential to increasing the value of your enterprise.

Access – information and use it instead of inventory

Data is now more available than ever.  However, there are two key challenges in making use of it.  The first is the acquisition of data.  For everything, from the location of a particular serial number of an item to syndicated data of leading indicators of demand, there exist methods, technologies and markets for the acquisition of data. 

Once you have the data, you must then organize, summarize, and analyze the data into information in such a way that better decisions can be made in less time.  As an example, knowing more about your customer’s demand sooner may help you operate your operations more effectively and efficiently to meet that customer’s demand when it actually comes to fruition.  Knowing the exact location of inventory as it transits and is transformed through your value network can, in some cases, help you respond more quickly to the changes in the market without adding more inventory.

Accelerate – continuously reduce lead-times and lot sizes

Whether you consider yourself a “lean” operation or a “six-sigma” shop or both (“lean six-sigma”), the reality remains that all manufacturers are obliged to constantly search for ways to reduce lead times and run times (batch or lot sizes) during which variation can occur.  This sometimes requires analysis of fixed versus variable cost such as the fixed cost to modify equipment so that changeovers can be completed more quickly against the variable cost of carrying inventory for a longer time, or perhaps indefinitely.

leverage techniques of process control reduce variation

In conjunction with continuously reducing lead-times and lot sizes, a careful and comprehensive approach to inventory management requires that you make use of what we have known for decades about statistics to identify variation (the reason for safety stock) and its sources, so that you can work continuously to reduce it.  As with the “Anticipate” process, you will reach diminishing returns, but your progress may not be linear or only incremental, and it will be difficult to anticipate when a step-function improvement will occur, so this is an ongoing responsibility.

So, there you have it, the “5A6σ”approach for inventory management, if you will. 

You need to do all of these in order to manage your inventory carefully and comprehensively. 

I suspect you are already careful and comprehensive in your approach to cash management.  And, since you spend so much of your cash on inventory, you need to take an equally intelligent approach to managing inventory.

And here’s a final thought to ponder from Henry David Thoreau as we begin to approach the weekend , “If a man does not keep pace with his companions, perhaps it is because he hears a different drummer.”

The Value Network, Optimization & Intelligent Visibility

The supply chain is more properly designated a value network through which many supply chains can be traced.  Material, money and data pulse among links in the value network, following the path of least resistance, accelerated by digital technologies, including additive manufacturing, more secure IoT infrastructure, RPA, and, potentially, blockchain. 

If each node in the value network makes decisions in isolation, the total value in one or more supply chain paths becomes less than it could be.  

In the best of all possible worlds, each node would eliminate activities that do not add value to its own transformation process such that it can reap the highest possible margin, subject to maximizing and maintaining the total value proposition for a value network or at least a supply chain within a value network.  This is the best way to ensure long-term profitability, assuming a minimum level of parity in bargaining position among trading partners and in advantage among competitors.

Delivering insights to managers that allow them to react in relevant-time without compromising the value of the network (or a relevant portion of a network, since value networks interconnect to form an extended value web) remains a challenge.

The good news is that many analytical techniques and the mechanisms for delivering them in timely, distributed ways are becoming ubiquitous.  For example, optimization techniques and scenarios can provide insights into profitable ranges for decisions, marginal benefits of incremental resources, and robustness of plans, given uncertain inputs.

When these techniques are combined with intelligent visibility that allows you detect and diagnose anomalies in your supply chain, then everyone can make coordinated decisions as they execute.  

I will leave you with these words of irony from Dale Carnegie, “You make more friends by becoming interested in other people than by trying to interest other people in yourself.”

Thanks again for stopping by and have a wonderful weekend!

On Memorial Day Weekend

Let us remember and honor all who serve a higher good than their own comfort and fulfillment. This is Memorial Day weekend for us in the U.S., but may our memory serve us well when the calendar does not. Let us never forget when uncommon valor becomes a common virtue and those who shirk not their duty, nor shrink from their sacrifice leave their families bereaved. May God bless all who have bravely and knowingly walked into the “valley of the shadow of death” but have never returned, freeing others to pass by unharmed. May they rest forever in our hallowed memories of the price of peace with liberty.  May God bless the families who will always suffer without them. And, may God bless those who have returned but not without cost and their families who suffer with them.

Leadership: Motivation or Manipulation?

Motivation is the inspiration to do the right thing.  A leader imparts it.  The best colleagues, clients, and partners embrace it.

Do you know when you are being motivated and when you are being manipulated?  Do you motivate people or manipulate them?  Is there a distinction and if so, what is the difference?  Is there an appropriate time for each?

Tricking someone to do what you want them to do is manipulation.  Those who respond to it are either taken in by the superficial validation of own importance that is implied by the manipulator or driven by a fear of the consequences of questioning the manipulator.

OK.  So what?

Most of us are called upon to be both leaders and followers.  Part of wisdom is knowing when to do which and how.  As a leader, there will be situations when time does not permit a comprehensive explanation and as followers, there are times when we need to accept the decision and execute without an argument.

But, leaders owe it to their stakeholders to do the following:

  1. Live their values – The more you do this, the less time you will need to spend on points 2 and 3.
  2. Communicate them clearly – Keep them few and short.  They can be phrased as expectations.
  3. Give direction and expect initiative that is consistent with those values.

And when following, you owe it to your leader and organization to question when the direction you are given appears to seriously diverge from either the leader’s stated expectations or your own core values.  You need to be able to orbit your leader’s values and expectations and the direction that you are given while maintaining your own values.

So . . . Resolve to do the following:

Decide on your own core values and live them as consistently and transparently as you can.

As a follower, there will be times when you disagree with the leader and must dutifully carry out your responsibility (within obvious moral limits) as a member of the team, but you can do it with comprehension and not out of either fear or a need for validating your worth.

No leader or follower is ever perfectly consistent and always acts out of motivation or is never manipulated, but isn’t it a goal worthy of continuous pursuit?

Finally, I leave you with this thought for the weekend:  “You can’t lead others until you serve something greater than your own ambition.”

I would be delighted to know your thoughts on this subject.  Have a wonderful weekend!

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Footnote and Question:  There will be those, both leaders and followers, who serve nothing more than their own immediate self-gratification.  These folks may not embrace leadership from either position.  Do we need to resort to manipulation in order to move some of these people the the right direction for the organization?

A Few Random Thoughts

This week, I was privileged to attend the INFORMS Analytics Conference in Huntington Beach, California and the IEG S&OP Conference in San Francisco.  I heard some insightful points and thought I would list a couple here (with appropriate attribution) along with a few thoughts of my own.  I hope that at least one strikes a chord with you.

If you use a heuristic to solve a problem with 100% complete and clean data, using a data model that exactly represents reality at any given moment, you still have an inexact answer.  But since such data and data models are rare (or nonexistent), even a pure optimization is still inexact and, in effect, a heuristic solution requiring both art and science on the part of the analyst. (Colin Kessinger, End-to-End Analytics)

If the purpose of Sales and Operations Planning is to make the best integrated decisions for running your business, then you will have a firm, published schedule and people will schedule other meetings (even customer meetings) around it. (Bob Ratay, SAP),

Key capabilities in an S&OP decision-making process are business agility, versatility, and elasticity.  (Olaf Gelhausen, Infineon)

S&OP is about a range, not “one-number” – one plan with a range and distribution of probabilities, but not one number. (Olaf Gelhausen, Infineon)

The best business decisions, even very qualitative ones such as those in the fashion industry are built on a foundation of rigorous data analysis and decision modeling, providing the qualitative decision-maker the largest head-start possible by reducing the “solution space” and delivering insight into the most sensitive tradeoffs.

Working with people is the hardest part of any business challenge – by comparison, the mathematics are relatively easy.

In business planning, longer term investment decisions require detailed scenario analysis.  Near term execution decisions require existential insight into the cash flow changes and their causes.  One might call the latter, “analytical awareness”.

Once sources have been qualified, sourcing decisions among sources (both near and far, “in” and “out”) should be cost-optimized and dynamic (Olaf Gelhausen, Infineon).

Thanks for dropping by Supply Chain ActionPlease feel free leave your random thoughts as a comment below or send them to me, and I’ll try to include them in an upcoming post.

Until next week, always choose life, light and love and don’t forget to laugh along the way.

Have a wonderful weekend!

Merry Christmas!

Phillips Brooks

On this weekend before Christmas, I pause from my usual postings of practical points or insightful perspective on business to share with you with the words of Phillips Brooks, penned in 1868, which embody my favorite thoughts at this time of year.  Have a wonderful weekend, and I wish you the very best Christmas and holiday season ever.

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O little town of Bethlehem,
How still we see thee lie;
Above thy deep and dreamless sleep
The silent stars go by:
Yet in thy dark streets shineth
The everlasting Light;
The hopes and fears of all the years
Are met in thee tonight.

 For Christ is born of Mary;
And gathered all above,
While mortals sleep, the angels keep
Their watch of wondering love.
O morning stars, together
Proclaim the holy birth;
And praises sing to God the King,
And peace to men on earth.

How silently, how silently,
The wondrous gift is given!
So God imparts to human hearts
The blessings of His heaven.
No ear may hear His coming,
But in this world of sin,
Where meek souls will receive Him still,
The dear Christ enters in.

O holy Child of Bethlehem,
Descend to us, we pray;
Cast out our sin, and enter in,
Be born in us today.
We hear the Christmas angels
The great glad tidings tell;
O come to us, abide with us,
Our Lord Emmanuel.

When to Collaborate and with Whom?

I hear a lot about collaboration at conferences these days and there are books and articles to match.  The prevailing implication is that sharing information and collaboration, however defined, is categorically meritorious.  

 There is very little, if anything, however, written or said about when to collaborate and with whom. 

Before you commit your organization to sharing information with either suppliers or customers, you must answer at least two fundamental questions. 

First, how much value can be created through collaborative synergy between your organization and your trading partner? 

Second, of that value, how much do you need to capture? 

Answering these questions will likely require some rather rigorous analysis of the total costs of operating without collaboration as well as a detailed calculation of where the value or savings will come from and what you will need from your trading partner in order to realize your targeted share of that value. 

It is clear and has been demonstrated that when two organizations cooperate for a shared goal, then they achieve better results.  But, it’s important to analytically establish the parameters so that you can plan, negotiate and operate with full information.

Thanks for stopping by. 

As we move into another weekend, remember that “Logic will get you from A to B. Imagination will take you everywhere.” (Albert Einstein)

Have a wonderful weekend.

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