VideoFor the first few months of this year, the U.S. economy was moving steadily toward recovery. The Credit Managers' Index (CMI), a key indicator of corporate economic trends, registered a rise each month from August 2009 until April 2010, and other benchmarks gave cause for optimism.
Then came May, with the BP oil leak, worries about European sovereign debt, disappointing employment data, and a sudden drop in the CMI index. Talk of a double-dip recession resumed, and CFOs were torn: Should they ramp up for growth or once again batten down the hatches?
The dilemma as to whether to reduce inventory if another downturn is coming or gear up for a resumption of growth is particularly acute now, as companies debate how to prepare for the holiday shopping season.
"No one is confident that they should buy up into this fourth quarter in a significant way, but, by the same token, they don't want to miss opportunities," says Bryan Eshelman, a retail and consumer products specialist with business advisory firm AlixPartners. "So it's really investing in the capability to react quickly that will help those that are most successful this fourth quarter."
Fortunately, the Great Recession prompted many companies to reevaluate their methods of demand forecasting and planning. Companies now test the market more frequently, assessing customer intentions via such means as dipping into markets tentatively before plunging into huge inventory orders. Merchandising methods, dubbed "hold-and-flow" and "delayed-distribution," are increasingly helping managers to look before they leap.
At the same time, corporate forecasters have grown more cognizant of the role companies themselves play in sparking or dampening demand. Rather than rely solely on such venerable prediction metrics as same-store sales, they are attempting to gauge how their own pricing, advertising, and sales practices affect customer behavior and how they can refine those practices to boost sales.
For these practices to succeed, some experts say, CFOs will need to begin linking sales predictions to production planning, instead of allowing the two functions to operate separately. At Coach, a maker of luxury handbags and other wardrobe accessories, CFO Mike Devine says that his role is "to make sure the organization maintains discipline in having our production forecasts line up with our sales forecasts." Rather than enforcing preexisting production, inventory, and sales plans, finance chiefs must be able to make quick adjustments as conditions change.
Before the recession, CFOs typically approached forecasting and planning "on a strategic basis," says Charlie Chase, business enablement manager for software company SAS Institute. "Now they need to do it on a tactical basis," he says. Think of it as an early Christmas present the company can give itself.
Going with the Flow
The recession schooled finance chiefs on the inherent risks of placing large inventories in a supply chain. Previously, companies typically made or bought products and distributed them to stores in bulk because that was the cheapest way to do it. Until, that is, demand dried up and companies had to take big write-downs and unload the goods at deep discount, if at all.
Some companies now postpone the manufacturing of goods until they are reasonably sure there is a market for them. More specifically, companies defer completion of a certain portion of a product line. "Previously, we would convert all raw materials purchased into finished goods," says Coach CFO Devine. "Now, we take a deeper position in continuing raw materials [but hold off on manufacturing]. This allows us to respond more nimbly to consumer buying patterns."
Coach might, for example, load up on more leather or silk than it needs to manufacture products for a given season, and use the remaining materials for later seasons. If demand suddenly does spike, however, "we'll have raw materials available to quickly up production," Devine says.
Similarly, some companies are stocking up at their warehouses but delaying the shipment of finished goods to stores. In a May earnings call, Saks announced that it would install such a "hold-and-flow system" in phases beginning this summer. The system "will drive allocation effectiveness by holding back a portion of certain merchandise orders at our distribution center…employing the product through the stores as demand dictates," says Ron Frasch, the luxury clothing chain's president and chief merchandising officer.
Such techniques do add warehousing costs, but also have the potential to boost revenues and gross margins. That's because improved precision in meeting demand makes it more likely that goods will be sold at full price. If they're used successfully, "the benefit of full-price sell-through outweighs any additional expense to warehouse the product," says Matthew Katz, a managing director at AlixPartners. "If you warehouse product and then don't get the full-price sell-through, however, then you've got a problem."
Shaping Demand
Companies are also adopting a more sophisticated approach to forecasting that includes probing the effects of their own actions on customers. Previously, companies relied solely on past sales-trend data, along with such well-worn gauges as seasonal effects on sales, as a basis for their forecasts, according to SAS's Chase. "Then, whatever is left over is called 'unexplained' or attributed to randomness," he says. "But, in fact, it can be attributed to sales promotion, marketing, price, and [the accuracy of your] economic forecast."
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