Doctor's Note (June): Unique Opportunities in a Downturn

We all assume higher productivity is better. So if a company is making a product for $100 and now starts producing it for $50, should the CEO get a bonus?

What if the cost savings are the result of closing down a plant in the US employing 200 people, and moving the production to Mexico, and what if the plant in Mexico uses less efficient methods so that 300 people are needed to do the same work? Should we factor the cost of lost taxes, unemployment payments, potentially an increased carbon footprint because of higher transportation costs?

Efficiency and productivity are about doing more with less, but current productivity measures don’t take into account the complete impact of changing work practices or of capitalizing on unique financial opportunities.

On May 17th, Columbus Dispatch reported that Hexion Specialty Chemicals managed to increase its profit for the quarter to $116 million even though sales decreased dramatically from a year ago. The profit was mainly due to the gain that Hexion made by buying the debt at less than face value.
This just highlights the opportunities that exist in a downturn. This is a great time to buy a house or a car if you have the cash for it. Companies have similar opportunities, especially those that are heavily leveraged. The trick is to find the cash.

A look at Hexion’s 10K is instructive. In the first 3 months of 2009, the company reduced inventories by $95 million and its receivables by $128 million. It does not take a genius to figure out that at least part of the debt purchase was financed by reducing inventories and receivables. Contrast this to some other companies like DuPont and Dow where the sum of inventories and receivables was essentially unchanged in the same three months. The lesson is clear. The companies that are not proactive have seen their inventories decline by a percent or two each month in line with the inventory picture for all US manufacturers. The companies like Hexion which are proactive have been able to take advantage of declining sales to free up cash which then can be used advantageously.

In an environment when sales are decreasing, pockets of inventory tend to pile up in unexpected places. Because sales do not uniformly decrease, inventory imbalances are almost inevitable. Traditional measures like days of supply (DOS) and safety stock targets do not work well because they are based on historical data. Continuous monitoring of how quickly your inventory is likely to be depleted (also known as inventory velocity) is essential. This is an area where supply chain managers can have a direct and dramatic effect on a company’s profitability.

The opportunity in the next three to six months is to use the supply chain to leverage other opportunities that might exist. Often this is to identify the areas where inventory can be reduced without affecting the overall health of the business. Supply chain planning can help to extract short term cash which the business can use effectively in these trying times.