In 2009, the battle-scarred economy will filter through to corporate bottom lines -- limiting firms' ability to raise capital through debt and equity markets. With traditional sources inaccessible, companies must rely on the supply chain to generate cash for the business. Simply put, to reduce debt, free up cash and improve corporate debt ratios, firms must reduce inventory and trim receivables. Here's the plan for how to do just that.
What 2008 rendered in consumer markets, 2009 promises its corporate counterpart. The troubled economy -- with evaporating jobs, a consumer spending free fall and a stock market meltdown -- is filtering through to corporate bottom lines. Revenues are down, certainly contributing to weak profits and the inability to raise cash through traditional means. Retail sales dropped for the sixth straight month and more unexpectedly, industrial production had a 9% dip, its worst since 1980. The anticipated, ominous straw of capital scarcity is showing signs of fracturing. Furthermore, bridging profit weakness through corporate equity isn't a viable option for 2009 -- the Dow had its worst year since 1931; the S&P was down a whopping 40% in 2008. As a result, companies must pull back from secondary stock offerings, now significantly less lucrative than a just year ago.
Credit markets may be even less appealing. While cash is abundant, those holding it have an aversion to lend. This year, acquiring the capital essential for growth will be expensive and time consuming -- if possible at all. While commercial paper outstanding is heading towards September levels, recovery will take time. Lenders still banking on Treasuries have driven the average junk-bond yield to over 20% for the first time ever. Highly leveraged firms will feel the weight of the impending crash. With debt maturing and refinance options restrained, firms must free up cash by focusing on working capital.
With traditional sources inaccessible, firms must rely on the supply chain to generate cash for the business. Simply put, to reduce debt, free up cash, and improve corporate debt ratios, firms must reduce inventory and trim receivables. Even companies not requiring immediate cash for operations should aggressively free capital. Companies not laden with debt can opportunistically deploy free cash flow to repurchase depressed stock, acquire distressed assets, hedge low commodity prices, and invest in research and development. The potential to stretch inventory investments, limit receivables and ultimately free working capital requires a rapid-fire approach to portfolio rationalization and inventory deployment. Companies should:
- Segment inventory portfolio. Not all products are created equal; inventory policies must be differentiated for each element of a product portfolio. By optimizing the organization of product classes, companies can apply granular-level policies for stocking requirements, deployment locations and replenishment policies. A good starting point is to segment products based on velocity, value and variability -- otherwise known as sales, gross margin, and both inherent variability and forecast error. Through this portfolio analysis, firms should be able to define two key targets for inventory reduction: high-variability safety stock exploiters and high-velocity cycle stock opportunists.
While a company should have a plan to analyze its entire portfolio, now is not the time. Firms must scope analyses into manageable chunks achievable in weeks. Attack the top 20% of opportunities now and leave the remainder for subsequent quarters. By reducing these assets first, firms will automatically reduce the amount of debt required to refinance and could improve bond ratings, paving the way toward capital liquidity. - Bottom up approach: carve off safety stock. Companies with many diverse products and subsequently, slower moving goods, should eliminate as much inventory from as many items as possible while protecting customer service. Focus on highly variable, sporadic demand products most often laden with unnecessarily high safety stock. Using probabilistic techniques to properly allocate variability at each stocking location will enable firms to more accurately evaluate required stocking levels and adjust policies to eliminate unnecessary stock. After exploiting the immediate opportunity to reset stocking levels, these approaches can yield further benefit by focusing on identifying the source, and then minimizing the variability. Cutting variability in half -- as a result of improved forecast accuracy, a reduction in lead-time variability, or through better manufacturing attainment -- can decrease safety stock up to a third.
- Top down approach: make best use of existing assets. Management has declared a 10% cut across the board, forcing a trim of your existing inventory investment. While demand planning improvements can reduce cycle stock, here's where a critical mistake often occurs. Firms spend considerable time and effort tweaking forecast engines, which reach useful limits fairly quickly, but don't evaluate inventory deployment or policies to deal with the inherent uncertainty in that forecast. Often, as demand falls, inventory investments fail to do so as quickly -- flipping balance sheets upside down.
When capital constraints exist, companies need to analyze their service mix and optimally invest inventory in order to minimize service failures and maximize profit contribution. For a large CPG company with many fast-moving, cycle stock intensive items, there are two points. First, determine which products to allocate more inventory dollars and where cuts can be made with minimal service degradation and lost sales. And secondly, decide where to best position inventory -- and in what form. - Determine true cost-to-serve to modify customer and product policies. Stock prices have already built-in your yet-to-come bad financial news. With sales declining across the board, firms can take advantage of this unfortunate reality to unload unprofitable sales without taking a stock hit. By defining your true cost-to-serve for each product and customer, you can ascertain the markets, channels and customers that are dragging your profitability, as well as the ones that consume hefty working capital. While firms shouldn't swear off unprofitable customers, they can eliminate certain rebate programs, increase pricing to contend with unprofitable policies or restructure payment terms to bring them into the black.
To further impact receivables, companies can also consider product rationalization by creating a true activity-based cost model -- one that couples the physical cost to make and distribute an item with the cost of marketing and selling it. This process will allow you to make informed decisions about rationalizing your customer base and product lines.
In 2009, freeing up cash will not only separate the strong from the weak, but it will determine who will lead moving into the next decade. In recessionary times, more so than any other economic cycle, cash is king.
Jeff Metersky is Vice President of Strategy at Chainalytics and Omer Bakkalbasi is Principal, Inventory Planning at Chainalytics. Chainalytics provides companies with consulting services to improve supply chain performance, specializing in the application of advanced decision sciences technology. www.chainalytics.com.
Interested in information related to this topic? Subscribe to our weekly Value-chain eNewsletter.
