2020 Reminds Supply Chain of the Importance to Operate for Cash

While the coronavirus pandemic is a global tragedy that has disrupted many lives and businesses, it has brought clarity to supply chain leaders.

Almost universally, supply chain leaders identified their top three priorities as ensuring employee safety, fulfilling customer demand (to protect or grow market share) and operating for cash (to maintain liquidity). One supply chain leader recently shared with me the insight that “COVID-19 has reminded us we can do nearly anything when we have clarity of purpose and priorities.”

Perhaps operating for cash is one of the clear, unifying principles that supply chains should retain as a performance priority going forward. One industrial manufacturing supply chain leader acknowledged being “too focused on profit,” but that cash consciousness has increased and would likely remain more important. This does not mean that supply chain is not concerned about profitable growth, only that it plays a distinct role in supporting this strategic business objective.

Our role is not to invent products, grow markets or develop new customer relationships. We mitigate risks and constraints while safely operating complex networks to fulfill demand for products and services. We also contribute to the effective use of working capital for maximum value at acceptable risk. This is an important part of the “cash flow equation” that maximizes liquidity for full flexibility to meet obligations and fund investment in growth.

The industrial supply chain leader’s perspective is that “we have chosen to be the goalie rather than the striker” on the soccer (or football) team. In other words, if we wanted the glory of scoring new deals or product inventions, we would have chosen a different profession. Supply chain, like the goalie, is unfortunately most noticed and associated with the negative impacts of operating shortfalls. Embracing this important role requires both courage and humility, and 2020 has been the year when supply chain has embraced its role and allowed its value to be on full display.

The resourcefulness and teamwork demonstrated by supply chain professionals has protected a lot of value for the businesses they serve. At the same time, they have confronted their shortfalls and identified opportunities for improvement. Many supply chain organizations have built credibility and earned respect based on this performance, particularly with financial stakeholders. Perhaps a continued focus on operating for cash, based on levers within supply chain’s range of influence, can help to maintain and strengthen these connections with finance beyond 2020.

A focus on cash does not correspond to a de-emphasis on cost or service.  But it does reflect the reality that a high portion of costs are structurally determined by business, organization and supply network design choices.  Fixed costs are considered “sunk” and cannot be impacted (up or down) by operating decisions within the next quarter (and often longer). This knowledge liberates supply chain to do what it does best — finding the operating plan that strikes the right balance between minimizing variable costs and controlling the risk of working capital like inventory that occupies cash. This is the reason why some high-tech companies choose to absorb air freight cost premiums on high-value items in return for faster cash conversion and reduced exposure to product devaluation or other risks.

During my interactions with supply chain clients, I encourage them to remain true to this mission by proposing S&OP supply plans that maintain inventory within the range required to operate the business. Allow finance or commercial roles to propose (and accept the responsibility for) discretionary decisions to absorb fixed costs that optimize reported quarterly profit or position anticipation stock for a speculative upside demand opportunity.

There is no conflict between operating for cash and delivering service levels that meet customer needs and business commitments. Maintaining service levels is a required condition (or constraint) which the operating plan must satisfy to deliver the variable margin which comprises the core of operating cash flow. However, a focus on cash allows supply chain to identify, quantify and escalate situations where inventory risk and the cost of operating complexity (relative to variable margin) are significant for one demand segment compared to the rest of the business.

Operating for cash is not at odds with aligning to support the long-term business strategy, but is part of a performance  continuum focused on the more immediate time horizon.  As business operations stabilize around current and emerging market conditions, supply chain will continue to maintain an appropriate balance between short-term performance and long-term strategy, as illustrated in the figure below.

This performance continuum allows for a distinction between how supply chain performs by planning and executing network operations versus how it supports, influences and implements design choices that optimize business performance or strategic investment decisions for growth and advanced capability. The essence of supply chain strategy is to find a way to address the entire continuum in a balanced way.

While it’s true that decisions toward the right have high potential impact, they do not occupy most of the supply chain organization’s time and effort. They are also beyond the direct control of supply chain leaders and cannot be used to evaluate supply network performance. Our recent conversations with companies have confirmed that financial metrics and investment criteria at many companies still favor the pursuit of scale for lowest cost supply, without regard to the risk and cost of complex network material flows.

How could your organization’s impact and influence grow by implementing a supply chain performance lens that emphasizes “operate for cash” principles to help key stakeholders understand the impact of business design choices on cash performance and working capital risk?

Paul Lord,
Senior Director Analyst,
Gartner Supply Chain
Paul.lord@gartner.com