Where do best-in-class class companies focus their cash-creation efforts? Inventory reduction. The 2010 Aberdeen Working Capital benchmark data shows that best-in-class companies make cross-functional efforts at inventory reduction twice as often as laggard companies, who more often choose to rely on their financial departments to collect receivables more quickly and pay bills more slowly.
The inventory lever is so fundamentally powerful that we recommend clients focus primarily on the strategic goal of reducing inventory.
When suppliers offer deep discounts for large-volume buys, the false economy of deep discount hides the cash-flow challenge. Companies can afford deep inventory in times of easy credit, so manufacturers offer deep discounts with extended dating to retailers and distributors in order to unload inventory and boost revenues. When retailers and distributors take the bait, they find themselves experiencing sluggish cash flow as they work through their excessive inventory. These experiences have taught some retailers and distributors a strong lesson about the cost of storage and the risk of obsolescence.
There are still many organizations that will buy inventory long and deep-looking in order to negotiate extended payment terms. Unlike other downturns, the Great Recession evaporated credit for suppliers to offer extended payment terms. Smart suppliers took the path of offering deeper discounts and holding firm on dating of extended payment terms. The suppliers wanted to unload their inventory and accelerate their cash cycle. The bottom line is, they understood that the combination of deeper price discount and longer payment terms would have a crushing effect on their working capital.
Retailers and distributors that took deep inventory positions found themselves between a rock and a hard place as consumers pulled back and easy credit lines for supporting inventory evaporated. In 2008 and 2009, many growing retailers suffocated in debt incurred by their deep inventory (including Steve & Barry’s, Goody’s, Gottschalks, and over 70 more). Distributors in several industries also fell into liquidation or sold at a huge discount to book value because they made the wrong bets on their inventory.
It is clear from our research and real-world experience that many companies labor under the illusion that more inventory with longer payment terms is a good thing. The reality is that it is an anchor that will drag them down and drown them.