indulge in complacency: how working capital (over)management hurts supply chain resilience | Timely LLP

the New York Times published an article in June 2021 that embodied that sentiment titled “How the World Got Burned Out of Everything.” In the article, the authors discuss the plight of consumers faced with empty shelves in stores, backlogs in retail, the inability to buy high-end electronics and even automobiles, all due to shortages of raw materials, silicon-based chips, or Work in Progression (WIP) to create the finished products.

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Companies aren’t rewarded based on maintaining high levels of inventory, from raw materials to work-in-progress to finished goods. Instead, they are seemingly rewarded for the opposite behavior. Rather than maintaining high inventory levels to instill resilience in the supply chain, companies have been pressured to keep levels low. Working capital ratios thrive when inventory declines. Short-term gains set the stage for ruin when assumptions no longer hold.

However, despite the dichotomy, companies can learn how to manage their supply chain and, in doing so, improve their overall working capital.

How did we get here?

The efficiency of the Japanese just-in-time (JIT) model adapted from the late 1980s seems to be the epicenter of the problems plaguing the supply chain today. At its core, JIT is a management philosophy that focuses on people, plants, and systems to increase overall efficiency and maintain low inventory levels along the way. It was developed in response to the pressures Toyota faced to remain competitive by reducing waste, improving product quality and production efficiency.

JIT works if companies like the change in dynamics it brings. Regular demand is essential to maintain tighter inventory levels. Buffers are reduced. Long-term contracts with suppliers provide essential relationships in the global supply chain network. A harvard business review 1986 article, titled “What’s Your Excuse for Not Using JIT?” chastised companies employing this approach. The article argued for increased adoption of the successful business philosophy. More and more companies have started to follow suit.

However, the philosophical aspects of JIT and its nuances have been lost as more Western companies lifted pieces of it to fit their business models. CEOs and CFOs failed to study and understand why it worked so well in Japan and the trade-offs created by its implementation. Instead, companies have focused on reducing inventory as a way to limit waste. This pushed their inventory risk to suppliers. This had unintended effects as the risk was concentrated in the supply chain on logistics, distribution and the vulnerable worker class.

It worked for a while.

The events of the pandemic and supply chain crisis exposed the flaws in the model and presented the stark reality of a failing supply chain. Strong supplier relationships work if you don’t push the burden and risk onto the logistics and distribution network. Once the pandemic disrupted constant demand and seasonal cycles, companies found themselves scavenging for inventory (e.g. raw materials, WIPs and finished goods). Borders were blocked with transport unable to continue due to closures. What good is just-in-time inventory if suppliers can’t guarantee delivery of critical components to manufacturing sites? The shortage of chips, for example, poses problems for the manufacture of cars, electronics and other consumer goods, as production cannot keep pace with demand. Factory closures during the pandemic and border restrictions caused delays in the delivery of JIT materials and this triggered a ripple effect that grew until supply chains began to unravel. disintegrate. A prime example is the Los Angeles and Port of Long Beach fiasco, which has over 100 container ships awaiting unloading. Inventory remains stuck in transit on water.

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Manage working capital components with a focus on inventory

The past year has shown a deterioration in working capital in the retail and manufacturing sectors as the number of days of inventory on hand (DOH) has increased. Inventory levels should be a leading indicator to manage overall cash flow. Delays in any aspect of inventory – from raw materials to work-in-progress to finished goods and any distribution in between – only delay the conversion to profit and, ultimately, cash.

The JIT model deserves careful consideration when evaluating working capital. While working capital management should start with inventory management, it shouldn’t just assume sales cuts to “make estimates for Wall Street.”

What you can’t measure, you can’t manage – Inventory

Peter Drucker once said, “If you can’t measure it, you can’t improve it”. So instead of disrupting your supply chain with inventory reduction, focus on reduction through a comprehensive program of continuous improvement that allows you to focus on the factors you CAN control. For example, you can control demand planning through demand fulfillment using simple digital transformation models. Gone are the days when only the Ph.D. the quants figured out how to program the models.

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The digital transformation has democratized regression analysis and forecasting so that you only have to feed historical datasets as a reference. Once the analytical models are run, they can be evaluated through visualization tools to determine the best fit to the data and then provide a reasonable prediction for the future. Without such a digital transformation, planning groups are flying blind to understand their true demand and prepare an effective demand fulfillment strategy for limited supply. They have to accept orders from managers who constantly want to build up inventory and accumulate it, resulting in higher working capital. Digital transformation also provides tools to discern which accounts are the most profitable and which have the lowest costs to be served. The analysis can test price elasticity to determine a customer’s price sensitivity and test the potential for future price increases. Each of these metrics can easily be distilled into continuous monitoring via a health check dashboard to show the overall health of the supply chain.

Start with a qualitative diagnosis. It is important to have a factual and validated assessment of the inventory management process. Cover pain points and bottlenecks in the end-to-end sequence of business events. Perform a gap analysis to focus on problem areas. Finally, perform a quantitative measurement. This metric is data-driven and performance-driven. Assess key performance indicators (KPIs) and benchmark supply chain components against your peers so you know where to spend time and effort to bring factors under control. Only then can you create enterprise-wide supply chain solutions.

About Donnie R. Losey

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