11 Lessons for Improving Payables
If you’re thinking about working capital, you aren’t alone. Facing uncertain demand and constrained credit markets, CFOs continue to focus on building and maintaining their companies’ cash positions. Working capital optimization (WCO) is back, but this isn’t your father’s WCO — the environment and the tools have changed.
Today it is more important than ever to explore the sources of leverage with your suppliers and customers, to use analytical approaches to identify precise opportunities, and to establish processes for managing through sometimes difficult negotiations and implementation. The basic levers have not changed. While Inventory and Receivables are equally important to the WCO equation, Payables are often more within a company’s control and can be extended by updating years old process & policy and standardizing terms to industry and categories.
There are many ways to extend Days Payable Outstanding (DPO). The best strategy is one that finds the right blend between best practices, company culture and the unique needs and requirements of each supplier and purchase categories.
What’s New About Working Capital Optimization Today?
- Consolidation among buyers has changed the balance of power in many industries
- Data availability and accessibility enables more informed negotiations
- Advanced technology supports analytics that offer actionable insights
- Strategic sourcing is now mainstream with proven, well-documented methodology
LESSON 1: One function needs to drive
DPO is part of the Purchase-to-Pay cycle, and although several functions have responsibilities related to DPO, in many companies it isn’t clear who has the bottom-line accountability to drive change. A/P Shared Services owns the data needed for analytics and may already understand the opportunities. Purchasing owns the relationships with suppliers. It is critical for success to have one either Finance or Purchasing can lead the program with resources from both functional areas playing team member roles. Success Stories exist: For one national bank, two executives in Procurement saw the DPO initiative as a boost that would help their company through tough times. On the other hand, a global retailer’s shared services VP saw the DPO initiative as a natural extension of his organization’s transformation. Both clients using integrated teams for success.
LESSON 2: A CXO should be the sponsor
Because a DPO initiative spans functions, it can devolve into turf wars or die from lack of resources without consistent, high-level support. We typically see CEO, CFO, CPO/CMO as sponsors and identifying saving target. For one national grocer, it was the CEO who sponsored the initiative—securing resources, driving decision making, leading steering committee meetings and even meeting with key suppliers. A dedicated project manager, cross-functional teams organized by category, and senior-level participation on the steering committee round out the program structure.
LESSON 3: Break it down by category The business case and strategy may differ from category to category. Run a pilot of a subset of suppliers to calibrate the approach and build credibility for the program. Consider key metrics other than DPO, and measure the impact on these metrics under a variety of approaches. An aggressive strategy will yield greater DPO improvement but may come at the expense of supplier relations. A less aggressive approach may yield smaller cash benefits but will also support other parallel objectives. For example, a CFO may also want to reduce the number of payment terms or implement electronic payments as part of the initiative.
LESSON 4: Form a Purchasing-Finance alliance
Suppliers aren’t going to accept these changes without pushback. They understand what matters to Purchasing and it usually isn’t payment terms. To avoid the “Mom vs. Dad” tactic, create a training program for all supplier-facing personnel including scripts, FAQs, role-playing and a well-documented escalation process. This preparation provides clear guidance and keeps all internal stakeholders aligned and on-message in their interactions with suppliers.
LESSON 5: Build a purchasing baseline for each supplier
The company doesn’t benefit if a supplier yields on a terms negotiation then turns around and “squeezes the balloon” through higher freight fees, longer lead times or less favorable pricing. Over time, this effect can make a DPO initiative become “economically neutral.” Instead, build a comprehensive purchasing baseline for each supplier that includes all levers of the relationship that affect profitability—then monitor changes aggressively.
LESSON 6: Use rigorous analytics to build a case Explore many sources of internal and external data — public company financials, private company data, industry metrics and internal payment terms across suppliers and categories — to construct a compelling, fact-based case for why suppliers should participate. How does your DPO compare to that of your competitors? How does your payment days compare to the supplier’s Days Sales Outstanding? How about DPO vs. Days Inventory Outstanding (DIO)?
LESSON 7: Use creative funding and rewards
Without ongoing cooperation from Procurement and Finance to monitor and manage performance with suppliers, the initiative may falter. Yet the functions don’t benefit equally. While budgets and management objectives should reflect the goals of the DPO effort, creative incentives and rewards can make them more tangible to members of your Purchasing team who are not currently measured on working capital. One CPG client gave spot bonuses to individuals based on the amount they saved in negotiations. The CEO also made a point of speaking frequently to team members to share company goals and why they are critical to success.
LESSON 8: Segment suppliers and tailor the “ask”
Not all suppliers are created equal. The opportunity will vary based on purchasing category, regional norms, size and relative power in the relationship. These factors determine not only your goal, but your approach and communication strategy. Use benchmarking to set targets for each cluster that maximize suppliers’ likelihood of participation, stretching them without alienating them. One hard goods retailer segmented suppliers into 20 different clusters and had a different “ask” for each cluster.
LESSON 9: Proactively and professionally manage the message
Suppliers may get political. The message coming from all levels of the organization—from the A/P clerk to Purchasing to the Account Manager to the CEO needs to be consistent, and able to withstand press scrutiny. One mass retailer framed the “ask” to highlight the benefit of lower prices for the consumer. So when the supplier involved the media, the retailer’s customer oriented message fared well.
LESSON 10: Implement through two pay cycles before declaring victory
Changes take time to flow through the supplier stakeholders. You may have reached agreement in principle with the sales rep, but that won’t necessarily prevent the supplier’s A/R clerk from calling expecting an “overdue” payment. Or, maybe the A/R clerk understands the new terms but the sales rep seems to have forgotten. Keep detailed records to avert misunderstandings and guard against having changes unravel.
LESSON 11: Monitor payment terms at least annually
Remember the “squeeze the balloon” problem? Suppliers may revert to old habits, and you stand to give back the ground you’ve won. Include terms in annual supplier relationship reviews, and monitor the supplier’s companywide terms compliance with a spend analytics tool. Efforts to improve working capital can present many challenges and pitfalls. Following these lessons learned can help you produce and maintain hard fought gains.