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Times are Tough - RIR Might Leave More Cash on Your Balance Sheet

Written By: Predrag Jakovljevic
Published On: November 11 2008

For residents and tourists of Paris (France), using RER or Paris Metro is certainly a way to save on commuting costs (and parking frustrations) compared to owning and renting cars. This blog post is not about transportation, but rather about an inventory management method with a similar name.

Namely, this blog post is about RIR or Rapid Inventory Rightsizing, which is an innovative new program to help embattled companies relatively quickly free up cash and reduce the impact of the current global credit crunch on their supply chains. This pretty straightforward concept and message of improving a free cash flow (FCF) came recently from ToolsGroup, a global provider of demand-driven inventory optimization (IO) solutions. Regular readers of this blog site might remember my recent series on shortening long tails of supply chains, where ToolsGroup was also the protagonist.

The idea behind RIR is to promptly reduce a ToolsGroup customer's working capital needs and thus ease the impact of the credit crunch. In this era of tight credit and higher cost of capital, cash is king. According to the United States (US) Federal Reserve's most recent quarterly survey of senior bank loan officers, 58 percent say that they have tightened lending standards to large and medium-sized businesses, and more than 80 percent surveyed said that their customers are paying more for loans. Some of us who have lately applied for a mortgage loan might be able to relate to the experience and lending practices.

Rationalizing (or rightsizing, if you will) inventory is a low-hanging-fruit source of short-term working capital and improved cash flow. When the inventory mix deteriorates over time, a large financial asset is not being used efficiently. Managers then find that they have too many of the slow-moving items they don't need (and that languish in stock) and not enough of the hot, fast-moving items that are most in demand.

RIR is now available from ToolsGroup and participating North American partners. This is a service-based offering that employs ToolsGroup software, but is not installed at the client’s site. The program is easy to implement because it requires no changes to the company's distribution/supply network or technology infrastructure. It consists of the following three steps:

  1. An immediate rightsizing of the inventory to eliminate the least effective inventory and insure profit-generating and strategic products are properly served. Capital will be rapidly reallocated to the most financially productive areas, whereas inventories that are not aligned with profits and customer service will be drawn down. Because this first step can be implemented in a few weeks, it can rapidly begin generating free cash flow, often within the same quarter;

  2. All inventories are adjusted to avoid excess inventory experienced in a slowdown, while maintaining required customer service levels. As revenues slow in certain product streams, most companies neglect to adjust their inventory targets to changing circumstances. While individual items’ levels will vary, overall inventory requirements should thus be reduced, freeing up additional cash flow; and

  3. An ongoing review process, managed either inside or outside the company, to keep inventory targets aligned with changing conditions and ensure sustainable results over time.


Service vs. Software Offering

As for how RIR is different than ToolsGroup’s standard offering, the Service Optimizer 99+ suite, the vendor and its partners employ the same technology, but deploy it differently as follows:

  • Many companies ToolsGroup engages with are focused on longer-term inventory optimization and supply chain projects, whereas this program is specifically aimed at companies that are focused on a short-term goal of improving working capital and easing the impact of the credit crunch. Therefore there is a lot of focus on the analysis of working capital improvement;

  • Normally, ToolsGroup builds the IO competence within the client during the implementation. In this program, the vendor rather uses its own domain competency and experience to “jump start” the project for fast results; and

  • Last but not least, this is a service-based “know-how” offering that employs ToolsGroup software, but is not installed at the client’s site.


Pricing starts at US $30,000 and depends on the complexity and size of the operation (again, it is strictly a service fee). Individual companies will find different results from this process, but can typically expect to generate cash of between 10 and 30 percent of their inventory value while maintaining the same or improved customer service levels. In other words, the program should cost a small fraction of the inventory saved and cash generated.

Playing Devil’s Advocate with a ToolsGroup's Executive

While I certainly fancy the idea and approach at first glance, I felt compelled to ask ToolsGroup a couple of prodding questions. For one, what happens when the economy turns around and the focus is more on growth and expansion rather than of cutting costs? Jeff Bodenstab, ToolsGroup’s vice president (VP) of marketing says:
Please refer to the step 3 at the end of the press release (PR), where it reads “... an ongoing review process, managed either inside or outside the company, to keep inventory targets aligned with changing conditions and ensure a sustainable results over time.” If the focus is more about growth and profitability than on working capital management, the goals and the targets are adjusted accordingly. This can be achieved either by an outside service or an internal system.

If this is the first-time offer, what are you basing your proof-of-concept on?
The 10-30 percent expected inventory reduction is based on our experience in more than 190 implementations at more than 150 customers. The technology is not new, only the implementation approach. This has been our bread-and-butter business for more than 10 years.

For a $30,000 investment, how much freed-up cash via inventory should a customer expect and in what time period?
First, let me reiterate that pricing starts at $30,000 for the initial rightsizing and depends on the complexity and size of the operation.

Let's do the math for a medium size business with $500 million in annual sales and $40 million in inventory. Let's also say that we feel quite confident that we can quickly help this company achieve at least a minimum 10 percent reduction in inventory in a few months time. That equates to a $4 million reduction in working capital, which generates equivalent debt reduction or increased cash.

In addition there would likely be other efficiencies and cost savings associated with less inventory, such as less storage, handling, and carrying cost, and less inventory obsolescence. Finally, we believe that many companies will continue to work with us, and will achieve even further savings, but we won’t know what that total potential value proposition looks like until we get in and do the first analysis.

The Verdict

The RIR program seems well suited for companies with large inventories not being put to optimal use. By improving inventory targets, companies should be able to reduce global inventory levels while still maintaining needed customer-service levels (i.e., fill rates). The program is targeted at chief executive officers (CEOs) and chief financial officers (CFOs) looking for increased liquidity or FCF, private equity funds wishing to improve return on investment capital (ROIC), and supply chain executives addressing corporate mandates to reduce inventory cost while maintaining customer service metrics.

Dear readers, is this a well thought-out value proposition from a vendor to help its customers during bleak times or merely a vendor's repackaging exercise to cash in on the current economic crisis? Should virtually all vendors try to come up with similar initiatives and thus justify their existence and customers’ investment and trust?

What are your opinions about the RIR program? What steps are you taking to free up cash from hefty inventory investments?
 
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