This short article will explain what working capital is and how to make best use of working capital in the Supply Chain. It will provide useful tips for businesses to apply that will be helpful in these uncertain times.
Working capital refers to the cash a business requires for its day-to-day operations. Technically, it’s a measure of a company’s efficiency and its short-term financial health. Often, it’s the company supply chain that is the first place that people look to for working capital reduction opportunities.
Optimisation of working capital is not about wildly slashing inventory levels and running the business on a shoestring. Optimisation of working capital is contextual and dependent on individual business circumstances. It’s about understanding the current service environment and identifying whether you are over or under servicing your customers. Next, it’s about tailoring your operations to strike the right balance between service and cost.
Working Capital Optimisation in the Supply Chain
The customer’s need shapes the Supply Chain. And so the customer service offer drives the inventory deployment. Specific customers will have varying service needs and it important to appreciate how these drive different costs in the business. Customer group and service examples might include:
High street deliveries, which entail frequent small drops and a high service. So inventory needs to be held close to the customer.
For mass retailers, the focus is on consistency and reliability of service. It’s also about maintaining low costs within the Supply Chain. This places a focus on ‘milking’ the supply chain assets and managing inventory tightly.
For remote customers, such as those in the mining industry, the Supply Chain dynamics might be around high service needs and costs and hence balancing the inventory and transport trade offs carefully.
It must be realised that if we change the customer base, or change the service offer, then the shape of the supply chain may need to change in terms of inventory levels, locations, transport assets and facilities and all will have a major impact on capital. Supply Chains are customer centric and will change depending on the types of customer and service provided. This is a key point.
Key Focus Areas
Here are four key focus areas:
Inventory; because it’s an obvious area to improve capital utilisation and because it can be one of the easiest and most beneficial areas to tackle.
Transport; because it tends to be over looked and people think it’s all about getting good rates from carriers and of course, it’s not.
The network; because its shape has a significant affect on capital requirements in terms of facilities and inventory.
And finally Warehousing. Because again this can suck in capital unnecessarily if incorrectly sized, equipped or utilised.
We must remember though, that the customer is central in all this and that the service that we offer our customers drives all of these cost areas.
Customers shape the distribution network at one end, based on customer locations, demand patterns and service needs. And suppliers have a similar impact at the other end. Routes to market, driven by our customers location and service needs might include; direct from supplier to customer, from our own warehouses to the customer, to the customer’s warehouse, or via a cross-dock facility. That route to market can change over time and so it drives changes in our needs for warehousing and inventory.
Likewise, the speed to market has a similar impact. If we take an apparel importer as an example, much of their stock might come on from overseas as store ready packages, with the appropriate size and range for each specific store. Pushed out as an allocation typically, then replenished based on sales demand. Many apparel retailers are now doing that replenishment as LCL rather than FCL and even by changing to airfreight for the tail end of the season. Higher freight costs could result, but it also drives lower inventory investment and fewer requirements for local warehousing and cross-docks. It can also deliver lower waste and markdowns and so improves the return on that inventory investment.
So aligning inventory to our service offer is critical or we end up with too much stock, stock in the wrong place, or we run out of critical stocks. This is why some retailers categorise their stock as fast or slow moving and deploy the inventory accordingly. For example, fast moving lines are stocked in a number of regional warehouses close to customer demand, but the slower moving lines, are held in a central warehouse and replenished at a slower lead-time.
The shape of the distribution network and the location and number of facilities within it, will also of course have a significant impact on the capital required for materials handling equipment, storage equipment, IT and transport.
Inventory is obviously one of the major focus areas and can still offer significant working capital reduction opportunities within most businesses. As an example an industrial products company was recently reviewing the profile of their inventory as part of a sales and operations planning implementation. The Pareto principle often applies, where it is common to find that 80% of a company’s sales come from 20% of their product range. This company had 95% of their sales coming from 5% of the product range based on many years of poor inventory planning. The opportunity to delete at least half the range is now underway, without having any significant impact on customer service.
The Square Root Law though rather simplistic states that if the number of stock locations are reduced the amount of safety stock inventory required in the network also reduces. As an example, a reduction from ten warehouses to five reduces the safety stock by 29%. The key point here is quite simply, that more warehouses equal more inventory.
Supply lead times also have an impact on inventory, often being referred to as product velocity. If product physically moves through the supply chain quicker, then less stock is sitting idle, stock turns improve and less capital is invested in that stock. Product velocity can be increased by handling and storing less, and by having less touch points in the supply chain, such as direct delivery from supplier to customer or store and cross docking rather than storing. For those unfamiliar with the term cross docking, it means that product comes in from the supply point, crosses the dock at the warehouse, and goes out on delivery to the customer, all in one hit. Normally no stock is left in the facility at the end of the day. Therefore, it operates like a post office sorter. Of course, all the products need to be labeled ready for delivery. A variation on this is a break bulk operation, where the product arrives in bulk, and is then broken down into store or customer orders based on their demand.
Supplier Management is an absolute priority and is very badly undertaken by 60-70% of the companies seen by the author. Suppliers are the start point of the supply chain and if poorly managed create noise all the way through the supply chain that will be significant, time consuming to fix, and costly. Measuring SIFOT or Supply In Full On Time is an essential KPI. If not well managed, suppliers may short deliver, over deliver and deliver late or even early. All of this additional noise in the system requires additional stock to cover the uncertainty.
Another key focus for inventory is Sales and Operations Planning or S&OP to use the acronym. For businesses who have not adopted S&OP, they should. Very few businesses would not benefit from implementing an S&OP process. S&OP need not be about expensive IT systems, it is about communication, across all functions of the business, it is about engagement and ownership, and it is about planning your inventory needs from supply, right through to the consumer. Many businesses do this really well, on a spreadsheet! Businesses that are more complex, generally need specialist systems. However, it’s the processes, communications and disciplines that deliver the benefits, which can be significant. Reductions in inventory of up to 20% and improved inventory availability that will lead to increased sales are common outcomes.
Warehousing can be a significant demand on capital and the point needs to be reinforced, that two things dictate the number, size and configuration of a warehouse network. Firstly the customer service offer, as that quite simply dictates how close to customers stock must be held, and secondly the supply base. If supply is close and consistent then less buffer stock may be required. If the suppliers are overseas and their service is inconsistent, this can drive higher buffer stock and warehouse capacity. It’s not brain surgery.
To minimise capital needs, ensure that warehousing capacity is not over sized or poorly utilised and make sure that the locations and number of warehouses are appropriate to the demand and supply needs of the supply chain. Flexibility in warehousing capacity can also be important and is possible by having over flow rental warehouses for short periods to meet peak demand.
Facility Ownership should also be considered. The outsourcing of warehouses is probably now at about 80-85%. Therefore, 15% of businesses for whatever reason are choosing to own and operate their own warehouses. Many for good reason of course, because they see it as a core part of their business. However, for those businesses that do not need to own their warehouses, most will buy, design, build and lease back. When warehousing needs are generic, rental will usually make sense.
The fourth key area to target for improved capital utilisation is Transport. The discussion here is primarily about a transport fleet that is owned rather than outsourced, although even if outsourced these focus areas will help reduce operating costs if not capital requirements.
The key objective with a transport fleet is to keep it well utilised. It’s rather like an airline, where aircraft must be kept flying as much as possible, with as many passengers as possible, to maximize the fleet capacity and reduce the unit cost. Similarly, a transport fleet that is sitting idle is still costing money and so ‘sweating the asset’ gives the best return. Having the right fleet size and mix in the first place is critical. With trucks that are too large or too small costs and fleet size are increased due to carting fresh air around or by having to make multiple trips to the same locations. As a business changes, this fleet need can change over time so it needs careful monitoring. The aim must be to ensure good fleet utilisation of the physical capacity, as well as hours through the shift and hours through the day.
Then there is the question of fleet ownership. In some cases where the fleet is specialised and very highly utilised, it can make sense to own it. But if the capacity needs of the fleet vary then leasing or even outsourcing can make better sense. Rather like the argument for warehousing, it can make sense to have someone else make that capital investment.
In summarising the top priorities in terms of improving the utilisation of working capital in the supply chain, these should be your list:
1. Is Customer Service. It drives the whole shape of the supply chain and the investment in it. There may be opportunities to renegotiate or adapt the customer service offer, or at least ensure it’s well aligned with customers needs.
2. Is Inventory. This is driven by the service offer and the need to hold buffer stocks to cater for peaks and troughs in demand and supply. An absolute must here is good S&OP for most businesses.
3. Is The Distribution Network. It is shaped by where and how much inventory we need to hold. Look at the routes to market and options such as direct from supplier delivery.
4. Is Warehousing, because that can be capital intensive and needs to be sweated to get the best return. The size, layouts and equipment used are all important.
And lastly, at 5. We have Transport. Similar to warehousing in that we need to make sure the asset is right for the task and utilisation maximised. In both cases consider outsourcing where it can reduce the investment required as well as give much needed agility in capacity.
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