Solution
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
Various problems can be decisive here. General as well as product-specific problems are listed:
- General:
- Since recipient (OEM) has no own stock, dependency on suppliers increases
- Continuous exchange of information with suppliers necessary
- Potential production stop/failure due to wrong sequence or even worse, not the right timing to deliver the products
- Product specific Company AA:
- Defective axles – very dangerous as 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 to be able to pay his employees.
What could be the reasons and how are those interlinked? What could be a very short-term fix, and what could he be working on the in upcoming weeks?
Problems could arise from the three different topics, all based on Net working capital. Net working capital = inventories + receivables + payables. Now the chart Nr.1 can be shared with interviewee
You can share diagram 1 with the candidate.
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 too early compared to what we have to – drainage of cash to early
Now ask the interviewee, based on these three levers, what could be possible measures and how can they be differentiated with regard to 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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- Very short-term (a few days) measures not possible, as physical goods cannot be liquidated in the short term and may be necessary for existing orders
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Very low potential
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Receivables
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- Open invoices from customers: Send reminders, or if already significantly overdue, sell receivables to a refinancing company.
- Grant customers discounts for early payment (long-term effect on P&L and cash position, however, negative).
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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 to postpone for a few days
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High potential, since the plant manager is not dependent on anyone else for the measure to be successful
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Measures for the next weeks:
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Inventories
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- Reduce any residual inventories (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, as 1) can be optimized independently and low dependence on other parties and 2) the "7 types of waste" provide a broad approach
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Receivables
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- Standardization/negotiation of payment terms/targets
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Medium, since the administrative work is done centrally, we can assume that there already is a certain degree of optimization
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Payables
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- Standardization/negotiation of payment terms/targets
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Medium, since the administrative work is done centrally, we can assume that there already is 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 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. Supplier S has three other suppliers for each component with different lead times, which are on average: 3 days, 5 days and 7 days. Occasionally, the suppliers of our supplier S have difficulties and the lead times go up to 6 days, 10 days and 14 days, respectively.
On average per month, AA needs 3600 springs. Sometimes the OEM-plant is quicker and produces up to 1000 cars a day.
Also, consider these given formulas:
Important:
- The interviewee has to pick the longest lead-time for the calculations (7 days) since the supply chain is always only as fast as the slowest chain element.
- Each axle has 2 springs, and since each car needs two axles (front and back axles) a car needs 4 springs.
- The interviewee has to guestimate the number of working 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 (3600 springs/20 days a month) = 1260 springs
Safety stock = ((1000 cars x 4) x 14 days) – (180 springs per day on average x 7 days)
= 56.000 – 1260
= 54.740 springs
Reorder point = 1260 springs + 54.740 springs = 56.000 springs
IV. Cash savings
The plant manager is surprised by the numbers since the current safety stock is far more at 60.000 springs.
What is the potential and how much capital cost would he save by reducing the safety stock to the newly calculated level? What are the risks of doing so? Are these kind of capital cost real costs?
Backround information: the WACC is 8% and a spring costs 10 Euros.
Potential: 60.000 – 54.740 = 5260 springs -> 52.600 Euro
Saved capital cost: 52.600 x 0,08 = 4208 Euro
Risks: running out of springs and not delivering them to the OEM plan, which is a major business threat.
Capital cost are not real cost you can see in the P&L, more comparable to opportunity cost. These kind of (implicit) capital costs have to be strongly distinguished from capital cost like interest (cost).
