Capital Ideas: The 2005 Working Capital Survey

Despite cheap credit and surplus cash, companies still find plenty of reasons to improve operational efficiency.

What’s dumber than a box of hammers? For home-improvement retailer Lowe’s Cos., it’s the same box sitting on “high steel,” the storage shelves that tower over every aisle, out of reach of customers. “If stock is on high steel, in a back room, or in a distribution center, then it’s not in sellable position,” says Robert Hull, CFO of the Mooresville, North Carolina–based company.

Sellable position is an obsession for Hull, who measures inventory turnover on a weekly basis. For Lowe’s, as with most retailers, inventory is the most critical element of working capital. At first glance, then, it seems surprising that CFO’s annual working capital survey, conducted by Purchase, New York–based REL Consultancy Group, showed Lowe’s with a 10 percent increase in days inventory outstanding (DIO). That caused the retailer’s overall days working capital (DWC) to soar 24 percent, to 60 days, and dropped Lowe’s — one of the top performers in its sector in our previous survey — out of the first quartile of specialty retailers.

But as it turns out, Lowe’s numbers are a good sign. Inventory spiked in 2004 because the company maintained historical levels of “safety stock” in its stores even as it increased the amount of products at its regional distribution centers. Lowe’s did that because it didn’t want any customers going away empty-handed during an initiative to increase reliance on that network of distribution centers. The initiative’s goal: less backup inventory in stores, and replenishment from distribution centers in three-and-a-half days instead of seven. Ultimately, Lowe’s R3 (for “rapid response replenishment”) initiative will mean less inventory overall, and more of the remaining stock where customers can see it. “We manage the business for the long term,” remarks Hull. “We’ll take a short-term blip in a metric.”

“[We] have taken a conservative approach,” explained Lowe’s 2004 annual report, “by adding inventory to our distribution network without lowering inventory levels in our stores.” Most of that safety stock has been removed from stores since, says Hull, and inventory levels have already dropped in the first quarter of this year.

“For retailers, inventory turnover and customer service are obviously conflicting objectives,” observes Stephen Payne, CEO of REL. Lowe’s move, he says, “makes perfect business sense. Lowe’s is using inventory as a strategic lever. It knows its initiative will drive out that excess inventory — and more — once it’s up and running.”

Why Working Capital Matters

Lowe’s is not alone. The 2004 annual reports of many U.S. companies, including Gillette, KLA-Tencor, McGraw-Hill, and Wal-Mart, as well as European firms such as France Telecom, Saint-Gobain, and Sainsbury’s, mention initiatives aimed squarely at reducing specific elements of working capital. At health-sciences firm Perkin-Elmer Inc., some 10,000 employees have received training in “compressing the cash cycle,” says director of global processing Frank Giammarco.

One might ask why working capital matters when debt is cheap and companies are awash in cash. Companies these days are urged to deploy cash, not squeeze more of it out of daily operations. But even as our survey shows hints of growing capital expenditures, working capital remains top of mind for many CFOs. Indeed, continued working capital improvement — or even a controlled, temporary deterioration — can ultimately drive growth.


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