It's Not Luck (7 page)

“This is paradise compared to what we, and our competitors, have given them until now. As a matter of fact, in order to not spoil them too much, we deliberately deteriorated our performance to only ninety percent. Yes,” he says confidently, “we can safely lower the stocks to maximum twenty days. But in any event we’ll know for sure in another four or five months.”

“How much do you have now in your regional warehouses?” Don asks.

“It has already dropped to forty days and continues to rapidly shrink. Of course, as time goes by this rapid decrease will slow down. Remember, we were so much out of control that in some of our warehouses, for some products, we had more than nine months of inventory.”

“Not bad,” I conclude, “not bad at all. So you increased on-time delivery from thirty percent to the nineties, while reducing inventories from ninety to forty days, and you are still going strong. Nice.”

“Forty days is what he currently has in the regional warehouses,” Stacey unnecessarily reminds me. “To guarantee that the replenishment time to the regional warehouses is only dependent on transportation and not on availability, Bob must also hold additional finished goods in the plants, his central stocks, as he calls them.”

“Yes, of course,” Bob laughs. “I wish my total finished goods inventory would have been only twenty days. As for the plant stock, I do the same thing. The replenishment time in this case is determined by the ability of the plant to produce its full range; the improvements we made last year shrunk this time considerably. I have roughly twenty days’ finished goods inventory in the plants. This is sufficient.”

“I see,” Stacey summarizes. “Before, you were sending products the minute they were produced, relying on a forecast that is three months into the future. No wonder you ended up with the wrong products in wrong places. Now you ship to a specific region only when the shops have actually consumed the product. That’s smart. I have to think more about it,” Stacey is trying to digest. “Can I get the detailed, logical trees?”

“No problem,” he beams, “I’d be delighted.”

Don looks totally puzzled. I don’t believe that he understood it all. He didn’t go over the logical trees with Bob, and he is not a logistical expert like Stacey.

“Do you have any questions, Don?” I ask him.

“Many. But I’m particularly curious as to what happened to the transportation costs?”

“We’re now replenishing regional stocks on a constant basis,” Bob patiently explains. “This enables us to ship only full truckloads. Moreover, we never need to air freight a small quantity to a regional warehouse, and the warehouses don’t have to ship to each other. No wonder transportation costs went down.”

“This was heavy stuff,” I say, “let’s break for lunch. Stacey, after lunch we’ll discuss your company, okay?”

“Sure thing, Boss.”

7

I don’t go to lunch with them. I need the time to think. Bob has already reduced his inventory by thirty days, and he will continue to reduce it. Operationally it makes perfect sense, but there’s a problem. A huge problem. Reducing finished goods inventory has a bad short-term impact on the bottom line.

We hold inventory on our books at its cost value—cost as calculated by cost accounting. This means that the finished goods inventory is not registered as raw material cost but rather as raw materials plus added value—the labor and overhead. During the period we reduce finished goods, all the added value in the portion we have reduced hits the bottom line as a loss.

I try to figure out the numbers in Bob’s case. He will reduce his inventory by about fifty days of sales. His company is now selling about $180 million a year; so fifty days means approximately $25 million. On the books I won’t see the inventory reduced by $25 million, since on the books we carry the finished goods at cost value rather than sales value. I will see the inventory reduced by about $17 million. And the impact on profit? For that I have to subtract from this number the money that we paid for raw materials, let’s say about $7 million. My God, his loss will grow by $10 million.

I’m trying not to panic. Of course this is just funny money, cost accounting distortions; and yes, later it will be more than compensated for by real money, by the real savings from less obsolescence and also, hopefully, by increased sales. But how am I going to explain all this to a prospective buyer? Even if he fully understands it, he will pretend that he doesn’t. It gives him a trump card to substantially decrease the price for the company.

Are there any positives? Obsolescence will go down. Due to reduction of inventory, introduction of new products will not mandate the write-off of stocks of old ones. How much is it? I flip through Bob’s budget. He budgeted $18 million for finished goods obsolescence. Has he factored in the new scenario, when the inventories are reduced? I fish out his last year’s performance. No, thank God. Last year it was $18 million, he just copied it from one year to another.

If the inventories are cut by about 50%, obsolescence will be cut even more. Especially as it is much easier to monitor the phasing-in of new products when half of the stocks are held in one place rather than scattered all over the country.

Okay, what does it translate to? Bob will be ahead by the amount he will not have to write-off, by about one million dollars a month; $12 million let’s say. The more I succeed to postpone the sale, the better off we are. If I can postpone it to the end of the year. . . . But that’s impossible.

When is it likely that the buyers’ examiners will start to check us with magnifying glasses? Even if I stand on my head and play every trick I know to procrastinate, it is going to happen in two or three months. Damn it, right at the worst possible time. Exactly when the inventories have been reduced, but the impact of less obsolescence is still in its infancy.

What the hell am I going to do? It’s one thing to try to sell a company that is almost breaking even. It’s a totally different story to try to sell a company that is losing over $10 million on sales of $180 million. To tell Bob to revert back to the old distribution system? No way. Besides, it won’t help. Bob and Stacey are absolutely right, if we don’t find a way to make the companies very profitable before they exchange hands, we are all doomed. Me, them and the companies. Everything will go down the drain.

We must find a way to increase sales immediately. It’s the only way out. And we cannot do it in the proper way. Pete cannot have the more advanced printing presses that he so desperately needs. Bob cannot afford the time to systematically improve his engineering department. We must move much faster. Damn these Wall Street sharks for putting this devastating pressure on us. Why can’t they leave us alone?

They return from lunch.

“Alex,” Don starts, “during lunch we discussed the impact Bob’s new distribution system will have on his bottom line.”

“Pretty devastating,” I say in a casual voice.

“So, you noticed it as well,” Don says, somewhat disappointed.

“What did you expect, that he wouldn’t?” Bob dismisses him, and to me he says, “What should I do? Ignore it, or inflate my central stocks—you know that with my excess capacity I can easily do it.”

I think about it for a minute. Inflating the central stocks, not like the regional stocks, will not cause any damage to Bob’s ability to quickly respond to the shops’ needs. Introduction of new products will be affected, but not by much. On the other hand, he won’t suffer from the bad effects that stem from the distortion in the way we currently evaluate inventories on our books. The temptation is big.

“No, Bob. Don’t do it,” I decide.

“I thought that would be your response. You never wanted to take the easy way, to play the numbers game. But, I thought I should ask.”

“Thank you. Okay, Stacey,” I say, “your turn.”

“Surprisingly, when you look at the general picture, it’s not much different,” she starts. “I, too, have revealed a lot of excess capacity in the past year—it’s going through our ears; we have even more than Bob. Our problem, as you may expect, is sales.

“As you know,” she continues, “we don’t sell to shops, we sell to industries that need high pressure steam. There are more and more technological improvements in our field, and some new products, but nothing close to what Bob has—some of our designs are ten years old. The problem is that competition is so fierce that often, in order to penetrate, we have to sell the initial equipment for our raw material cost. We make our money more and more on the additions and spare parts. They are still quite lucrative.”

“Is your supply of spare parts adequate?” Don asks.

“No,” Stacey admits, “not at all. Oh, we have mountains of spare parts, all over the place. But too often it’s not the right part in the right place, and then the clients are all over us.”

“Could Bob’s distribution system help you, as well?”

“It might. That’s why I asked for the logical trees of it. We would have to do many adjustments; our situation is quite different. Responding ninety percent of the time is not sufficient. You see, whenever a client needs a spare part from us and we can’t deliver immediately, we are shutting down part of his operation. I need to bring my response from what it is now, about ninety-five percent, to almost one hundred percent.

“It’s clear we can do a better job. We have to reexamine the levels of inventory that we’re holding in our regional stocks. I think by following Bob’s concepts I can vastly improve.” Turning to me she adds, “Alex, better service on spare parts will not be sufficient to solve my sales problem. I need a real breakthrough idea.”

“You said that the prices for spare parts are quite lucrative,” Don hesitantly starts.

“Yes, I did,” Stacey confirms. When she realizes that Don is reluctant to continue, she encourages him. “Come on, speak up. Many times an outsider can come up with an idea that we, so entrenched in the way things are always done, are too blind to see.”

“It’s probably nothing,” he continues, “but I thought that you sell the basic equipment for only raw material cost, just to get a foot in the door.”

“That’s also correct.”

“Does it mean that the company who sells the basic equipment to a client has, for all practical purposes, a monopoly on the spare parts that client will need?” Don sounds much more confident.

“You are absolutely right,” Stacey answers. “Each company has its unique designs. You sell the basic system and the client is locked into buying additions and spare parts from you.”

“Well, can you get ahold of your competitors’ designs? I assume that technically you can produce them. The differences between theirs and yours cannot be so big.”

“So that’s what you mean,” Stacey sounds disappointed. “To your question, Don, not only can we get hold of their designs, we’ve already done it. And yes, we can technically and legally produce their spare parts. So what are you suggesting?”

“For you to offer their clients the appropriate spare parts,” he says much less confidently. “But it’s obvious that you’ve already thought about it. Why won’t it work?”

“Simple, Don,” she answers. “Why would their clients buy from us? Because we’ll offer it at a slightly lower price?”

“Yes, I see,” he breaks in, “and then your competitors will do the same to you, and the result would be a price war.”

“And if there is something,” Stacey concludes, “that we have to avoid at all costs, it’s a price war.”

“Sorry, it was a dumb idea.”

“Not so dumb,” Stacey smiles at him. “If we’ll succeed in properly implementing the equivalent of Bob’s distribution system, and we have time to establish an outstanding reputation in spare parts supply, then your idea might work. The problem is that building such a reputation takes years, and we have months.”

“Fellows,” I slowly say, “we need marketing ideas. Something that will differentiate us, that will make our offers much more attractive than our competitors’. Something that we can implement fast.”

“Yes,” Stacey agrees, “but we cannot risk doing it by reducing prices.”

“Which means,” I add, “that those ideas must only take advantage of the products that we already produce. Maybe with slight changes, nothing major.”

“Right,” Bob joins in, “we need real breakthrough ideas.”

“Yes,” and to myself I add, “three of them; one for each of the companies.”

8

We are about to finish dinner when the unavoidable occurs. “What about the car, Dad?” Dave asks.

Not bad, the kid has patience. I was expecting the attack would start as soon as I entered the house. Julie . probably advised him to wait until I was relaxed and fed. Somehow it provokes me. “What about it?” I reply.

“Can I use your car while you have fun in Europe?”

“Fun?” I say.

“Sorry, not fun, hard work. Can I have your car while you are away?”

I don’t like his tone of voice, he is not requesting, he’s practically demanding. “Give me one good reason why I should?”

He doesn’t answer.

“Well?” I press.

“If you don’t want to give me the car, don’t give it,” he mutters into his plate.

I can leave it at that. I actually don’t want to give him my car, and now I don’t have to. It’s okay.