LEAN, MEAN, GROWING MACHINE
Growing sales in Asia while keeping a tight rein on working capital is never easy, but the CFOs of BASF and Honeywell are proving that it can be done.
By Simon Littlewood

For Arjun Sarker, working as a CFO in Asia today is both the best of times and the worst of times.

His firm, Honeywell Specialty Materials, faces enormous growth potential in the region, a prospect that Sarker is only too keen to exploit. But as finance director for Asia Pacific, Sarker is also guardian of the company's capital efficiency. And therein lies the rub, for increased sales almost always inflate a company's working capital.

"Increasingly, Asia is seen as the key engine of growth - especially given the low growth rates elsewhere in the world," Sarker says of his company, a US$3.2 billion-a-year firm that makes materials used in products such as bullet-proof vests, ultra-tough ropes and ozone-friendly freezer insulation. As a result, investment is pouring into the region and expectations are high.

However, adds Sarker, rather than delivering growth at any cost, Honeywell's operations in Asia are under pressure to deliver trim, healthy growth - the sort that doesn't pump up the firm's working capital or its operating costs. Frequently in Asia, notes Sarker, companies have accepted below-par returns on their investments in the name of building a regional presence. But today, he says, such attitudes no longer apply. "One way or another, our Asian businesses need to start delivering return-on-capital numbers that match their US counterparts."

Sarker is far from alone. All across Asia, finance chiefs are facing exactly the same dilemma: how to harness the exciting growth taking place in countries like India and China, but without letting receivables and inventory balloon out of control. Indeed, ask some exasperated CFOs, is it even possible to grow sales at the same time as reining in working capital? To Sarker and a number of other CFOs, the answer is yes, but it isn't easy..

Full Steam Ahead

Growth in Asia is certainly exciting by global standards. Consider current forecasts from the World Bank: this year it expects GDP in Asia, excluding Japan, to grow at 5.9 percent, compared to 3.4 percent in the US and just 1.7 percent in Europe. Next year, the World Bank estimates GDP growth in the region will reach 6.3 percent. Little wonder, then, that the Asian arms of multinational corporations are increasingly shouldering responsibility for growth at their companies.

At the same time, however, managing working capital in Asia has traditionally never been easy. For one, the region includes 30-odd countries spread over a giant area, many of them separated by seas, which often means holding inventory in lots of locations. What's more, from a CFO's perspective much of Asia notoriously has a poor payment record, scant credit information and poor receivables management practices.

So how do CFOs go about encouraging growth without sacrificing their working capital performance? One company that thinks it has the answer is BASF, a US$32 billion-a-year German chemicals group. Hans-Juergen Seeger, CFO Greater China of BASF, acknowledges that Asia carries a great weight of expectation as his company's primary source of growth. "Right now, China is one of the few markets able to deliver substantial growth," he explains. "Our aim in China is to triple our sales in US dollars over the next ten years." And to that end, BASF is investing US$3 billion in two new chemical plants due to open at the end of 2004 and beginning of 2005.

However, just like Sarker at Honeywell, Seeger didn't want his growth to come at the expense of an over-inflated balance sheet. So back in 2001, Seeger teamed up with his sales director to dissect the firm's entire sales, service and collections processes. Their aim was simple: on the one hand, to put in place measures designed to grow sales, but on the other, to improve cash flow and working capital management. Along the way, they wanted to instill a sales philosophy centered on the concept of "customer lifetime value" (CLV), whereby salesmen analyze customers by their long-term rather than their short-term profit potential and then dedicate their attentions to the most valuable segments of the market.

In analyzing the business, Seeger and his colleagues first looked at BASF's portfolio of customers, working out the lifetime value of each of them and then matching the results against the actions of the company's salesmen. Surprisingly, notes Seeger, "we found that we were not always aligning our sales activity to where the future value of the business lay."

Next, BASF carried out a survey of its customers and discovered once again that not all was well: BASF was falling down on meeting service expectations, and customer retention was an issue. For Seeger, "this was a real concern". As he explains: "In our industry fixed capital costs are high so long-term customer relationships are essential." Inevitably, with poor service levels, high customer turnover, and salesmen ignoring key clients, BASF's working capital was suffering.

To change all that, BASF's China operation decided to reinvent itself as a customer-focused organization. First of all, salesmen were given CLV data and then reorganized to concentrate on the clients with the highest future value. Moreover, the way salesmen were paid was changed, with greater variable pay and bonuses linked not just to sales but also to targets based on metrics such as days sales outstanding (DSO) and cash flow.

Second, BASF's customer service department was upgraded. In the past it had suffered from poor morale because staff bore the brunt of customer complaints but were largely powerless to respond thanks to a territorial mindset in the sales team. All that was changed as the service department was raised in status and new procedures were put in place to break down customer fiefdoms among salesmen.

The results, says Seeger, have been dramatic. For one, revenues are shooting up as salesmen systematically focus on higher-opportunity customers. For another, customer retention has improved thanks to better service. And just as importantly, cash flow and DSO have improved - as BASF's customers become longer term and more loyal, so their payment record gets better. "We scored a triple whammy," says Seeger, although he declines to reveal exact figures.

Taking Stock

But sales and receivables weren't the only things that BASF looked at. As part of its drive for healthy growth, the firm also focused on another important aspect of working capital: inventory. To that end, Seeger teamed up with Peter Conway, BASF's supply chain manager in China.

As Conway sees it, most companies tend to take a top-down approach to managing their inventories by tackling headline metrics such as inventory turnover, capacity utilization, replenishment lead times and the like. But, he argues, in a high growth environment this can have negative results for customer service and the arguments for lean inventory are usually overwhelmed by the arguments for achieving sales revenue targets. Under these circumstances it's far more effective to use a bottom-up philosophy. That means putting the customer first and working back from there.

Using the same CLV data that Seeger and his finance team supplied to the sales department, Conway started aligning inventory levels based around the importance of each individual customer. Clients were divided into three "tiers", with Tier 1 clients being the most valuable. Equally, BASF's products were divided into three categories, with A products being high-value, fast-moving goods, and C products being low-value, slow-moving goods.

The idea was simple: Tier 1 clients buying category A products were given the highest priority and could expect BASF to supply them with goods at the drop of a hat. Conversely, service for Tier 3 clients buying predominantly category C products would be much slower, with low stock levels.

"We challenged the notion that we needed to give 24/7 service for every product," says Conway, explaining that for small clients it just didn't make financial sense. Nonetheless, the shift in philosophy had to be handled carefully. As Conway notes: "The customer will always demand a lot so it's critical to manage their expectations." What's more, sales teams had to be trained not to promise the earth in order to secure a deal. They had to realize that, while some clients would receive goods in one day, for others it would take a week.

"At BASF we looked at the relationships between service, working capital and customer value in a holistic way," enthuses Conway. "The role of the CFO in breaking down those silos was vital."

Sales vs Finance

At Honeywell, Sarker couldn't agree more strongly. He too believes that finance chiefs have a crucial part to play. The CFO, he says, is better positioned than anybody "to bring hard data to bear on a company's customer base, and get sales leaders to focus on value rather than just revenue."

Not that it's easy. Many are the CFOs who've had to square up to their sales directors across the boardroom table in a bid to bring financial discipline to company growth. As for Sarker, he prefers a less adversarial approach and uses a process of education to drive his message home. On a regular basis, staff from the finance team are dispatched to the sales and marketing departments to teach them the basics of finance and spread the word about the merits of careful capital management.

Sarker has also put in place a number of other steps, such as compensating salesmen based on the accuracy of their forecasts in an attempt to rein in excessive inventory. "It's astonishing how quickly minds get focussed by this," smiles Sarker. And for Honeywell's most valuable product lines, Sarker has doubled the frequency with which forecasts are made compared to the slower-moving lines. Once again, though, time spent educating salesmen is crucial. As Sarker notes: "If the sales team don't understand why their bonuses are being affected by working capital metrics then they grow resentful and performance suffers."

Sarker has taken big steps in improving the management of his receivables too. One important idea, and one that mirrors practices at BASF, is that of "customer intimacy". Every member of staff in each different stage of Honeywell's order-to-cash process should know their corresponding staff in the customer's purchase-to-pay process. That way, it's possible to track a sale from the moment an order is placed to the moment it becomes cash. Should a problem arise at any stage in the customer's cycle - be it a faulty product or an incorrect invoice - then Honeywell staff are on top of the issue immediately.

Of course, putting in place such measures takes a lot of effort, and nothing is harder than changing the way people think and work. Nonetheless, Sarker is certain it's all worthwhile as he starts to look forward to fewer of the worse times, and more of the better.

Simon Littlewood is a freelance writer based in Singapore.