Internal controls provide competitive advantage during and after major downturn

Summary

Business controls lead to a large competitive advantage when an unexpected economic shock hit.

Situation

In the mid 1990s, Philips Indonesia was enjoying the booming days of the Asian Tiger economies. Due to infrastructure investments, more and more households were getting electricity supplies, and more established areas were getting upgrades in capacity. Even the fairly mundane market for consumer light bulbs was growing annually by more than 20%. However, the culture of sales and easy growth combined with rapid expansion lead to unstructured growth in many businesses. Philips Indonesia decided to implement a new sales and distribution system to improve reporting and control. 

Implementation

A new ERP system was implemented, and a follow-up project of business control improvement was implemented by Tim under the leadership of the Finance Director. Despite the complacent mood due to the seemingly never-ending boom, a multi-layered improvement project began. First, internal separation of duties was established, and system changes or compensating controls were introduced to eliminate gaps. In the the process, it became clear that credit checks, of customers in the large Lighting division had not been updated for several years, although in the benign economic conditions, there appeared to be little bad-debt risk.  

Many small customers with insufficient credit guarantees were exited. Large customers were required to update guarantees in hard form: liens, mortgages and letters of credit (the inconvenience compensated with extra business).

At the same time, new profitability reports were introduced. For the first time, management saw daily contribution margin reporting per customer and product family. A new inventory management system was integrated into the sales and distribution system, giving visibility into lead times to meet out-of-stock demand. Price list controls and discount systems were standardised and controlled by system modifications.

Unforeseen development 

In 1997, the East Asian Crisis hit Indonesia like a tsunami. The currency depreciated by 17000%. The banking system collapsed, and building sites were abandoned overnight, leaving cranes and equipment lying idle. Social unrest deepened, leading to military action, civilian deaths and finally the overthrow of the Soeharto regime. Many multi-nationals pulled out, their distribution channel in tatters with bankrupt distributors and too much stock in the chain to control necessary price increases. 

Results

Unlike all other large domestic and international competitors, Philips was in a strong position. With a small number of large customers, all with good credit, it was able to withstand the crash. The close relationship with the distributors lead to controlled price increases to protect cash flow.The new system-controlled pricing and discount system was not designed with the expectation of having to roll-out regular and co-ordinated price increases, but it served this purpose very well. Philips could quickly and effectively control the impact of large currency swings,and the distrubutors had compelete confidence in the fairness and transparency of price changes.

Enormous distributor loyalty was earnt since other visible multi-nationals simply withdrew. Philips went on to establish an enormously strong market position as the economy recovered. When competitors reentered the market, they naturally tried to win the business of the large distributors; however, the loyalty to Philips was ovewhelming. Thus, as the economy recovered, Philips reaped the benefits of a greatly strengthened market position

Philips did not not see the downturn coming. But business controls and the improved visibility into costs, margins and foreign currency management gave a great competitive advantage.