Monday, April 22, 2013

Target to create oscillation

In many industrial companies, December is a not a good month. The sales volume for these companies has an oscillating pattern over the whole year, with month-to-month differences that can be as big as 20%. Demand in December is the lowest of the year because of the Christmas holidays, and because in December demand is reduced by active de-stocking.
Managers have targets for running their business, and for many managers that includes a target  –strange enough if you look at it— to have a low level of working capital at the end of the year. The easiest way to achieve that target is to reduce the stocks.  The target is not to have a constant low working capital: it only needs to be low at the end of the year; This is obviously for reporting purposes: it looks good and tidy in the annual report.

A calculation example of the effect: If your customer on average has 60 days of stock, and the customer decides to reduce his working capital with ten percent,  in December he buys less product for the equivalent of 6 days' sales, creating an additional 20% (6 days divided by 30 days) dip in your already low December volume. 

As a result, in January stocks will be too low for normal operations and fast replenishments need to be ordered. This creates a hurried peak in January demand, often resulting again in lower February orders.  So the working capital target is responsible for a considerable part of the oscillating pattern: after a normal November, it creates a deep dip in December, a peak in January and again a dip in February.  The target thus contributes considerably to inefficiencies in the chain.  But you get what you ask: lower inventory.

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