The Answer is a Resounding Yes

Bookmark and Share

Of course, the question is: does supply chain excellence pay off?

As reported in this article in the latest issue of Supply Chain Management Review, researchers at Michigan State compared the supply chain leaders with their nearest competitors and found that the supply chain leaders reported better financials across the board. For the data from 2004 through 2007, companies with leading supply chain capabilities reported:

  • 50 percent higher net margins

  • 20 percent lower operating and SG&A (Sales, General & Administration) expenses

  • 12 percent lower average inventories (days of sales)

  • 30 percent less working capital expenses/sales

  • Twice the ROA (return on assets)

  • Twice the ROE (return on equity)

  • 44 percent higher economic value added

  • Twice the returns on stock prices

  • 2.4 times the risk-weighted stock returns, and

  • 46 percent greater market value-to-assets ratio

Not surprising, but this potentially addresses the question of proving with data what most of the supply chain practitioners knew through personal experience. In fact, all supply chain capabilities have the potential to reduce the costs either directly or by increasing the efficiencies. In each case, they affect the corporate financials positively. The relationship between the corporate financials and supply chain functions is very direct. There are two things that appear on the financial statements that effective supply chain practices directly control.

  1. The first is the inventory. It appears under the current assets in the corporate balance sheets. Supply chains control inventory and can reduce it significantly without affecting the revenues of a firm. Inventories add to the current assets, which is part of total assets of a corporation. Between two companies with the same revenue, the one with lower total assets will have higher asset turnover – the equation is that simple! My book on supply chain processes shows a graphic view of how the corporate financials are affected directly by supply chain functions. Lower inventory directly affects the inventory turnover (reported above as days of sales), and higher asset turnover positively impacts the ROA, ROE, and the working capital to sales ratio.
  2. The second is cost of sales. Cost of sales consist of direct costs such as the cost of merchandise, cost of raw materials, cost of direct labor, and so on; it also has some indirect cost components such as the cost of distribution including the freight and warehousing costs. Most of these costs are controlled through supply chain processes and good processes can directly reduce most of these costs. A detailed analysis of the Cost of Goods Sold is presented in my previous article here. Cost of sales appears in the corporate P&L statement right under the Revenues. This number drives the gross margin that a firm can report. Higher gross margins typically lead to higher net margins, lower operating and SG&A, and lower working capital to sales ratio.

However, supply chain is simply an effective tool, and most firms need to also develop teams of people who can deploy this tool successfully to produce the financial results typical of companies with excellent supply chains.

 

Want to know more about supply chain processes? How they work and what they afford? Check out my book on Enterprise Supply Chain Management at Amazon. You will find every supply chain function described in simple language that makes sense, as well as see its relationship to other functions.

 

Business Strategy & Supply Chains

[Click here to learn more about my book on Enterprise Supply Chain Management or to buy it.]

What do supply chains have to offer to the business strategy? It turns out, a lot.

To understand, let us review some of the basic concepts of strategy. Strategy was initially postulated as a balancing act between the external and internal forces in a corporation where the firm matched its (internal) strengths and weaknesses against the (external) opportunities and threats. Since then, many researchers have added their own work to the field of defining what is corporate strategy, how to think about it, how to formulate good strategy, and have provided various frameworks to help the evolution of the concept of corporate strategy. In short, the goal of any corporate strategy is to create competitive advantages for the business in its industry segment so that it is well-positioned for financial success.

Porter’s three generic strategies

Porter’s three basic strategies were suggested by him in 90s and have become a mainstay of the strategy literature. These three strategies are based on pursuing cost, differentiation, or focus as the main strategy and then adopting the policies, investments, and projects around that. The cost strategy is based on pursuing the cost leadership so that the firm has a definite cost advantage over the competition. If the firm is successful in achieving cost that is below the average cost of products/services offered in a segment, then it allows the firm to either be more profitable or expand its market share. Differentiation strategy postulates that firms can have competitive advantages over the others in their segment if they can image develop unique features in their products or services that are valuable to its customers. Of course, for this strategy to work, the cost of developing these unique features must be less than the premium that the buyers are ready to pay for these features. The third generic strategy is the focus strategy that primary postulates creating a niche within the segment to achieve competitive advantage. These niches are created when the product is specifically designed and targeted at a well defined customer segment. The firm must identify the customer segment it wants to target and then define the unique features that will be valuable to this segment – note that cost itself may be one of those unique features that appeal to this segment, so can be other product features. There are many styles of strategies now defined that are primarily combinations and variations of these three generic strategies. That makes sense because a company may adopt different strategies for different business units or products depending on its current positioning in that segment, its strengths, available resources, and skills required to address the demands of a strategy.

Resource based view of strategy

A Resource-based View (RBV) of the competitive advantages emerged on the premise that it is only the resources of a firm that create the competitive advantages. When a firm possesses resources that are unique to it and can create value for its buyers, then the firm has competitive advantages. These resources can be direct such as cash and assets, indirect such as brand value, or firm’s capabilities such as its supply chain processes.

Capability based view of strategy

Then, there is the concept of competing on capabilities. This became a prevalent way of thinking about strategy after some Harvard researchers provided examples using Wal-mart and how its capabilities won the company the top spot in its industry segment.

It is a little ironic that capabilities came last in the evolution of thinking on corporate strategy since this is so basic to the success of corporations as well as to the successful implementation of any strategy the firm may have picked up to pursue. After all, any strategy that remains unexecuted does not deliver. Executing a strategy necessarily means that firms create capabilities that are demanded by the strategy. Take, for example, the cost strategy that Wal-mart has followed since its inception – it is the capabilities that Wal-mart developed to pursue the low-cost strategy that allowed it to reduce costs across its value chain. If Wal-mart was unable to create and maintain such functional capabilities then simply having a strategy to pursue low costs does not do any good. To pursue low cost, Wal-mart analyzed its whole value chain and developed capabilities in all business functions where such potential existed – such as store operations, distribution, warehousing, inventory management, and even merchandising functions such as seasonal merchandise and pricing optimization.

The same remains true for any other strategy that a firm might select. For example, differentiation strategy may lead to developing capabilities in product design, manufacturing, delivery, or customer service. Consider Kindle: this is a clear example that has propelled Amazon to develop capabilities in innovative product design which was not its mainstay as a retailer! Also consider the delivery model of the books using Kindle that provides another clear differentiator to Amazon compared to its competitors.

While the resource strategy considers direct and indirect resources as enabling competitive advantages and that is true, the fact is that these resources themselves are a result of functional capabilities that, over time, have delivered these resources in addition to their direct contribution to creating the competitive advantages. If Coke as a brand is valuable today, it is because the company developed superior marketing capabilities in the past years that have consistently worked towards creating the brand that now can be leveraged as a competitive advantage. Same is true for cash assets that Wal-mart may have – these assets themselves are a result of their functional capabilities allowing cost reduction rather than the other way around. Therefore, I see the direct & indirect resources simply as byproducts of a successful strategy that drives functional capabilities to create competitive advantages and also delivers these benefits in terms of direct/indirect resources which can be leveraged in advancing these competitive advantages. Remember that these resources alone are not sustainable by themselves and continue to depend on the original functional capabilities that created them in the first place.

The capabilities based competitive advantages, therefore, just happens to be the core precept of creating and maintaining strategic edge in an industry.

What do the supply chains have to offer to corporate strategy?

Now that we have refreshed the basic concepts of strategy, let us see what can supply chains offer to corporate strategy? Supply chains primarily focus on the operations of a firm; supply chain council defines the five basic supply chain functions as Plan, Source, Make, Deliver, and Return. Depending on the industry you are in, all or some of these functions will be part of your supply chain. All the supply chain functions primarily offer the firm cost reduction opportunities directly or indirectly. Supply chain functions like warehouse automation and transportation optimization direct reduce their cost of goods sold (COGS), and other functions like inventory optimization reduce the requirements for working capital thus increasing return on assets (ROA). All these options provide opportunities for creating competitive advantages for a firm. These supply chain functions can direct affect the cost basis and provide the firm with the cost advantages. You can read more about the financial impact of supply chain functions in this article here.

Then, there are other supply chain functions that can provide differentiators through process integration, such as those in the order fulfillment area. These functions not only add to the operational efficiency but can also provide differentiation in customer service through perfect order fulfillment and ability to track and communicate the customer order status throughout the fulfillment process.

Better planning through better demand forecasting can affect all the operations in a supply chain in a made-to-stock or retail situations. These planning functions can substantially reduce the cost basis by reducing inventory, increasing manufacturing operations efficiency, increasing distribution operations efficiency, and in reducing plan volatility that stabilizes the operations.

Optimization based supply chain solutions such as manufacturing planning, scheduling, and sequencing; inventory optimization, transportation optimization, purchase planning, etc. make use of powerful mathematical models to represent the real-life supply chain constraints with the objective of reducing cost or increasing throughput. Both of these (reducing cost or increasing throughput) can help organizations create and sustain competitive advantages by creating cost, delivery, and customer service differentiators.

Summary

Firms should analyze their corporate strategies and dissect their value chain (operations) to establish the functional capabilities that will help them achieve the goals set by such strategies. Supply chain functions, specifically, provide many such opportunities and combined with standard packages solutions can help the companies achieve their strategic goals systematically when these efforts are aligned with the strategic goals through the identification of required functional capabilities.

 

Do it Right: Don’t Undermine Your Investments in Supply Chain Technologies

In my last post, I talked about why it is important to have the people with the right skills to fully leverage the supply chain technology investments. In this blog, let me expand that equation further to see what are the other factors that corporations must ensure in order to fully leverage their supply chain solutions and the promised returns on their investments.

The following picture represents the main reasons why most of the failed technology/solution investments do not pay off.

image

People:

Supply chain planning solutions typically are built as decision support systems with complex algorithms underneath. These solutions require people with the right skills for configuration, tuning, reviewing and resolving errors, and maintaining the planning parameters for the system to function at its best. Depending on the solution, these skills may vary from statistics, to mathematical programming, to data mining, etc. People can acquire these skills through training, academic background, and/or prior professional experience. However, the key is to plan for the people with right skills and not undermine the solution capabilities for want of a few good people. Also remember that we are talking about only a handful of super users that would fall in this category, since the large majority of the users, using the output of such systems don’t have to be specialists at all! Read more about this aspect of supply chain solutions in my previous post.

Process:

Most corporations believe that their processes are unique, and therefore provide them with competitive advantage that others in the same industry do not have. The truth is that for most part, it is a myth. Very few processes in an enterprise actually have the potential of providing such competitive advantage, while most others will be just fine as long as they are efficiently planned, executed, and reviewed. Being open to review the old processes in an unbiased way, and adopting the standard process supported by the solution not only shortens the implementation timelines, it also saves money, and resources. And usually, it provides a standard way of doing business with other partners in the industry using similar solutions. Be open to evaluate all processes and adopt changes where such changes make sense.

Infrastructure:

Successfully implementing complex business applications requires proper infrastructure planning. With infrastructure in this context, I mean hardware as well as software infrastructure. An example of software infrastructure will be ability to manage common master data among many business applications; ability to extract, cleanse, consolidate, govern, and publish such data to all applications that need them; ability to analyze information; ability to collaborate; have automated alerts, and event based messaging to prompt user action when required. often these capabilities are not planned as part of the supply chain solutions since they are not mandatory. However, they allow the enterprise to fully leverage the core solution while absence of these capabilities truly constrains the ability to reap any substantial ROI. To a large extent, this can also be said about the hardware: having centrally hosted servers with proper back-up, disaster recovery plans that are routinely tested, high speed network among corporate locations, RF terminals, large monitors, etc., does add to the overall productivity, usability, and adoption of these applications. Only such investments with the right processes ensure business continuity in natural or man-made disasters. Having the correct infrastructure for a supply chain technology initiative requires holistic planning, the kind that is mostly missing from IT-centric project planning exercises.

Customization:

This is another huge factor affecting successful implementation and adoption of new supply chain solutions. Unless a solution is custom built to your requirements, chances are that your processes will never map a 100% to the process supported by the packaged solution. However, to avoid functionality gaps that may be truly constraining, you must determine these gaps prior to the investment in the solution. Since most of the bigger software vendors would have years of experience with similar customers, it is also a good opportunity to question all such gaps and determine if they are real gaps, or merely entrenched habits that are hard to break. Remember, every custom enhancement to the solution costs money to develop, pushes back the project timelines affecting ROI, becomes a permanent constraint to solution upgrades, increases on-going maintenance fees, and adds to testing and validation costs for original deployment and every upgrade thereafter. This is a sure TCO killer.

Metrics:

What gets measured, gets delivered. Therefore, define clear expectations on prospective operational improvements through well-defined metrics. What is it that the technology is expected to deliver: higher inventory turns, higher number of orders processed per buyer, higher fulfillment rates? Also make sure that you have the historical data on these metrics to compare the new numbers against. All ROI is questionable unless it can be established through consistent trend on the defined metrics, against a historical data set. Finally, make sure that these new metrics are aligned with the people’s individual goals. Many a times, personnel goals are tied to the operational metrics, and when these operational metrics get revised due to new technology, the revision of the personnel goals is easily forgotten. But remembering to realign the two will make sure people have no hesitation in adopting the new technology, since the new technology is going to help them with their new set of goals.