Tuesday, April 13, 2010

The Answer is a Resounding Yes

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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.

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