Category Archives: Best Practices

Time to Shorten those Payment Cycles

If you want a sustained recovery, it’s time to start shortening those payment cycles. During the recession, the average payment cycle time in many companies shot up due to “cash flow issues”, and it’s already coming back to bite them in the rear end. As SI has said before, this is not the solution to cash flow and any “cost savings” that the business appears to benefit from (by having more cash in the bank that can potentially earn interest on short 60 or 90 day notes) is more than eaten up by the higher costs the suppliers have to charge to make up for the high interest rates they have to pay to obtain working capital.

It’s important to remember that late payments put extraordinary pressure on suppliers, especially small and medium sized suppliers, which often desperately need cash to purchase equipment, raw materials, and, most importantly, meet their payroll. Furthermore, in addition to cash flow problems caused by late payments, many firms incur significantly extra costs for the time and money spent chasing payments and securing interim financing, usually at exorbitantly high rates – which can often exceed 20% compared to your rate of borrowing, which can be as low as 5%.

All these costs do nothing but drive up the supplier’s cost of operation, and effectively, the price they will need to charge to maintain enough profitability to survive. That’s why many prices for components are rising faster than the raw commodity costs. The lack of prompt payments has cut many suppliers to the bone. Extending payment terms doesn’t help with cash flow or “cost savings”. Extending payment terms only drives up the price in the long term while increasing the risk of a major supply disruption as a supplier could go out of business if all its customers take too long to pay.

So instead of extending Days Payable Outstanding, consider looking at other strategies that can lower your cost of operations – such as improving forecast accuracy, balanced just in time (JIT) production, and low cost financing options that are available to you, as a large company, and not your supplier. Better forecasts lead to less missed opportunities and a reduced need to clear inventory at significant markdowns, balanced just in time (JIT) production reduces inventory costs, which is much better than just shifting them to a third party, and financing your purchase at prime or less will cost everyone less in the long run that forcing a supplier to take out short term financing at 20% to 40% per annum.

What Competing Agendas?

The following was recently spoken at a leading sourcing conference:

The dynamics and sometimes competing agendas between finance and procurement are widely known.

Huh? What competing agendas? I am on planet Earth, right?

But more seriously, the fact that this myth is continually perpetuated is a serious problem. The reality is that, in a properly run organization, Finance and Procurement have the same fundamental agenda: Reduce Cost. Increase Efficiency. Drive Innovation. The only difference is that, for the most part, Finance is internally focussed while, for the most part, Supply Management is externally focussed. Just like the real goal of corporate finance is to insure that the company has more than enough money to achieve its goals and generate a return for the shareholders, the real goal of Procurement is to insure that the company has more than enough money to obtain the goods and services it needs and generate value for the customers, which, in turn, generates value for the shareholders.

The ultimate goal of any organization is to derive value for the stakeholders — employees, customers, and shareholders alike. Value is more than profit, it’s also sustainability and brand image. For example, if all a company does is produce cheap products that wear out quickly, either it’s going to go broke in warranty costs, or, if the product is not under warranty, it’s going to have a lot of upset customers who are not going to buy again, putting the long term financial viability of the company on the line.

As a result, Finance is about more than cutting costs and hitting budgets, it’s about analyzing the value of an internal spend and determining if the value is there to help meet the company’s goals. If hiring the best people increases that option, then Finance should determine that a higher payroll is the right decision and cost should be cut from somewhere else or, if there are no less critical areas, debt should be secured to obtain additional value, and profit, down the road.

Similarly, Procurement is about more than cutting costs to hit a savings target. It’s about finding the optimal balance of cost and value-add to maximize the overall return to the company. If buying from a supplier that costs 10% more will have a huge impact in brand perception, because either the component manufacturer is well respected and using their name will increase consumer interest or because the defect rate is significantly lower, then the slightly higher cost supplier is chosen. But if it’s a simple office supplies spend, then cost is cut to the low end of market pricing.

And both organizations are trying to find the right balance between cost cutting and value generation to meet the company’s goals and increase shareholder return. Just because Procurement is always spending while Finance is always trying to cut spend doesn’t mean that the departments are in opposition. Finance knows better than any other department that companies have to spend money to make money, it just wants to insure that the money is being spent wisely. And a good Procurement organization has better spending as its ultimate goal. There is no competing agenda between the Finance and Procurement Group, and any organization that thinks there is has a serious problem as they are not aligned, and alignment is become a key to success in today’s economy now that the Old Normal has returned.

Cost Leaders Do Not Sacrifice Quality or Customer Focus, Part II

Yesterday’s post talked about the principles of cost leadership and how cost leaders do not compromise quality and customer focus. It’s only low cost if quality, service, and other factors stay equal. Otherwise, it’s low cost up-front, higher cost (and loss) later on. If an organization is not on the cost leadership track, it should be. However, like any other initiative, there are a number of show stoppers and initiative killers that can prevent the organization from becoming a cost leader if they are not identified and addressed as soon as they materialize. As per the recent article on why businesses should shift from cost management to cost leadership in Chief Executive, these include:

  • Complexity
    If the initiative is not easy to explain and not easily understood by the stakeholders, it may stall before it starts.
  • Lack of Cross-Functional Support
    If there is no buy-in by key stakeholders across the board, failure is likely eminent.
  • Impatience
    Stakeholders will want to see actionable recommendations from any initiative quickly, and these actionable recommendations will need to be capable of being implemented in the near term.
  • Under-Resourcing
    Don’t attempt to build equity or buy-in by under-resourcing the initiative (to keep costs low); as the authors of the article note, this is equivalent to crippling the racehorse at the starting gate
  • Education
    Training will be critical for the success of a cost leadership initiative. A training component will need to be included. Moreover, training is often the best tool to reduce the fear and apprehension that goes with any new initiative.
  • Under-Communication
    Communication is critical for any initiative, and early wins must be publicized and recognized to maintain the support necessary for success.
  • Over-Hyping
    No initiative is perfect and all-encompassing. Don’t overestimate the potential impact of the initiative, and never, ever, say that the new system will fix everything.

Cost Leaders Do Not Sacrifice Quality or Customer Focus, Part I

I was pleased to see that this recent article over on ChiefExecutive.Net on why businesses should shift from cost management to cost leadership, that emphasized the need to control cost in the current economy, clearly stated that cost leaders do not compromise quality or customer focus. Every time I see a headline or article on cost management that emphasizes the need to identify low-cost producers, I get worried because, as many manufacturers who jumped on the outsourcing bandwagon have learned, low cost does not always translate into cost savings if quality is not maintained.

The article defines cost leadership as the:

  1. recognition as the lowest cost producer in one’s industry, without compromise in quality or customer focus
  2. realization of a long-term cost-centric culture where cost consciousness is a strategic and leadership preoccupation across functional lines
  3. dissemination of cost information with regard to customer, product, distribution channel, and the like that is timely, understandable, credible, and actionable to fuel continuous improvement
  4. establishment of aggressive and balanced performance targets across the value chain

And it’s a good definition. With costs rising across the board, cost control is very important, but cost control must take into account quality, customer needs, and continuous innovation. If quality is bad, costs will add up in repairs and returns and profits will drop as customers leave for your competitor. If the focus is not on the customer, market share will slowly decrease as your competitors begin to offer products and services that better serve the customer. And if continuous innovation is not employed, costs will creep back up.

The article also noted three practices of costs leaders that are worth diving into:

  • Less Is More
    Simplified products and services, even if they cost a little more up front, will usually cost a lot less over the lifetime of that product or service.
  • Customer Profitability
    Each customer should be profitable, and, more importantly, if you deliver a product or service to businesses, it should make them profitable.
  • New Formula
    If a product requires costly raw materials, or contains raw materials that are heavily regulated, or produces hazardous waste in its manufacturing, reengineering the product to use less costly raw materials, less regulated raw materials, or production processes that do not produce hazardous waste will significantly reduce costs while maintaining, or improving, quality in the process.

The article also highlighted a number of cost leadership initiative killers that you need to watch out for and address as soon as they are encountered. But that’s the subject of Part II.

Should You Move Your Production Back to the US?

In the outsourcing craze, there was a mad rush to move manufacturing to China and services to India. In the latter case, with the rising costs in the big, mature, outsourcing centers, it’s now cheaper to open call centers and back-office shops on home soil in the US and UK than to move them to India, where they are so desperate for talent that they are now hiring Americans in America to fulfill American outsourcing agreements. In the former, the price of production, especially with logistics costs and a weakening American dollar, is rising monthly. For some industries, it may soon be cheaper to produce at home, if it isn’t already. Especially when the total lifetime cost of ownership is taken into account.

Consider this recent article in Fortune which notes how some American businesses, fed up with the poor quality of having their products made in China, are moving production back to the US. In “why we left our factories in China”, we find out that Sleek Audio, a small business that makes in-ear headphones for iPods and other audio devices, fed up with low quality, too much travel, communications problems, shipping delays, rising costs, and — worst of all — a ruined shipment of 10,000 sets of earphones that cost millions and nearly brought the company to its knees, decided to quit China and move manufacturing back to the US. Their up-front costs are about 15% to 20% higher on-shore, but since they are now able to produce a higher-end product (that can command a higher price), they can justify the cost.

Now it’s true that some companies get great prices and great quality from Chinese factories, but the reality is that these are usually the large multi-nationals that can afford to have someone on the ground full-time to oversee production. If you can afford to oversee production and insure your production runs get the appropriate timing, priority, and quality checks that you need, you can get good quality. But if you don’t have someone on the ground full time, then you may not even realize there is a problem until the next day as most small operations don’t have a phone manned at 2 AM. And since your production run is usually squeezed between bigger ones, there may not be much attention paid to quality or other issues important to you.

In other words, if you’re a Global 3000 multi-national, then it’s likely that production in China still makes sense for the organization for the time being, but if you’re a small or mid-sized manufacturer, it might be time to pull production back home — especially with the economic incentives being offered by many states to revitalize the economy.