Volume 1: Deals & Forward Buys
These days one can read a lot about predicting customer demand, AI and integrated supply chains. No critique from my side, after all, I am one of the guys doing that. But in this article I want to touch on an aspect that we do not discuss too often: Do we actually exploit the opportunities at hand when our suppliers give extraordinary offers? Or do we let traditonal thinking and KPIs to some extent confine ourselves to a middle ground approch?
By getting the proper attention from your company on the opportunities that exist here, you can contribute to your company’s top line, create improved margins and improve profit rates.
Being responsible for your company’s supply chain planning or purchasing, you for sure have your targets set for service levels, inventory levels or inventory turnover.
These are important goals. On one side the availability of your products supports your company’s market- and competitive strategy, whilst your inventory levels reflect your company’s capital spend, capacity utilization and even assortment management. Both groups of goals are tightly connected. Capital is furthermore a resource that your company has to have a conscious relationship to – capital is, after all, a limited resource. And capital has a cost. Well, you might say, the interest rates are low now, so it does not matter that much. True, but if you ask your CFO what his target yield on alternative investments is, he would probably have a pretty high number for you. So, the term “inventory turnover” is now probably deeply rooted in the consciousness of most of us – and it tends to drive a lot of our thinking.
And it should. My point here, however, is that the focus on inventory turnover should not let us refrain from hunting for more increased profitability. As a matter of fact, it sometimes may pay off to make decisions that actually lower the inventory turnover, at least temporarily.
Forward Buying: Inventory Turnover vs profitable buying
A great capacity in the field of profitable buying back in time (when we wrote checks) formulated the dilemma quite strikingly: “I am now going to write you a check. What do you prefer I write on the check – Inventory Turnover Rate or Amount?”
He posed his question after having listening to my lining out of measures I was about to put in place to reduce the inventory levels for one of my clients. “It’s in its place to remind you that optimizing supply chains must focus on improving profitability. What you can contribute to with regards to capital and cost reductions is of course of the good, but do not overlook that utilization of the commercial terms that you at any time can achieve with the suppliers directly impacts the company profits.
Look beyond traditional KPIs and let science driven Forward Buys drive your profotability
As such, there are many companies out there that unfortunately overlook the value of letting the planner be an investor with full responsibility of driving the overall profitability of the portfolio of suppliers and items he or she is managing. By providing the buyer with the right tools, insights and decision framework, this can generate some fantastic opportunities. Fast! – and straight to the bottom line!”
This is so true. I have later had great satisfaction by witnessing companies take this to its full potentials, even to such an extent that they have been using the profit and cash to buy other companies.
Forward Buying – a story from daily life
It is time for a management meeting in your company. You are responsible for planning & execution of the supply chain – and are as such responsible for achieving the above mentioned goals. Your CFO is meticulously monitoring the capital spend: “I see that our inventory levels are 8% higher than what is the norm for this period of the year. Not good. With respect to our inventory turn targets, you should have been 12% lower, shouldn’t you?” The warehouse manager chimes in and argues that “…in relation to our efficiency targets in the warehouse, we are now at a utilization level of over 70%. Have your department started loosing control?!”. There is, however, some encouragement coming from the sales director: “…even if the inventory levels are a bit inflated right now, there are a lot of positive feedbacsk from the customers. We seem to have bought the right stuff to support the promotion that we now are running”.
Luckily, you are indeed a well prepared supply chain manager: “In reality, your observations are all correct. Here is the reason: During last quarter, one of our suppliers realized that they were not going to achieve their sales targets. So they approached us to see if we could help out. After negotiations with us, they agreed on reduced purchase prices to us for a limited period of time. In cooperation with the market department, we found that some of these products were perfectly suited for a promotion that we already had underway. Now we could give very good offers to our customers and at the same time retain very high profits, as the supplier agreed to some really good discounts.”
Let your planners view their portfolio of suppliers and items in an investment perspective
The CFO is not entirely convinced, so he asks: “OK, so you achieved improved margins, but as a matter of fact, you actually have put considerably more products on stock, which actually drives capital- and inventory holding costs. Did you take that into account in your calculations? And, come on – does this really mean so much for our bottom line?” “It is correct”, you respond, “-after all we had already planned for the volumes needed to cover regular, seasonally adjusted demand. What we actually did now, was to carefully manage the actual ordering-, capital-, inventory holding- and freight costs so that I knew the exact accumulated profit curve from buying one day, two days and so on extra. And I knew the exact number of days where we maximized the profits. But at the same time I knew that our budget on Forward Buys was at 3,5 million Euro. Both constraints now were taken into account coming from the unique characteristics of the 28 items that now qualified to be included in our Forward Buy. And since you ask me about the bottom line effect, this Forward Buy adds 650.000 Euro to our bottom line profits and increases our annual profit margin from 2,5% to 2,9%. And all costs are included”.
The warehouse manager is not so concerned about the overall profitability, but is more focused on his operations not being disrupted, so he says: “That may seem like a good theory, but step into my warehouse and see for yourself! You clearly have bought an all time high overstock. If this promotion goes wrong, you expect us to stumble over all these extra volumes till midsummer, don’t you?!” “That’s right, we did expect a fuller warehouse now and some time, going forward. We did actually take the extra receiving work into account in our calculation. We bought 27 days extra on these items and, according to my calculations, we should be back to normal levels again on 17 April. Our seemingly high overstock is actually made up of 87% stock coming from that Forward Buy. So, yes, we are actually in control.»
The sales director chimes in: “The prospect of getting into trouble by overestimating the sales from my side did concern me. So I asked the supply chain manager for a simulation of what would happen if we sold only half of the estimated volumes for the promo. The simulation indicated that we would be back to normal on 8 May instead of 17 April. The numbers, however, show that we are well ahead of the sales budget, so this is going to be all fine!”.
Profitable decisions put into system
Maybe you think the above-mentioned illustration is a bit far-fetched. Well, actually it isn’t. I am daily observing companies actively exploiting these opportunities and that have own programs to build process support and competence around this. Just because there is so much money in it.
As you will have noticed, I have repeatedly called this Forward Buy. So what is it, really? You are executing a Forward Buy when you have conditions from your supplier that favor buying more than you normally would have done to cover demand for a defined period in time. There are not many decisions a buyer – or should I in this context rather say investment buyer – can make than those related to deals or forward buys; the ROI could easily reach 60-80%! Just as with investments in general, this is a question of weighing in an number of factors, risk and, not to forget – timing.
The question becomes: Is this something for me? If you don’t pay attention and exploit the opportunities here, you are literally leaving your money on the table. When your supplier does not reach the quarterly targets or is just about to achieve his annual bonus, overlooking this opportunity for you may mean a lot of money lost. Money that could have showed right at your company’s bottom line.
If you work in a company where the general opinion is that “this is nothing we can do, as we operate with fixed prices, negotiating annually”, one approach could be: Well, speculate in what the new prices will be. Or, once the new prices are known, regard the time up to the effective date of the new prices as an investment opportunity window!
And if you work in a company where one thinks that this is simple stuff, «we can easily solve it in a spread sheet», my answer is: Maybe you can. But probably not. There is a lot of science that goes into Forward Buys and Deals. Don’t rely on your own judgement, use world class science developed for proper Supply Chain Profit Optimization!