I. Possible reasons for customer's frustration could be either a lack in product quality or a poor delivery of the axles.
II. Possible reasons for this liquidity issue arise from three different components within the net working capital: receivables, payables, inventories.
III. The optimal reorder point is 56,000 springs.
IV. The savings potential is 52,600 EUR. In addition 4,208 EUR imputed capital costs can be saved.
Paragraphs highlighted in green indicate diagrams or tables that can be shared in the “Case exhibits” section.
Paragraphs highlighted in blue can be verbally communicated to the interviewee.
Paragraphs highlighted in orange indicate hints for you how to guide the interviewee through the case.
I. Client situation
The CEO of the OEM plant in Problem-City has increasingly become unhappy and scheduled an ad-hoc meeting with the manager of the corresponding plant manager of company AA.
What could be a reason and what differentiates AA’s product from other suppliers of the problem-city plant?
Several possible problems possible, but since the customer of company AA is unhappy it should must do something with the products (axles) AA produces. Possible reasons coud be:
- Wrong sequence or even worse, not the right time for the delivery of the products
- Faulty axles – very dangerous since axles are a safety-relevant component
II. Derivation of measure list
The plant manager of AA took the meeting very serious and did an internal assessment of the production and financials. Besides some production issues, he detected a serious cash problem with a concerning low liquidity. He was not sure he would be able to pay his employees.
What could be the reasons and how are those two problems interlinked? What could be a very short-term fix, and what could be working in the upcoming weeks?
Problems could arise from the three different topics, all based on net working capital. Net working capital = inventories + receivables - payables.
Interlinkage:
- High inventories result in low liquidity due to tied cash in inventories.
- Receivables: customer is not paying the bill on time – outstanding cash
- Payables: we are paying the customer to early compared to what we have to – drainage of cash to early
You can share diagram 1 with the candidate.
Now ask the interviewee, based on these three levers, what could be possible measures and how can they be differentiated regarding their potential and time frame. What is your proposal and why?
If the candidate is stuck you can share table 1 & 2.
Short-term measures:
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Inventories
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- Depending on time frame, but real short-term (a couple of days) measures not available
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Very low potential
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Receivables
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- Outstanding bills of customers: send overdue message, or if already overdue try to sell the receivable to a refinance enterprise/company
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Medium-to high potential
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Payables
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- Don’t pay the supplier or ask the supplier the postpone for a few days
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High potential, since the plant manager is not dependent from somebody else for the measure to be successful
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Medium-term measures for the next weeks:
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Inventories
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- Reduce any residual inventories that is not really needed (raw product, half and partly finished products and finished products)
- Reduction through optimization of order point and quantity at supplier
- Reduction through mitigation of the 7 types of waste (transport, inventory, motion, waiting, over-production, over-engineering, defects)
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High potential, since 7 types of waste offer many measures along the value chain
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Receivables
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- Outstanding bills of customers: send overdue message, or if already overdue try to sell the receivable to a refinance enterprise/company
- Standardize payment terms
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Medium, since the administrative work is done centrally, we can assume that there is already a certain degree of optimization
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Payables
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- Don’t pay the supplier or ask the supplier the postpone for a few days
- Optimize the payment cycle, standardize payment terms
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Medium, since the administrative work is done centrally, we can assume that there is already a certain degree of optimization
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III. Inventory optimization
The plant manager likes your structured and weighted measure list and decides that he wants you to work on the component “springs” by calculating and adjusting the reorder point.
For doing that he gives you some more information:
The plant operates 5 days a week, with one shift each day. One shift is 8 hours.
AA has (here simplified) only one supplier S for this product. This supplier S has three other suppliers for each component they have different lead times which are on average: 3 days, 5 days and 7 days. On some occasions, the sub-suppliers of S have difficulties and the lead times go up to 6 days, 10 days and 14 days (in the same order as above).
On an average month, AA needs 3,600 springs. Sometimes the OEM-plant is quicker and produces up to 1,000 cars a day.
Also, consider these given formulas:
Important things that the candidate should consider. Help her out if she is stuck in the process.
- The interviewee has to pick the longest lead-time for the calculations (7 days) since the supply chain always is only as fast as the slowest chain element.
- Each axle has 2 springs, and since each car needs two axles (front and back axle) a car needs 4 springs.
- The interviewee has to guesstimate the number of days in a month. We assume that an average month has 20 working days.
Lead time demand = lead time x average daily usage = 7 days x (3,600 springs/20 days a month) = 1,260 springs
Safety stock = ((1,000 cars x 4) x 14 days) – (180 springs per average day x 7 days)
= 56,000 – 1,260
= 54,740 springs
Reorder point = 1,260 springs + 54,740 springs = 56,000 springs
IV. Cash savings
The plant manager is surprised by the numbers since the current safety stock is 60.000 springs and obviously well above that number.
What is the potential and how much capital cost would he save by reducing the safety stock to the new calculated level? What are the risks of doing so?
Background information: the WACC is 8% and a spring costs 10 Euros.
Potential: 60,000 – 54,740 = 5,260 springs -> 52,600 EUR
Saved capital costs: 52,600 x 0.08 = 4,208 EUR
Risks: running out of springs and not delivering them to the OEM plan. Major business threat.
