The Essence of Good Working Capital Management

In yesterday’s post we noted that playing games with working capital only costs the organization in the end; specifically, for every 10% of working capital an organization messes with, it loses 1% of total working capital (or 10% of the working capital messed with). Not a good deal, any way one wants to look at it.

Working Capital doesn’t have to be hard to manage. While an expert can get quite sophisticated about it, all one really has to do is:

  1. Get a good grip on receivables
    What is the organization expecting from sales and when; what reimbursements is the organization entitled to and when; what tax rebates is the organization expecting and when.
  2. Get a clear picture on fixed payables
    What is the average monthly payroll, the average monthly overhead (rent, utilities, etc), and regular non-monthly expenses that are projected over the next year.
  3. Get a good estimate of average disruption costs
    When a receivables disruption has occurred — regardless of if it was due to a late payment, lost customer, lost sales from a competitive product, or market delay due to a supply chain disruption — how much has it cost on average and how long has it persisted. This is the contingency fund that is required (and can be amortized monthly over the next twelve months).

Once this is known, the organization knows how much cash it has to work with every month. Only then can it truly begin working capital management and determine when it should pay early to take advantage of an early payment discount, borrow to pay on time to prevent costs from rising (as the supplier’s cost of capital is much higher than the organization’s), pay late and pay the penalty (as the organization’s cost of capital is higher and/or the supplier is able to bear the burden of payment late more than the organization is able to bear the burden of paying on time), or get innovative and work with the supplier to reduce costs across the supply chain. Without a solid understanding of cash flow, working capital management can’t even begin. And good working capital management definitely doesn’t involve booking revenue early, paying suppliers late, or other quarter and year end games to present a rosier picture than reality, because these games always get discovered and the organization always loses, in hard dollars, in the end.

You Can’t Buy Anything for a Quarter, So Why Do We Still Care About Them?

And more importantly, besides the fact that quarterly reporting pretty much became mandatory in North America with the Securities Exchange Act of 1934, why did we ever?

For those of you that are lost, I’m referring to the fact that when you focus on a quarterly number, you often screw up the year, or, as demonstrated in some recent research by the REL Consultancy, a Hackett Group Company, the next year. As summarized in this recent Industry Week article on how It’s All in the Game When It Comes to Year-End Cash Management (among others), attempts to game the system and post good fourth quarter results by delaying payment, manipulating receivables, or offering deep customer discounts just to book last-minute sales always lead to first quarter losses in the subsequent year that exceed the gains in the fourth quarter.

Specifically, the research indicated that while working-capital performance improved by 10% in 2011 Q4, it dropped by 11% in 2012 Q1. In other words, the loss exceeded the gain by 1%!

We’ve become way too focussed on the short term and the year end. What’s important is the long term. Given the choice between a 5% gain today and a 15% gain in a year and a 10% gain today with a guaranteed loss of 5% in a year, a company should always choose the first option as it gives the greatest combined gain over two years. But today, most public companies will choose the 10% gain today, turn a blind eye to the impending loss, and, if pressured, mumble that “we’ll figure it out later”. The problem is, if the gain comes at the expense of a deep discount on maintenance and labour rates are skyrocketing, at the expense of putting off needed upgrades to energy hogging equipment when energy costs are skyrocketing or delaying payables when interest costs are mounting, there’s no way to figure it out later. Cost are going to go up and losses are going to mount.

Not only do companies have to start managing working capital on a year-round basis, as the article notes, but they have to start managing growth on a long-term basis and re-instate the five and ten year plans as one to two year plans just aren’t enough. If this means they have to f*ck Wall Street and go private, so be it. Until we abandon this success today at all costs mindset, we’re never going to take supply chains to the next level.

It’s My Blog

This ain’t a blog for the neutral minded
No security blanket for the media blinded
And I ain’t gonna be just a drop in the cloud
You’re gonna hear my view when I type it out loud

It’s my blog
It’s now or never
It ain’t gonna last forever
So I’m gonna cut through the online fog

(It’s My Blog)
My views are like an open highway
Like Frankie said, “I did it my way”
I’m just gonna cut through the online fog
‘Cause it’s my blog

To the visionaries who stand their ground
For all the lone wolfs who never back down
Tomorrow will be harder, make no mistake
No more getting lucky, gotta make your own break

It’s my blog
It’s now or never
It ain’t gonna last forever
So I’m gonna cut through the online fog

(It’s My Blog)
My views are like an open highway
Like Frankie said, “I did it my way”
I’m just gonna cut through the online fog
‘Cause it’s my blog

It’s gonna stand firm
When they’re calling it out
It wont’ bend, won’t break
It won’t back down

It’s my blog
It’s now or never
It ain’t gonna last forever
So I’m gonna cut through the online fog

(It’s My Blog)
My views are like an open highway
Like Frankie said, “I did it my way”
I’m just gonna cut through the online fog
‘Cause it’s my blog

Is The Air Force’s Billion Dollar Flop the Biggest Supply Chain Failure in History?

Six years ago, Supply Chain Digest published a piece on “The 11 Greatest Supply Chain Disasters” in history, which was updated in a blog post on The Top Supply Chain Disasters of All Time by Editor-in-Chief Dan Gilmore back in 2009 which added five new ones to the list, bringing the total to 16.

The top three were:

  • the failure of Foxmeyer’s “Lights Out” Warehouse,
    which was the top disaster in the original report and wiped out the 5 Billion dollar company almost over night;
  • the Boeing outsourcing fiasco,
    which led to massive 2-year plus delays in the production and delivery of the long-awaited 787 Dreamliner and some 2 Billion in charges to fix supplier problems; and
  • GM’s Robot Mania,
    in the 1980s when CEO Robert Smith pent 40 Billion on robots that didn’t work for the most part

But SI thinks the Recent Air Force Modernization Effort should top the list. As per this great article over on the New York Times Site on the Billion-Dollar Flop, the six-year old effort that had already eaten up more than 1 Billion didn’t even achieve a quarter of the planned capabilities — with another Billion required to achieve that minimal target. This says that the effort, supposed to cost $628 Million, would require over 8 Billion to complete! This easily dwarfs the 2 Billion in charges plus losses due to delayed sales suffered by Boing and the 5 Million Foxmeyer failure.

Does it dwarf the GM failure? The failed gamble cost GM a lot, but they are still in business, and posted almost 1.5 Billion in profit last year. And they were able to fix their processes and technology and improve over time.

In comparison, the Air Force is stuck relying on legacy logistics systems, some of which have been in use since the 1970s. And it turns out that this failure is just the tip of the iceberg, with the Institute for Defense Analyses noting that modernization of the department’s software systems, which has been a priority for 15 years, has cost over 5.8 Billion as of 2009 and most large operational software system efforts are still behind schedule. So now we’re up to six billion.

And the losses mount for every year a legacy system (way) past it’s prime has to remain in production. With today’s rapid pace of software, and hardware, refresh cycles, it’s often difficult to find a replacement part for a piece of hardware that is only 3-years old, and if you do find it, it’s costly. The Air Force has to find replacement parts for systems that are 13 and 30 years old! And lets not forget energy and support costs! Older systems often consume way more power and require more support hours than newer systems. Plus, over time, the expertise in supporting such systems goes from relatively common to extremely rare as more and more people retire or move to different systems and technologies and no new people learn the antiquated systems. As a result, the expertise that remains becomes very costly as the few people left demand a premium and expenses mount when they have to be flown in from halfway across the country.

Plus, the failure has instilled a fear of future technology fiascos, causing them to impose an across-the-board deadline of 18 to 24 months for future upgrade projects. While this sounds good in theory, and an upgrade project for most systems generally shouldn’t take longer, there are some systems where the requirements analysis is going to take 6-12 months and the migration plan, which will involve a lot of data mappings, development, and testing, will take just as long. Add a staged implementation plan, quality assurance, and user testing, as well as time for any customizations the COTS (Commercial Off The Shelf) Vendor has to make to the core system, and the project could take longer. So, this is going to prevent some upgrades from happening until COTS technology in certain area improves or a vendor is willing to bite the bullet and create the mapping middleware without a contract in the hopes it will get one. In the mean time, losses mount.

While SI does not have the data to calculate, it would bet that if you did a total loss analysis over all delayed and failed projects leading up to, revolving around, and including the modernization initiative, over the last decade, the number would be 5 times higher, just like the license cost of an on-premise software solution amortized over five years turns out to often be 1/10th of the total cost of ownership.

It might not add up to a 40 Billion loss yet, but by the time the Air Force recovers and modernizes all of the systems that need modernizing, it will likely get there.