Measuring the Value of the Supply Chain

Strong supply chain management practices can reduce operating costs and help organizations control the costs of their logistics function. In many organizations executives are unaware that supply chain management is also a profit center. Once the right metrics are adopted, it is possible to gauge the impacts of supply chain management practices on the main indicators of corporate value: The Income Statement and the Balance Sheet.

In recent years, when economic circumstances have often been challenging, executives have demanded cost reduction and savings throughout their organizations. Supply chain managers have responded to these demands by taking the lead in delivering what collectively amounts to billions of dollars of savings in inventories, freight costs, procurement and other costs associated with logistics. Though CEOs no longer view cost reduction as their number one goal – their focus having moved towards the creation of profitable growth – supply chain and logistics managers are not yet mobilizing themselves in support of this new goal. The main reason for this can be found in the fact that they have become too comfortable focusing on cost savings and feel much less at ease promoting top-line benefits, particularly as the evidence suggests they are still unsure about how they should go about achieving them.

There is a general tendency to dismiss as too nebulous those investments in supply chain personnel, processes and technology that cannot be proven to be key drivers in achieving competitive advantage and, therefore, profitable growth. Many corporate-level executives have not yet understood the intrinsic connection between supply chain competency and corporate performance, and as a result they are unable to appreciate the true value of investment in the supply chain. For that reason supply chain professionals must be ready to deliver value through their own initiatives in order to support their companies’ strategic vision. If they can show tangible contributions to the overall performance of their enterprises, this will provide a valuable showcase for supply chain management, help to make it clear what effect it can have on the organization and enhance the perception of the value of the supply chain among senior executives.

Indicators of an organization’s financial performance are already recognized as being the Income Statement and the Balance Sheet reports. Income Statements measure profitability over a specific period of time, taking into account flows of revenue and expenses in order to calculate net profit for a given time period. It gives a valuable insight into how an organization generates its revenues and shows how margins can be eroded by both direct and indirect costs. Balance Sheets provide a record of changes in assets and liabilities, which will partly be based on the activities that are outlined in the Income Statements.

Supply Chain Management and the Income Statement

The Income Statement is a useful starting point in revealing the impact of supply chain activities in a specific period, whether that is viewed from the perspective of either sales or costs.

Looking at the structure of the Income Statement, Sales emerges as the first figure. Sales results can be affected by supply chain operations. Higher levels of customer retention lead to greater sales, which typically occur because customers are more likely to place a greater proportion of their purchases with a given supplier. If a company wants to generate improved sales flows and supply a greater volume of products to customers showing high levels of demand then it must show itself to be flexible, responsive and reliable in the delivery of those goods. Achieving that is heavily dependent on the quality of supply chain operations.

If it lacks flexibility, a supply chain will not be sufficiently agile to respond to changes in the market, nor will it be able to gain or maintain competitive advantage. If it fails to be responsive, a company will find that the speed at which it can deliver products to the customer through the supply chain will decrease. If the supply chain is not reliable, a company will perform poorly in terms of delivering the right product to the right place, at the right time, in the right condition and packaging, in the right quantity, with the right documentation and to the right customer.

Supply chain management has a growing potential to be viewed as a front-office tool for Sales. Demand manifests itself through multiple channels, such as online marketplaces, as well as through partnerships. In each of these channels the supply chain can be a critical element in supporting the sales of goods, and the exchange of information and funds. More and more margin potential is now being derived after a product is shipped. Service and support, therefore, are becoming just as important as the product itself. If the supply chain is to be at the heart of a company’s profitable sales and support processes, then it must ensure that it does not falter or fail in the face of the demands placed upon it.

If we look at another component of the Income Statement – Sales Returns and Allowances – we can easily highlight another area where the supply chain must remain robust. Delayed deliveries are among the typical faults in supply chain management that impact Sales Returns and Allowances. There are many factors that can trigger the return of goods by a client, such as poor quality of product or service, incomplete or partial delivery of goods, incorrect quantities shipped, or incorrect product attributes – for example when the color, technical specifications or functionality of the product are wrong. The returns these errors generate will ultimately reduce total sales figures. If a company chooses to offset the negative impact of these factors on customer satisfaction and loyalty by offering discounts or special prices that will increase the allowance value and sales figures are further eroded.

Cost of Goods Sold (COGS) is an important figure as well in the Income Statement, which describes the direct expenses incurred in producing a particular good for sale, including the actual cost of materials and direct labor costs associated with getting the product into a sellable condition. This figure is directly related to supply chain operations because the transactions and operations that add up to produce this figure are, per se, supply chain operations. Supply chain glitches that impact COGS can be easily tracked under the header of cost of materials. The purchase price of the goods or services is a result of negotiations between the purchasing department and the supplier’s sales department. When an organization takes a myopic, silo-based approach to purchasing, where it remains separated from supply chain operations, it will not benefit from the organic and cross-departmental perspective that seeks to link supplier relationship management closely with the characteristics of an efficiently and effectively managed supply chain. The final price paid for a product or service must instead reflect the total investment required to perform a specific action or a series of actions, which means taking into account the purchase price plus the costs of all other activities along the supply chain. It may often be the case that the purchase price represents only a fraction of the total cost. Those companies that achieve best practice in cost management take this into account, and factor in all of the costs associated not only with producing a product or service, but also with delivering it to their customers.

Another important component adds to the Income Statement, namely Operating Expenses. Supply chain management activities that are registered under this heading usually occur in the back office. One of the first back-office processes that must be taken into account to properly measure Operating Expenses is the management of business rules during planning cycles. This refers to the process of establishing, maintaining, and enforcing decision support criteria for supply chain planning, and includes activities such as the measurement of service levels against the service requirements laid down for trading partners and other stakeholders in the supply chain. If the demand planning function can be made more reliable then the flow of goods and funds along the supply chain will be much more stable, and consequently the people responsible for running the supply chain will need less time to anticipate changes in demand. The result is a more responsive supply chain, which means organizations will be able to spend less time on fire-fighting, as many potential problems will be headed off before they occur or will be addressed more quickly should they arise.

Another potential source of hidden Operating Expenses is the planning of total inventory limits, which includes raw materials, work in process, finished and purchased finished goods. This also comes about when those responsible for the supply chain set to work on building replenishment and ownership models, product mix and stocking locations. As these people work on defining an integrated supply chain transportation strategy and maintaining the data that characterizes total supply chain transportation requirements, as well as the management of transporters both within an organization and with its trading partners, there is significant potential for operating expenses to increase. It is also important to remember at this point other key tasks, such as establishing, maintaining and enforcing rules for the management of production details, which include part/item master, bills of materials/formulas, routings, processes, equipment requirements, tooling, as well as other information that specifies the method of production for any given product. These usually go hand in hand with the process of specifying, maintaining and disposing of manufacturing capital assets, including repairs, alterations, calibration and many other tasks that are necessary to maintain the production capabilities of the fixed asset base that supports the manufacturing function. The same is true of the continuous management of activities that ensure equipment and facilities are maintained in proper order.

All the factors mentioned above that contribute to the final figure for Operating Expenses are related to activities that occur within an organization.

The next article will describe the connections between supply chain management the Balance Sheet.