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Does Your Supply Chain Deliver Shareholder Value?

Mar 1, 2008
When toy manufacturer Mattel was forced into a series of bruising product recalls last summer, its stock price plummeted by some 25% from its year-to-date peak. Boeing's share price has hit turbulence since it announced last summer that supply problems are delaying initial deliveries of its new 787 Dreamliner aircraft. The plane maker's stock has fallen by an estimated 20% in that time. Examples of how supply chain disruptions affect stock price and hence shareholder value abound, yet the specific risk factors involved are not well understood.

Although more research is needed into the relationship between supply chain risk and financial performance, there is a growing recognition-spurred to some extent by incidents such as those mentioned above-that companies need to make the connection and incorporate it into their corporate strategies. Some analysts and investors are beginning to appreciate the importance of a robust supply chain to company profitability.

In response, corporate leaders, including those who oversee supply chains, need to gain a better understanding of how they can make their enterprises less prone to the risks that undermine investor confidence.

Star Performers
Product recalls and supplier problems are just two examples of how supply chain-related issues can sully a company's reputation in the eyes of investors. For example, "There is a growing school of thought that says lean is not necessarily a friend of resiliency," said Darryl Moody, COO of Resilient Corp., a Washington, DC-based company that offers business intelligence solutions.

Poorly planned and executed product launches, and breakdowns in just-in-time distribution networks are other problems that can shift market sentiment against an enterprise.

The implication is not that companies should junk well-established supply chain practices. Rather, they should be prepared to view their supply chains through a shareholder value lens and, if necessary, make adjustments that make the organization a better and more secure investment prospect. As Moody pointed out, the investment community is starting to question whether there is something about an organization's supply chain or logistics strategy that makes the organization a riskier investment.

Columbia Partners LLC, an investment management company based in Chevy Chase, MD, has gone a step further by creating portfolios of companies that "We think are doing a better job at supply chain or that are resilient to disruption," said K. Dunlop Scott, Columbia's president and COO. By using stock market modeling and a number of "crude external indicators," Columbia generated lists of companies that have outperformed the S&P 500. "Several of the portfolios performed much better than the broader indices in 2007," said Scott.

A lot more work is needed to hone the performance indicators Columbia used to evaluate companies for resiliency, but its initial foray into picking stock market winners according to their ability to withstand supply chain shocks looks very promising.

The types of capabilities that determine resilience levels and hence a company's ability to cope with adversity include the proportion of its manufacturing base that is outsourced and which countries it operates in. Corporate attitudes toward eliminating risk and recovering from disruptions is another important consideration. From an investor's standpoint, a company that is aware of its risk profile and is actively pursuing ways to increase resiliency "is likely to have a lower degree of volatility in their earnings stream and should therefore be valued more highly," explained Scott.

Taking Action
So short of a total overhaul of your manufacturing strategy or some other draconian change, how can you make your supply chain more appealing to investors? You need to know what factors investors weigh to assess your supply chain, and as Scott readily acknowledged, more development work is needed to establish a well-defined set of performance factors or indicators.

In the meantime, there are a number of ways in which companies can make their supply chains more resilient and hence investor-friendly.

There are many ways to build organizational resilience (see The Resilient Enterprise, Yossi Sheffi, MIT Press, October 2005, for a detailed account), but a first step is to think broadly about the threats the enterprise faces. "Companies need to identify the few things that can bring the enterprise down and then figure out a contingency plan for that unlikely eventuality," said Jim Rice, deputy director, MIT Center for Transportation & Logistics, based in Cambridge, MA, and an expert on supply chain risk. Rice emphasized that firms need to explore their vulnerabilities across the entire supply network, not just within their own walls. That requires "firms to be thinking about risk not to protect assets but to protect the ability of the firm to generate economic wealth," said Rice.

A clear line of communication with the C-suite is crucial. Operational people are generally savvy when it comes to the importance of avoiding supply chain disruptions. "The problem is, one, they never have enough resources to look at this, and two, the people they work for or with, the CFO and CEO, think they are already doing these things," Scott said.

Third, and perhaps most importantly, operational folks tend not to speak the language of the front office, Scott added.

At the same time, the C-suite may not understand or appreciate that enhancing supply chain resilience has a positive influence on stock price. This lack of awareness at the top can be extremely damaging to a company when it is compounded by ignorance of key supply chain functions such as supplier management. The U.S. auto industry is a prime example of this.

Mismanagement of suppliers over recent years, aided and abetted by a single-minded focus on cost cutting from the top down, has led to supplier bankruptcies and defaults that have seriously eroded stock valuations in the industry. The huge risks associated with a dysfunctional supplier network and the consequent impact on share price went unrecognized for too long in the industry.

When senior management makes the connection, it becomes apparent that "all of a sudden, the millions of dollars spent on risk mitigation, remediation, or avoidance are dwarfed by the hundreds of millions of dollars you'll gain from preserving shareholder value," Scott said. A useful way to drive home the importance of building resilience is to relate the multi-million dollar cost of a disaster such as a major recall-and the associated impact on the company's market value-to senior executives whose compensation is tied to the value of stock options.

Even with the support of C-level executives, however, building resilience and, by implication, investor confidence, may or may not be a high priority within the company. You need to target your efforts to get maximum impact and to be in alignment with the organization's strategic goals.

Resilient has developed what it calls a hierarchical inventory of resiliency indicators. At the top of the ladder are 10 Level-1 indicators such as operational risk, legal and regulatory, and supply chain/procurement. A company's resiliency is scored on a scale of 1 to 4 on each of the indicators to generate a profile. Going down the hierarchy, the Level-1 areas are proved on the basis of more than 80 Level-2 categories, and these, in turn, are dependent on some 300 Level-3 indicators. "Our assessment of the supply chain area does not equate to an audit of supply chain or a best practices review," said Moody, but highlights the elements of supply chain that are important to overall resiliency.

In this holistic assessment, even if the supply chain scores below par, this does not automatically assign it a top priority for remedial action, pointed out Moody. "You have to decide whether it's part of your strategy to be a little worse on physical supply chain issues because you will make it up in other areas such as IT," he said.

After having positioned supply chain on your corporate resiliency map, it is possible to focus on what specific capabilities need to be addressed. For example, the company may have devoted resources to achieving efficient order processing at the expense of other important activities such as supplier management. It may be that too much effort has gone into acquiring the latest and greatest software and not enough into the management decisions that impact resiliency. But even then, you may decide that correcting these weaknesses is not the answer.

As Moody explained, fixing a deficient functional area may have an adverse impact on other parts of the business or you may decide that the investment is needed more urgently elsewhere.

Similarly, in an organization with multiple divisions, it is fairly likely that some units are doing a good job at managing risk, while others have barely made a start, pointed out Scott. But from a corporate resiliency perspective, he asked, "Do the ones that are not doing well matter that much?" For example, if 40% of your revenue streams come from a department that relies heavily on operations in China, that unit represents a high level of potential risk and warrants special attention. "Do some triage up front," advised Scott, and then plan your corrective efforts according to the relative needs of other departments.

Deeper Dive
Having created portfolios of companies that demonstrate the importance of supply chain resiliency to stock market performance, the next step is to develop more precise risk indicators, said Scott. This will require a closer look at the internal workings of supply chains and how these relate to an organization's risk profile. Investors and analysts need some sort of resilience scale that enables them to compare how companies are performing "so we can see which companies might be the ones that we would want to include in a resilient investment index," he said. Investors know that risk can't be eliminated, "they just want to know that they are investing with companies that have thought about this and have at least begun to quantify it," Scott said.

Rice agreed that practitioners need ways to quantify and compare the risks their organizations are subject to, so they can decide which ones need to be addressed. Currently for most companies, "it's a qualitative approach applied to a problem that needs a quantitative analysis," he said.

Also, more research is needed into how offshore outsourcing strategies can elevate risk levels, Rice added. For example, "the exposure that comes from outsourcing manufacturing to China is far greater than we all recognize," he suggested. In addition to the product quality problems that have attracted so much attention lately, costs and intellectual property issues detract from the case for outsourcing to China. "No one has done the seminal study that takes all these factors into consideration," Rice said.

But even armed with the best research available, the onus is still on companies to decide what effort they are prepared to devote to achieving a level of supply chain resiliency that curries favor with the investment community. As Moody pointed out, if an enterprise decides that a certain level of risk and vulnerability is acceptable, then it will be business as usual. "But if the ratings agencies, investors, and stakeholders have a different opinion, then something needs to be done."
About the Author
Ken Cottrill is the editor for MIT Supply Chain Strategy, an independent newsletter published by IOMA with the mission to drive competitive advantage by linking corporate strategy and supply chain management. Its 10 issues each year shepherd senior executives from a broad cross section of industries and corporate disciplines through developing a strategy that defines how their supply chain should work. To learn more visit IOMA.com/ISSUES/SCS.
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