This Week on SCDigest:
The Real Value of (Less) Inventory
Supply Chain Graphic of the Week, plus more Supply Chain News Bites
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Reader Question - On Improving DC Labor Retention
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This Week's Supply Chain News Bites
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Supply Chain Graphic of the Week: Shop Floor to Top Floor


This Week's Supply Chain by the Numbers - Berkshire Hathaway, Sealy, Chinese Drywall, Kia Motors



As the dollar gained strength, the instability on Wall Street continued last week.  Our Supply Chain and Logistics stock index was sharply down across all groups.

In the software group, SAP finished the week down 12.5%; JDA slid 10.8%.  In the hardware group, Intermec plummeted 10.5%, while Zebra was off a mere 1.7%.  In the transportation and logistics group, Prologis fell 9.6%, followed by Ryder (down 8.9%) and J.B. Hunt (down 8%).

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Top Story: Measuring Inventory Accuracy - No Clear Answer, Experts Say

Vendor News: Intelligrated Moving Ahead with FKI Logistex Integration, Strikes Deal with Ohio and Union on Expansion


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The Real Value of (Less) Inventory

OK, I better write this column before it becomes so common knowledge to everyone that it has little value.


The topic is the value of inventory – or more specifically, the value of less inventory.


I started to write this column earlier this summer, but began by talking about measures of inventory performance, such as inventory turns. I ran out of time before I got to the main point I was trying to make – but generated a tremendous amount of great reader response nevertheless (See Readers Respond – Measuring Inventory Performance).


It wasn’t that long ago that supply chain professionals and even some financial types did not well understand the role of inventory and free cash flow. Now, it seems like you can hardly read a corporate earnings report without seeing some connection between inventory and cash flow.

Gilmore Says:

"Permanently reducing your level of inventories relative to sales and sales growth can have a dramatic impact on a company’s share price."

What do you say?

Send us
your Feedback here

Case in point: Goodyear announced last week that its inventory reduction program had generated a $1 billion in working capital reduction through Q3 2009.


Earlier this year, we reported on how Home Depot was striving to improve its inventory turns – meaning “reduce inventories relative to sales” – from 4 to 5. If it can do that, it also means $1 billion in annual cash flow improvement to the home improvement giant. A billion here, a billion there – it adds up.


So, for everyone’s benefit, let’s go through the basics.


It takes cash – capital – to produce or acquire inventory. That cash is tied up in that inventory, not usable by the corporation. It is called “working capital,”  and it is not available for other parts of the business. Since many companies turn to financing instruments to support their short-term working capital needs, this has a very real “cost” to the business.


So, for every dollar in inventory reduction, this leads to a dollar reduction in working capital requirements – and, therefore, to a dollar improvement in “free cash flow.”  Free cash flow is different than “profits” and “earnings per share,” – and is a critical metric for many financial analysts and investors. More on that in a minute.


The best way I know to illustrate this connection is to use a Walmart example.


In the middle part of this decade, Walmart actually let its inventories grow somewhat out of control – the growth of inventories versus growth in sales reached very high levels versus its historical ratios. It reached a level of as much as 90% inventory growth versus sales growth in 2005.


I think there is a direct connection between that period of poor inventory management and the fact that Walmart’s operating and stock price performance languished during the same period.


What followed? Several initiatives, such as Walmart’s Inventory DeLoad program, designed to get inventory growth back to historical norms.


The result? The graphic below says it all:



After Inventory DeLoad and the other programs, in fiscal 2007, Walmart was able to keep inventory growth in its US stores group to just 12% of sales growth (.7% inventory growth versus 5.7% sales growth).


That, in turn, drove a tremendous growth in free cash flow, which at 25% was not only substantially above sales growth, but about three times profit growth. And not surprisingly, Walmart’s fortunes and stock price were bolstered soon thereafter.


OK, this relationship of inventory to working capital to free cash flow was not well understood even just a few years ago, but certainly has gained much traction in the past few years. Those connections gained even more traction in the recession, when cash and cash flow became “king.”


In fact, a recent panel discussion of Wall Street types at the CSCMP conference in Chicago noted that many companies were looking to the supply chain as a new form of “financing.” As the credit market dried up, or borrowing rates moved to ridiculously high levels, CFOs realized that by squeezing inventories, their companies would generate cash that would supplement their needs for outside capital that was increasingly tough to come by.


But even if you know all this, here is something you may not know: permanently reducing your level of inventories relative to sales and sales growth can have a dramatic impact on a company’s share price.


Gerry Marsh, an independent financial consultant who has worked with many of the world’s leading companies, made that clear to me in a white paper that Gene Tyndall and I wrote a few years back on the value of global supply chain improvements. You can find the chart here that Marsh created that shows, based on his proprietary model, how increases in inventory turns/inventory capital reduction can directly impact share price. In this example, based on a composite apparel company we created for the report (Action Apparel), improving inventory turns from 6 to 7 would actually increase the company’s stock valuation by an incredible 13%.


Why? Because “buy side” Wall Street analysts see that the company can drive more cash flow from each sales dollar – and free cash flow generation is what they care about. In fact, Marsh can powerfully demonstrate how differences in free cash flow generation clearly explain the difference in stock price multiples for companies that on the surface have very similar earnings per share and earnings growth.


The bottom line: inventory management is perhaps the defining element of supply chain management – where supply and demand truly meet. Getting that right not only reduces operating costs, but has a dramatic impact on cash flow and shareholder value.


Those that well understand this have a real leg up on their peers and competition.


What is your reaction to Gilmore’s column on the value of inventory reduction? What would you add? Is this becoming well understood in business today? Let us know your thoughts at the Feedback button below.

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A variety of letters this week, with some more on our First Thoughts piece on The True Costs of Offshoring. That includes our Feedback of the week from Kathleen Fasanella of Fashion Incubator, who says large retailers are unnecessarily contributing to the loss of US manufacturing.


Tony Tyler, however, disagrees with Boston Consulting Group’s George Stalk, who argued in our piece that retailers are better off with OK merchandising and great supply chains than the other way around.


You will also find letters on supply chain for small and medium-sized businesses (SMBs), managing supplier risk, and comments from a reader who thinks when we publish articles about oil speculation and such, we actually contribute to the problem. We say: don’t blame the messenger.


Feedback of the Week - On the True Costs of Outsourcing:


As the author of a book on DIY apparel manufacturing, I suppose I'm another "manufacturing fundamentalist" - mostly.


Stepping neatly aside the points and counterpoints already made, I suggest there's other problems affecting consumer choice with respect to the retail purchasing infrastructure of big retailers. Currently, it is nigh impossible to be a vendor to department stores if you're not producing offshore.


Unfortunately, seasonal products such as apparel require a timely feedback loop to address consumer demands such as fit, sizing and styling. These demands cannot be readily addressed with offshore push manufacturing. By the time feedback works its way back to the production floor, they're already cutting the next season's goods.


Minimally, it takes 18 months to respond to consumer's wishes.


A solution for smaller producers making higher margin goods is lean manufacturing. I have a client in Houston who sells women's gym clothes - consumer direct - from their website. They carry no finished goods in inventory. From the time product is ordered by the customer, it is cut, sewn and shipped all within 24 hours.


While this is a tiny company with only four employees, they were on track to break seven figures last year. This is a model that anyone can adopt and modify to scale, but it requires a vastly different mindset and capital requirements. Typically, the set-up is roughly equivalent to one machine per operator. With lean manufacturing, we use pods, a semi-circular arrangement of many machines per operator. It also results in higher quality.


Kathleen Fasanella

Fashion Incubator

More on the True Costs of Offshoring:


I would like to make a comment on Mr. Stalk’s thoughts.


I’m afraid that I disagree [that Stalk prefers OK merchandising and a great supply chain in retail to the reverse situation].


It is the marketing hype that sells into today’s markets for many products. The Hype often bends the truth, but marketing was never really about “Integrity” anyway.


If you stock up and sell out because of Hype, you can make great margins. But buying at promo prices and selling at regular prices produces even better margins.


Many items destined for promos arrive early and get sold at the regular price with greater margins than if they had arrived at the correct time.


Equally, many of his promo items also arrive late and are sold at the regular price, albeit a bit more slowly, despite the fact that some customers do take rain checks on the late arrivals.


The marketing hype gets people into the stores – say on a July 4th weekend and boosts the business, even if the products are already sold out, or have not yet arrived.


So the poor Supply Chain combined with good marketing hype leads, in this case, to greater margins!


Tony Tyler


eF3 Systems Inc.

On Supply Chain for SMBs:


This is a pretty good article.

I am passionate about helping SMBs. The question that I have is:

- what is really important to SMBs?

My experience selling enterprise software (Oracle ERP, Oracle Supply Chain) to the SMBs made me realize that SMBs do have supply chain problems which they describe with terms like:

  • “we have an inventory problem”
  • “the distributors are not moving inventory”

It is likely that marketing to the SMBs will require a hyper-customer-centric approach - i.e., we have to speak their language and speak it very fluently - hence, the "hyper" customer-centricity.

Looking forward to continuing the dialogue.


Shankar Saikia
Technology Entrepreneur & Sales & Marketing Consultant

On Managing Supplier Risk:


Good article, the point of you must use information from multiple sources, financial and otherwise is critical. While I have not used the Altman method, looking at these ratios in the context of current financial health has been a sanity check I have used on public companies.


For private companies, there is no replacement for on-site monitoring and visits, while it can be a delicate subject to approach, if you have a strong partnership with your critical supplier, random visits can be a valuable tool. I do also ask for a list of their critical path suppliers, what steps are they doing to weather this storm, how are they investing in improving their efficiency, what % of the business do you control, has it changed and what steps you can do to help them weather the storm? And depending on the level of risk to my business (sole source supplier, technology, etc.) I would also prepare a formal SWOT analyses, rating the critical supplier risk each quarter.


It is my experience that a true partnership will allow you to see the trouble coming ahead; however, the best relationship needs to be checked, just as the supplier should do in checking your viability.


Randal T. Platts

Supply Chain/Manufacturing Operations Professional

Been there, done that, in 1986 no less. It might work in the US, but other countries' accounting standards are different. It showed the two largest domestic electronics manufacturers in Taiwan as approaching bankruptcy. They are still thriving (but not the largest). It assumes an arms-length relationship between the company and its bank. That's not true around Asia.


My advice: Talk to your sales office (if you have one) in the supplier’s country about how they check credit-worthiness of their customers. If you don't have a sales office, contact a major accounting firm from your country who operates there.


Dick Locke

Global Procurement Group

Global Supply Management Training

On Oil Prices Set to Soar:


Printing articles like this feed the fuel to flame the fires that will come when oil prices start to rise.

People read articles and believe them to be true. So everyone gets scared or investors start buying up oil shares; thus, the prices keep rising.

Stop fueling the flames.

Timothy Otzenberger
Lenzing Fibers Inc
Shipping/Day Process Supervisor



i2 Founder Sanjiv Sidhu left what high-tech company to start i2?


Texas Instruments - the company was originally called Intellection, later changing its name to i2