How does your position in the value chain affect your working capital – and what to do about it? Wholesalers

In a series of three articles, we give our point of view on common working capital related challenges connected to an organization’s position in the value chain. This third article provides advice and examples on how to tackle challenges in the wholesaler part of the value chain.

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The wholesalers’ KPI performance

In our analysis of working capital across the value chain, wholesalers perform below average in terms of accounts payable and accounts receivable but especially stand out as having high days in stock. This is not very surprising, as part of their value proposition is handling low volume suppliers and supply chain complexities for their customers. Wholesalers also mainly stock finished goods, resulting in a high inventory value in proportion to COGS. Thus, it may be acceptable or even warranted for these companies to tie more capital – but all the more important is tying the right capital, which means having the right products in stock at the right place to match customers’ needs.

Below are five key areas to consider to when optimizing inventory levels as a wholesaler:

1. Footprint – balancing of lead time and scale

The goal of a wholesaler supply chain is to be set up in such a way as to keep costs low through efficiency while delivering reliably and at sufficient lead times.

One large central warehouse is usually the most effective setup from a working capital perspective as fewer sites result in less buffer stock. Eg, a large number of low sales SKUs can have very few units in stock without pushing up inventory excessively. Also, from an operational efficiency perspective one central warehouse is usually best as economies of scale drives up efficiencies in inbound, picking and packing, etcetera, which can be further amplified through automation.

The factor driving up working capital is pressure for shorter lead times from customers. With identical products and pricing made transparent through web catalogues, more businesses are competing using lead time. This pushes stocking locations closer and closer to the end customer, resulting in increased inventory through distributed buffer stock. Therefore, some regional warehousing is often needed, but should be reserved for frequently sold and urgent assortment.

Decisions on footprints are usually difficult to set, especially in markets subject to change. Here, the cost to change need to be kept at a minimum. One often successful approach is starting with an efficient central warehouse. Since unless volumes decrease drastically, the investment will count towards a long-term cost advantage against competitors. After that, small local warehouses can be piloted in regions of high customer density and scaled to a suitable level. Ideally, these satellite locations pay for themselves through increased sales as a result of higher availability. A way to further leverage such a network is by spreading the medium-turnover inventory across multiple sites in one region while utilizing existing internal transportation to relocate these products as demand arises. By doing this, lead times can be kept short for a broader a broader assortment without raising inventory levels.

2. Assortment – know what your customers prioritize

As a wholesaler, naturally your customers will want the broadest assortment possible with the shortest lead times which would lead to an infinite inventory. But as the customers also will want a reasonable price, this is not an option. Instead the optimization problem needs to be solved by knowing what your customers prioritize and aligning your assortment to that, while taking your own profitability into account. Here, having structured your sales data will come in handy along with customer insight initiatives and integrations with your customers. The goal is understanding what your customers’ required assortment is at all times. The more you can keep your assortment flexible, with systematic phasing in and out of products the better you can meet your customers’ current requirements without swelling your inventory.

Part of keeping a customer relevant assortment is finding the right depth per product category. Do customers really need four different colors per chair and three different brands of mineral wool? In a lot of cases customers are indifferent between these options. A large product depth also adds administrative burden for procurement and pricing organizations.

3. Inventory policy – a tool for pushing stocking location backwards in the supply chain

Intimately related to both footprint and assortment is inventory policy. This refers to which items in your assortment are kept in stock and which are not, including subsegments and criteria connected to these two groups. The whole idea behind the concept is making distinctions which help in pushing stocking location of items backwards in the supply chain to reduce inventory.

An example of a useful inventory policy is the ABC method, where:

A-items are “Always in stock”. These are the most frequently sold items where lead times and direct transportation costs require you to stock them. Especially if your supplier is not stocking the items reliably.

B-items are “By-order items”, meaning that they are only ordered from your supplier when receiving a firm customer order. These are items stocked by your supplier for which you can arrange cost effective delivery to your customers with sufficient lead time – either as transit or shipped directly from the supplier.

C-items are “Customer specific”. These items require management of customer expectations since lead times will be long for these items. The reason is that they are low frequency items you do not want to stock even though your supplier is not stocking them at sufficient quantities either. They commonly include items with exceptional order quantities. For example an item where 12 months rolling consumption prompts stocking of 40 units whereas consumption actually consists of one item sold per month, followed one annual order of 200 units.

4. Differentiation – how to steer an inventory with diverse characteristics

In addition to having a broad assortment of products, wholesalers usually carry products with very different characteristics including value and consumption patterns, but also size and weight. This increases the need for product segmentation and differentiated inventory steering models. Going from an inventory steering model with 1-dimension such as Cost of Goods sold (COGS) to a 2-dimensional inventory steering model, inventory can often be reduced 10-15 %. Good differentiation dimensions here are commonly cost of goods sold and consumption pattern. For these inventory steering models to function, sales forecast data is extremely important. And given the number of products carried by most wholesalers it is usually not possible to use any other forecast than extrapolations of historical sales. Sales forecasts based on sales staff or general market information tend to lack SKU detail or be overly optimistic. One way of increasing the quality of forecast however is through integration with the customers e.g. through collaboration on SKU specific market campaigns and Vendor managed inventory (VMI).

5. Data management and systems – the foundation for efficient, high-quality processes

With large assortments, multiple suppliers as well as customers come large sets of data. Without control of this, many of the above recommendations will either be too burdensome to set up or suffer in quality due to insufficient data. Thus, the two below points are worth considering regarding data and systems as a wholesaler:

  1. Set up structured data management with data warehouses and processes for maintenance of data quality, including your master data.
  2. Invest in Inventory Management Systems meant to handle inventory steering in a wholesaler business. I.e. do not try to run your entire supply chain using Microsoft AX. It will lead to; sub-optimal workarounds, manual excel shuffling and likely a higher IT spend trying to configure your inadequate system

Wholesaler's challenges and how to deal with them

Challenges

  • Keeping down inventory and logistics costs while maintaining high service levels and availability

  • Increased demand for shorter lead times

  • Broad varying product assortments

  • Many suppliers, customers and large sets of data

What to do?

  • Efficient central warehouse and flexible decentralized stocking locations according to lead time requirements
  • Manage the product range and communicate with customers to keep correct products in assortment
  • Inventory policy as help in pushing stocking location backwards in the supply chain
  • Differentiated inventory steering models
  • Sufficient data and systems capabilities to handle product assortment and supply chain complexity

Study sampling and information

  • 200 companies with net turnover between 1-10 billion SEK were screened whereof 152 companies were allocated to a step in the value chain, ie: Raw material & processing, Manufacturing, Wholesale and Retail. 48 companies were either service companies or difficult to define.
  • For the selected companies, the operating working capital components* were analyzed in relation to revenue. Further, turnover days using revenue, spend and cost of goods sold were calculated*.

* Working capital components refer to: Accounts receivables, Accounts payable, Inventory, Prepaid expenses & accrued income, Accrued expenses and prepaid income

** Turnover days refer to: Days sales outstanding, Days payables outstanding and Days in stock

Need a working capital expert? Capacent have carried out over 300 working capital projects and have experience from most industries. So if your company is pursuing working capital reductions, do not hesitate to contact Erik Påhlson (erik.pahlson@capacent.se) or Fredrik Hammarström (fredrik.hammarstrom@capacent.se). We would be glad to make sure you get the most out of your initiative and are happy to tie our compensation to achieved results.