The Case for Supply Chain
May 26th, 2006Despite their reputation, CEOs are not really all that hard to please. All they want is revenue growth, profitability, and a return on capital. Oh, and let’s not forget, superlative levels of customer satisfaction. As supply chain operations can definitely impact and help improve all these area of performance, the supply chain executive’s primary duty is to craft a compelling case to persuade the C-suite to invest in the continuous improvement of his or her organization. That’s what I mean by making “the case for supply chain”.
This means developing a vision and strategies to convince the top executives, energize the staff and secure their commitment to a process of rapidly maximizing the value the supply chain adds to the business. The “case for supply chain” also has to do with making the connection between supply chain performance and financial performance. Truth be told, the CEO and most of the executive team want to hear about dollars and sense rather than lean supply chains, MRP, or collaborative forecasting.
To be effective, this deceptively simple task has to link supply chain KPIs to the metrics in the P&L and Balance Sheet and develop a credible strategic portfolio of initiatives designed rapidly improve both sets. The financial performance of the company is typically measured by revenue growth, profit margin, and asset efficiency. Aside from revenue growth, the DuPont formula, which has been in use longer than I can remeber, calculates the classical profitability measure of a business, or ROA (return on assets) as follows:
ROA (Return on Assets) = NOPAT (Net Profit After Tax) / Assets
or:
ROA = NOPAT / Sales x Sales / Assets
which is:
ROA = Profit Margin x Asset Efficiency.
Some people use the term “Turnover” instead of “Asset Efficiency” to convey, among other things, how important inventory velocity is to profitability. Ideally one would want a business with a high margin and a high turnover however, depending on the type of industry one could be higher than the other. Take for example the case of a grocery and a shipbuilder: the grocery has low profit margins typically so that turnover is very important whereas the shipbuilder has very low turns so that margins have to compensate to achieve an acceptable ROA.
So how does one link supply chain performance to financial measures? Below is an example that shows potential relationships between the various supply chain processes and the resulting financial performance. For example: revenue growth can be affected by improved forecasting accuracy which in turn optimizes manufacturing scheduling thus potentially uncovering idle capacity and free it up for further sales volume. Similarly, better transportation management will result in lower freigh costs which in turn affect the cost of goods sold resulting in a better profit margin. And lastly, better inventory management will result in a shorter cash-to cash cycle and in turn a higher return on assets.
In the next several posts, a methodology aimed at making the appropriate connections between supply chain drivers and financial performance measures will be discussed.
