Author Archives: thedoctor

Is Your Supply Chain OCF? Part II

In Part I, we asked if your supply chain was OCF, and by OCF we meant Operating Cash Flow and not Obsessive Compulsive Finance, although you have to be the latter in order to achieve the former. We explained that, at least from a working capital management viewpoint, it is a better measure of financial health than other financial measures. We finished with a question – How Do You Impact It?

First, let’s look at one detailed formula:

  1. revenue as reported
  2. – (increase in) operating trade receivables
  3. – investment income
  4. – other income that is non cash and/or non sales related
  5. – costs of sales
  6. – all other expenses
  7. + (increase in) operating trade payables
  8. + non cash expense items
  9. + financing expenses

Based on this formula, supply chain can impact:

  • 1. Revenue as Reported
    by creating new value-added services, creating enhanced versions of a product that can be sold at a premium, etc.
  • 2. Receivables
    by creating agreements that allow for faster collection, by factoring, etc.
  • 5. Cost of Sales
    by reducing product and service costs, reducing inventory costs, reducing transport costs, etc.
  • 6. All Other Expenses
    by reducing indirect costs, SG&A overheads, etc.
  • 7. Payables
    by taking advantage of early payment discounting, by reducing amounts owed through reciprocal trade agreement, etc.
  • 9. Finance Expenses
    by taking advantage of market knowledge to obtain best rates, by selecting appropriate currencies (to hedge against), etc.

And the impact can be measured as follows:

Supply Chain Contribution to OCF / OCF

where Supply Chain Contribution is, technically (where all projections are without Supply Chain Contribution):

  • Actual Revenue – Projected Revenue +
  • Projected Receivables – Actual Receivables +
  • Projected Cost of Sales – Actual Cost of Sales +
  • Projected Other Expenses – Actual Other Expenses +
  • Actual Payables – Projected Payables** +
  • Projected Finance Expenses – Actual Finance Expenses

** while this is technically correct from a Finance view who want the organization to hold onto cash longer, from a Supply Chain view it’s usually stupid, as SI has argued for years, because your cost of capital is often lower than that of a supplier and the goal is to lower overall supply chain costs. In other words, the improvement in payables is probably coming at a cost of a greater improvement in cost of sales.

In other words, if Supply Chain Contribution to OCF was 400K and the OCF was 2M, then supply chain contributed 20% and that’s proof in the pudding that supply chain has value.

Is Your Supply Chain OCF? Part I

Is it? Well, if it’s any good, it’s probably Obsessive Compulsive about Finance, but that’s not what I’m referring to. By OCF, I’m referring to the Operating Cash Flow Metric that some are claiming is the right way to measure supply chain contributions to the organization, and, as such, the measure that should be used in place of EBITDA (Earnings Before Interest Taxes Depreciation and Amortization), ROI (Return On Investment), or ROIC (Return On Invested Capital).

Operating Cash Flow refers to the amount of cash a company generates from the revenues it brings in, excluding costs associated with long-term investment on capital items or investments in securities. The IFRS (International Financial Reporting Standards) defines operation cash flow as cash generated from operations less taxation and interest plus investment income received less dividends. The calculation of cash generated involves determining cash collected from customers and subtracting cash paid to suppliers.

The push for OCF contribution, specifically, the measure of how much additional cash was generated or how much cash payment was avoided, as a measure of supply chain success by a few pundits (including David Schneider) is due to the fact that it is a more accurate measure of how much cash a company has generated (or used) than traditional measures of profitability such as net income or EBIT. (Wikipedia)

The rationale is that other measures are (much) more easily manipulated. For example, a company with numerous fixed assets (factories, equipment, etc.) would have decreased net income due to depreciation, but since depreciation is a non-cash expense, the net income amount is not a true measure of the cash position of the company. In addition, since a company can choose to recognize receivables before the cash is received, traditional balance sheets and resulting EBIT(DA) are also not accurate measurements of the true cash picture. And since companies need cash to run (as pesky people want to be paid), cash flow is often the true measure of company vitality.

OCF allows a company to get a much better grip on its working capital than other measures, and since Supply Chain revolves around working capital, the metric makes sense. So how do you impact it?

Stay Tuned for Part II.

A Managed Relationship is a Measured Relationship

I have to agree with the author of this recent piece in Inside Supply Management on “Building Relationships” who said that

if your organization isn’t seeking internal customer feedback – and using it as a learning tool – you may not be as strategic as you think.

As Thomas Nash, of First Line Consultants, says, “Supply management doesn’t own internal stakeholders’ budgets, we don’t own their spend and we don’t run their business unit/function.” The reality is that “Supply management provides stakeholders with fact-based proposals on how to better manage their spend based on reality, our expertise and best practice.”

This means that unless Supply Management is providing stakeholders with the proposals they need, in the manner they need, and the support to execute those proposals, it will not be doing a good job of managing indirect spend in the organization.

So how do you measure internal stakeholder satisfaction? The article gives some good tips to get you started:

  • Involve Staff
    Involve your staff in the process of creating the survey, choosing a process to deliver it, and a set of metrics to measure it.
  • Consider Timing
    The evaluation process should be done annually, but not during budget planning or vacation season. You need as many responses as possible, and they need to be good, thoughtful, responses.
  • Watch Your Language
    Use language the stakeholders can understand, not technical Supply Management terminology. In particular, when surveying legal, use their language; when surveying finance, use their language; and when surveying marketing, don’t be afraid to use a few buzzwords.
  • Be Patient
    The relationship-building and subsequent evaluation/measurement process won’t happen overnight. It will be a multi-year process, but with effort, the organization will get there and the results will improve year-over-year.
  • Share Results
    Share what you learned and the changes you intend to make as a result of the assessment. Do so quickly, and make sure the identified changes get implemented in a timely manner so the stakeholders can see that Supply Management is endeavoring to improve their service levels to the rest of the organization. This is how you become the trusted go-to department in the organization and get indirect spend appropriately managed.

The Price is the Price Only if You Pay the Price

Over at Next Level Purchasing, Charles recently published a good article on How Suppliers Defend Price In Negotiation. In summary, if the supplier thinks that you are not on your game, it will defend its price with a steaming pile of bull-crap.

Of the 7 examples that Charles gives for a common supplier response used when you attempt to start negotiations, my favourite has to be:

We are the only company that provides this product/service, so we don’t play pricing games – our price is our price.

First of all, unless you have it in your head that you have to have an iPad, there is no single source provider of any product or service. Pick a product. Any product. I guarantee there’s a dozen variations of it out there, somewhere. Maybe not all providers can meet your volume demands, and it’s probably the case that not all have the same quality level, but still, unless you’re insisting on a name-brand product, there are always multiple options.

Second, any supplier who wants to sell something bad enough will negotiate on price. Very few companies have the power to set a price in stone, and they are all selling branded products or services, like iPads, Wiis, or Playstations. Everything else is up for negotiation. And even if the price on the base product can’t move, maybe a value-added service can be thrown in at a deep discount.

The price is the price ONLY if you pay it. Given a choice between moving a line in the sand or being stuck with a mountain of inventory, which choice do you think a supplier is going to make?

Now, this isn’t to say that you should be requesting unreasonable price concessions, as everyone deserves a fair margin, but that you shouldn’t believe that the price is the price.

And if I was asked to choose a runner up, it would be:

“Is price the only criterion on which you are basing your decision?”

Of course not, but don’t let the supplier distract you. If you’ve done a proper cost model and determined that the supplier has built in a hefty margin of 20%, compared to the market average of 10%, unless you’re getting very valuable value-added services thrown in for free, you need to cut that margin in half to stay competitive.