At Kraft, cash is king

Cash is king, as the old saying goes.

And as companies navigate their way through the economic downturn and confront tighter credit rules, they have once again taken that maxim to heart and are looking for ways to increase their cash flow.

At Kraft Foods Inc., freeing up cash has become a companywide imperative. Back in 2007—well before the current economic troubles hit—Chief Financial Officer Tim McLevish set a goal of improving Kraft's overall cash flow by US $1 billion. Why so much? The world's second-largest food company was planning for future growth. "The higher the free cash flow, the better a company is able to gain access to capital and investment markets with a lower rate of borrowing for capital expenditures, acquisitions, or share repurchasing," explains Philippe Lambotte, Kraft's senior vice president of customer logistics in North America. "While top-line and bottomline growth are important, the necessary condition for them to fund growth is that free cash flow is available."

When Kraft launched its cash-flow initiative, it took a close look at areas like payables, receivables, working capital (including days of inventory on hand), and capital expenditures. At first glance, it might seem that the initiative should be the province of the finance department. But in fact, the supply chain connection is a strong one: unsold inventory sitting in a warehouse or on a store shelf represents money for the taking. Typically, 20 to 30 percent of the costs associated with a Kraft product are tied up in inventory, Lambotte notes; for some products, it can be as much as 50 percent.

Thus, if the company could make just the right amount of goods for a market and get them quickly into the hands of the consumer, it would speed up the cycle for converting products to cash. The relationship between inventory and cash flow put Kraft's supply chain organization front and center in the multiyear project.

The complexity of Kraft
While Kraft's supply chain may have been a natural focus for freeing up cash, finding more money there would not be easy. The company's breadth and diversity meant that it could not attack the problem by rolling out a centralized, one-size-fits-all initiative.

Kraft is a huge, multinational company with US $43 billion in annual revenues. It sells products in more than 150 countries and has operations in 70 of them. Its lineup of products includes such well-known brands as Kraft macaroni and cheese, Maxwell House coffee, Philadelphia cream cheese, Oscar Meyer meats, Oreo cookies, and Seven Seas salad dressings, to name just a few.

To serve such diverse brands and markets, Kraft is organized into 23 business units. In North America and Europe, these business units tend to focus exclusively on a product category, such as dairy, beverages, or food service. Twelve of the 23 units follow this model. The others focus on national markets, such as Brazil or China, and carry a range of brands. Each of the business units has its own supply chain, says Lambotte.

Adding to Kraft's supply chain complexity is the fact that inventory ownership varies depending on the sales arrangement with the customer. Kraft may own the inventory on the store shelf, as is often the case with items like pizza and cookies. With some other products, such as coffee, the food giant owns the inventory only until it reaches the customer's distribution center.

Because of these different inventory-ownership arrangements, Kraft could not impose a single solution for generating cash on all of its business units. The project's leaders decided to consider each business unit's supply chain on a case-by-case basis. "When you think about inventory, you have to think about the flexibility of your supply chain as well as that of your retail customers," explains Lambotte. "That's where you have to be careful, because if you don't make the right decision, you will have less inventory, but not enough on the shelf—which defeats the purpose of improving cash flow."

Case-by-case analysis
The initiative's leaders recognized that to get managers and employees to focus on improving cash flow, they would have to change their mindset about the value of inventory. "The challenge we faced was the need to explain to employees that when you put away a pallet of product and store it for a month, you've tied up that [economic] value unless you sell that product," says Lambotte. "Our people didn't think about it this way."

Kraft decided on a twofold approach. First, it would provide incentives for the business units to improve working capital, giving bonuses to managers based on how well they freed up cash. Second, it would provide the business units with some expert assistance, in the form of a Cash Flow Excellence (CAFÉ) team that would act as internal consultants. The experts on the team are Kraft middle managers who have dealt with cash-flow issues for many years and can advise each business unit on good practices. "We created a 'SWAT' team of multifunctional experts," says Lambotte. "Whether in Brazil, Russia, or the United States, they know what type of questions to ask." ("SWAT," an acronym for the law-enforcement term "special weapons and tactics," is often used in business to refer to a team of specialists that is called in to resolve a situation that local managers may be unable to handle.)

The team of experts conducts one- to two-day workshops for the business units. These sessions are under the auspices of the business unit's general manager and include employees from all of the business unit's functions. During the sessions, the group analyzes the specific situation facing the unit's supply chain and develops a list of actions that could free up cash.

This case-by-case approach is critical to the initiative's success. "We look at the situational analysis and determine the pinch points, which is very different by business unit," says Lambotte. "Some business units may have more raw material on hand than finished goods, or one with a very heavy manufacturing process may have more value in spare parts. Some business units may have too much inventory tied up with inefficient payment terms or long payables. The list could be one page but big and difficult. Or it could be short-term and very easy."

Tactics for attacking inventory
Although each business unit sets its own agenda for cash-flow liberation, there are some specific steps they often adopt. For example, to reduce unsold inventory, many units choose to work with customers to rationalize the number of stock-keeping units (SKUs) and phase out low-revenue products that have high demand volatility. Although elimination of any item means a reduction in revenue, the remaining (betterselling and more profitable) items can often increase the total cash flow.

Another tactic for paring down inventory is to deploy what Kraft calls "repetitive flexible manufacturing." Instead of responding daily to changing demand, manufacturing lines produce high-volume items at a regular frequency and in fixed quantities. Lambotte explains it this way: Suppose Kraft sells 20 cookies per month, every month. Under its traditional system, the company makes 20 cookies at once, and the cookies may sit in stock for a month before they are sold. "Repetitive flexible manufacturing allows me to produce five cookies per week, every week," he says.

At the moment, several of Kraft's plants are piloting repetitive flexible manufacturing to evaluate its impact on total supply chain costs. From an inventory standpoint, the technique is a winner because it results in less inventory sitting around unsold. From a manufacturing point of view, however, small-batch production may be not be as desirable because it is more costly than longer production runs.

The business units are also weighing the need for certain levels of customer service against the need to generate cash. In some cases, reducing the service level for some products—say, to a 98-percent fill rate on orders—has allowed them to reduce inventory holdings.

"Improving working capital does require less inventory, which can, in turn, lower customer service levels," Lambotte explains. "When an SKU has a lower shelf velocity, it might not matter so much to provide high service, since the customer's purchase frequency is not so high. Therefore, reducing service levels of the lower-demand SKU can provide a good possibility to free cash flow. We have successfully piloted this approach with some of our retail customers," he says.

In concert with these efforts to slim down inventory, Kraft has bought some software that helps the company determine the right quantities and locations for the stock it's now carrying. "It's one thing to forecast how much you're going to make, but from a supply chain point of view, you have to forecast where you will sell it from; meaning, will the inventory be in California or New England?" says Lambotte. There is little margin for error when inventories are kept low, he adds. "When you don't have enough product, any move you make with the product had better be the right one."

A $1 billion goal
Kraft began rolling out its CAFÉ initiative first in the United States in 2007. It expanded the program to Europe in 2008 and to other parts of the world in 2009. The individual business units' efforts have already paid off handsomely for the food manufacturer.

For the 12 months ending March 31, 2009, cash flow from Kraft's operations was US $4.3 billion, compared to US $3.6 billion in the previous 12-month period, a 19.9-percent increase. A substantial part of the cash contribution came from the company's supply chain operations.

That's a noteworthy accomplishment, but Kraft has set its sights on even loftier goals. "We're aiming for an incremental $1 billion versus what we did two or three years ago, and we're almost there," says Lambotte. "Clearly, our days of inventory on hand has been going down by a double-digit percentage. The trick will be to continue that on an ongoing basis."