Working Capital 11/15/04 5:22 PM Page 1

Opportunities for Action in Operations

Working Capital Productivity: The

Overlooked Measure of Business
Performance Improvement
Working Capital 11/15/04 5:22 PM Page 3

Working Capital Productivity: The

Overlooked Measure of Business
Performance Improvement

More than a decade ago, IBMs then chairman, John

Akers, lamented that he could see examples of cycle-
time reduction and quality improvement throughout
IBM but that those gains were not having an impact
on the bottom line. Today, many executives are still
facing the same issue: they need a simple yet effective
measure of overall operational performance. That
measure is working capital productivity.

We define working capital productivity as the sum of

accounts receivable plus all inventories, minus
accounts payable, averaged for the year and then
divided into net sales. Thus, it is not a driver of
improvement, like a focus on efficiency or cost.
Rather, it is a measure of the improvement caused by
different initiatives.

Working capital productivity, in other words, is an

indirect indicator of a well-run operation. At a typical
manufacturer, for instance, when a customer places
an order, distribution ships it and then issues an
invoice that the customer pays when it is satisfied.
Distribution orders replacement stock from manufac-
turing, which delivers stock and then adjusts its pro-
duction schedule. The effect of the customers order
ripples through the entire organization, eventually
reaching other organizations, such as suppliers. In the
end, each ripple has a positive or negative impact
on levels of working capital and, therefore, on work-
ing capital productivity. (See Exhibit 1.)

Senior executives who focus on being world-class com-

petitors are achieving high levels of working capital
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Exhibit 1. Working Capital Productivity Reflects

a Companys Overall Operational Performance

Order cycle Order cycle Order cycle

Manufacturing Scheduling cycle Distribution

Suppliers Raw materials Finished goods Finished Customer
Work in progress goods

Delivery cycle Delivery cycle Delivery cycle

Payment Sales,
cycle Accounts general, and Accounts Payment cycle
payable administrative receivable
Billing cycle Billing cycle

SOURCE: BCG analysis.

productivity and saving hundreds of millions of dol-

lars for their companies and shareholders. Increas-
ing working capital productivity has also helped
these companies become much more competitive
with higher quality, lower costs, and faster response
rates.

Linking Performance Improvement

to Working Capital Productivity
When organizations attempt to improve operational
performance, they can choose from a wide array of
approaches: Six Sigma, total quality management,
lean manufacturing, and reengineering, to name a
few. But for executives looking at the corporation as a
whole, two problems can arise when they opt for any
of these approaches. First, they may focus too narrow-
ly on applying just one, making it hard to judge over-
all performance because they see the results of just
that initiative. Second, even when companies use such
high-leverage improvement programs, they still find
that assessing progress across many different parts of
Working Capital 11/15/04 5:22 PM Page 5

the business can be very difficult. A focus on working

capital productivity helps solve both problems.

Indeed, almost any performance-improvement effort

has an impact on working capital productivity. Take
flexible manufacturing or improving customer ser-
vice. Such initiatives reduce costs and boost overall
working capital productivity by shrinking inventories
and driving down accounts receivable. Or consider
the effect of paying suppliers quickly if they meet
enhanced delivery-performance requirements. At first
blush, paying suppliers faster would seem to reduce
working capital productivity, but companies that do so
often receive better service and faster deliveries
which drives down inventories and raw materials, and
improves working capital productivity. For instance,
Wal-Mart is well known for paying its suppliers faster
than its competitors do as an incentive to provide fre-
quent and reliable resupply. This allows Wal-Mart to
achieve much faster inventory turns and thus higher
overall working-capital productivity than its competi-
tors. Whats more, responsive service from suppliers
means that Wal-Mart has much higher in-store avail-
ability than its competitors, leading to more sales per
square foot and higher fixed-asset productivity as well.

Similarly, there is a correlation between improve-

ments in working capital productivity and improve-
ments in overall labor productivity (defined as sales
per employee). The Boston Consulting Group con-
ducted a survey of 500 companies from Europe,
Japan, and North America in a variety of industries
and found that for every doubling of working capital
productivity, labor productivity tends to jump 20 to 60
percent. (See Exhibit 2 for a sample of the data.)
Toyota, for example, has improved its working capital
productivity fourfold over the past 25 years. During
the same period, the automakers overall labor pro-
ductivity has improved 200 percent.
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Exhibit 2. Doubling Working Capital Productivity

Coincides with a Jump in Labor Productivity

Industry in which working Average improvement in

capital productivity doubled labor productivity (%)
Computers 59
Construction equipment 57
Industrial gases 40
Air conditioners 38
Automobiles 36

SOURCE: BCG analysis.

NOTE: Labor productivity is defined as sales per employee.

Of course, this does not mean that focusing on work-

ing capital productivity directly drives improvements
in labor productivity. Rather, the types of things that
companies do to improve working capital productivity
(for example, reducing batch sizes or improving qual-
ity to cut material in rework) tend to be the things
that diminish the need for labor and hence promote
labor productivity.

Shedding Light on Well-Run Operations

To better understand the link between working capi-

tal productivity and overall performance, we met with
executives of companies that had achieved notable
improvements in working capital productivity. In
every case, we found that their organizations also
were at the forefront of applying continuous improve-
ment principles. Although all the companies had
already improved greatly, their executives continued
to seek still higher levels of performance, customer
satisfaction, and flexibility. Working capital productivi-
ty gave these executives a birds-eye view of their
progress in a single calculation.
Working Capital 11/15/04 5:22 PM Page 7

We also found that the companies shared several

other traits. First, they closely tracked their competi-
tors improvements to ensure that their own organiza-
tions were turning in better performances. Com-
panies cannot buy a piece of equipment to do this.
They must go through the experience of changing
processes and of learning by doing. The more organi-
zations focus on learning, the quicker they learn and
the further they move ahead of the competition.
Improving working capital productivity is an experi-
ence-intensive phenomenon, and you create advan-
tage if you accumulate more experience than your
competitors do.

Second, successful organizations often look to other

industries for insights and for opportunities to im-
prove working capital productivity. For example, a
leading manufacturer of office products took a lesson
from the apparel playbook and learned from the
practices of leading clothing manufacturers. These
manufacturers managed production using actual
retail sales to set schedules, thereby dramatically
reducing duplicate and excess inventories. The office
products manufacturer began managing the stocks of
its products while they were in the big retailers
stores, thereby achieving improved levels of service
and reduced inventories.

Third, companies that are excelling extend their meas-

urement and management of working capital pro-
ductivity into the organizations of their customers and
suppliers. By doing so, they are able to measure the
performance of the system as a whole more accurate-
ly. For instance, a group of automobile manufacturers
and suppliers of automobile seats, upholstery, and
fabric teamed up to share data on working capital
productivity in order to help make their supply chain
more cost-effective, responsive, and competitive.
Working Capital 11/15/04 5:22 PM Page 8

Avoiding Common Pitfalls

We have also noticed that focusing on working capital

productivity has potential pitfalls. Four areas in partic-
ular need to be watched closely.

Resources and Management. Because the labor and

capital savings from an increase in working capital
productivity are predictable and large, management
needs to ensure that the improvement effort is fund-
ed and managed appropriately. If it is attempted on a
shoestring budget or without total commitment from
management, the needed cross-functional changes
wont happen, working capital improvements will be
slow, and frustrations will be many.

Focus and Logic. Plans for working capital improve-

ment still must make good business sense. Good
plans focus on systemwide improvements. Plans based
on simply extending payables, for example, will help
improve working capital productivity in the near term
but could hurt a business in the longer term.

Goal Setting. Set goals for the rate of improvement

rather than for absolute levels of working capital pro-
ductivity. Rates of improvement are measurements of
change. In return for committing resources to opera-
tional improvements, you should expect increases of
40 percent in all labor productivity as a result of dou-
bling working capital productivity at a steady year-in,
year-out rate. (See Exhibit 3.)

Accounting. When comparing your working capital

productivity with that of your competitors or of
benchmark companies, be aware of the accounting
vagaries that can distort such comparisons. For exam-
ple, make consistent adjustments for differing last-in,
first-out and first-in, first-out policies. Add back
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Exhibit 3. When Working Capital Productivity

Improves Consistently, So Does Labor Productivity
Example: Manufacturer of consumer durables
Labor 300
140% slope
produc-
tivity 250
(index:
year 1 = Year 10 Year 15
100) 200

Year 5
150

100
Year 1

50
0 100 200 300 400 500 600 700 800 900 1,000
Working capital productivity
(index: year 1 = 100)

As working capital productivity doubles,

labor productivity increases by 40 percent.

SOURCE: BCG analysis.

NOTE: Labor productivity is defined as sales per employee.

progress payments to work in progress. Crosscheck

performance based on year-end results with quarterly
statements to find those companies that dress the bal-
ance sheet at years end. Be aware that reported
improvements could also come from sticking it to
suppliers by increasing days payable.

Discovering the Missing Link

Today, reducing costs, improving quality, and saving

time through all parts of an organization are the
mantra of executives in every industry. In their pur-
suit of those goals, however, they tend to overlook
working capital productivity because it is an indirect
measure. They see it as a narrow financial calculation
and miss its link to the overall systemic performance
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of an organization. As a result, executives forfeit a

powerful lens to track improvements across the
company.

It can be a costly oversight. If you are attempting to

dramatically improve operational effectiveness and
you are not experiencing a 40 percent improvement
in all labor productivity for every doubling of working
capital turns, then your investments are not yielding
sufficient returns. You are missing opportunities to
transfer gains in performance to the bottom line, and
you are leaving yourself vulnerable to more resource-
ful competitors.

George Stalk Jr.

Harold L. Sirkin

George Stalk Jr. is a senior vice president and director in the

Toronto office of The Boston Consulting Group. Harold L.
Sirkin is a senior vice president and director in the firms
Chicago office and head of BCGs global Operations
practice.

You may contact the authors by e-mail at:

stalk.george@bcg.com
hal.ops@bcg.com

To receive future publications in electronic form about this

topic or others, please visit our subscription Web site at
www.bcg.com/subscribe.

The Boston Consulting Group, Inc. 2004. All rights reserved.

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