Reduce working capital. Lower the cost of production. Both are admirable goals, but what happens when they conflict with one another? That was the challenge faced by CEAG AG, the German maker of power supplies and charging units for cell phones and other high-tech products.
Based in Ostbevern, Germany, CEAG has three manufacturing plants in China-two in Shenzhen and one in Beijing. The setup helps keep production costs low. But it also generates a host of complications, resulting in higher levels of working capital all along the supply chain.
Longer supply lines mean extended order-to-payment cycles, tying up crucial resources. They also raise the financial risk of doing business in multiple countries, while boosting market volatility. Many companies respond by building up safety stocks, causing a serious drag on balance sheets.
CEAG wanted to reap the benefits of overseas production while dramatically cutting working capital. It turned for help to Fraunhofer ATL, a large research institute in Nuremberg with a focus on logistics. Together the parties devised a way to identify just how much capital was deployed at every major step of the company's supply chain.
CEAG, which sells product under the brand name FRIWO, is a mid-sized manufacturer with a commanding lead in the worldwide market for mobile phone chargers. It operates as two distinct business units: FRIWO Mobile Power (FMP), which sells price-sensitive equipment to the mass market, and FRIWO Power Solutions (FMP), a maker of customized power-supply products in lesser quantities. They account for 80 percent and 20 percent, respectively, of the company's annual turnover of around $263m. In all, CEAG sells some 150 million units each year.
The supply chain is complex. Finished goods move out of China through Hong Kong, either as consignment stock bound for Europe, or as direct shipments to markets in Europe, the U.S., Latin America and Asia. There can be lengthy delays, as well as caches of safety stock, throughout the process.
Receivables tend to get stretched out as well. Peter Klaus, a research associate at Fraunhofer ATL, estimates that $35.2m was tied up in the CEAG supply chain in the form of inventory, consisting of finished goods, raw material and work in progress. That number represented more than 35 percent of total assets, with accounts receivable absorbing another 28 percent.
Step one was to map the flow of working capital. CEAG and Fraunhofer created a graphic visualization of the supply chain, divided into six major stages: raw materials and supplies (including accounts payable), production, ocean transport, land transport, consignment stocks and accounts receivable. In addition, each segment was displayed in two "dimensions": the amount of capital tied up, and the period during which it was committed. The layout of the numbers made it easy to spot where the most money was deployed; amounts were in proportion to the size of colored arrows in each of the six columns.
A series of formulas applied to the data gave CEAG new insight into its supply chain. In the category for accounts receivable, for example, it was able to calculate the theoretical amount per day over a year's time. Multiplying that number by customers' actual payment targets yielded the amount of capital employed.
The mapping was applied to various levels of the supply chain, beginning with the entire company, then broken down into FMP, FPS and their major customers. In the last category, the process highlighted FPS's top five customers in terms of sales, and FMP's five most important accounts. (Because FMP's market is highly fragmented, sales volume is not considered a useful metric.)
Armed with this wealth of new information, CEAG could start whittling down working capital in each key area of operations. In all, it identified nearly $12m in possible reductions, out of $38m in deployed capital. Optimization efforts at each stage of the chain yielded reductions in accounts receivable from 45 to 35 days, in consignment stocks from 18 to 13 days, in European land transport from six to 3.3 days, in ocean transport from 27 to 22.5 days, and in production from seven to 6.5 days.
Each change has had an impact on the bottom line. For example, CEAG saved more than four days of ocean transport by shifting to faster vessels. For a single product, that meant six fewer containers needed, for a savings of $439,000 in working capital. The 10-day reduction in accounts receivable would free up another $8.8m.
Cutting down on accounts receivable or consignment stocks isn't always easy, especially when the customer is a large and powerful account with the freedom to choose its suppliers. But there are ways to get around that barrier, said Klaus. For CEAG, the level of consignment inventories turned out to be higher than what the customer wanted, driven instead by an "overly eager" sales force. Moreover, through an "open-book exercise," customers can be shown the ultimate cost of excessive receivables and onerous payment terms.
In the long term, CEAG plans to rearrange some safety stocks for additional savings, possibly centralizing its inventories, while doing a better job of sharing forecasts with key customers and suppliers.
It all began with a simple colored chart. As CEAG and Fraunhofer said in their description of the project, "The visualization is easy to communicate, and therefore a powerful tool to support executives in facing these challenges."
Fraunhofer ATL Congratulates CEAG AG
We would like to give special thanks to the CEAG AG, our partner in the project case presented. All the support and the information provided by Rolf EndreÃƒÅ¸ (CEO of CEAG AG) and Dr. Stefan Sack (vice president of operations for CEAG AG) were fundamental for the case study.
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