Supply Chain and Operations Financial Impact
As the emphasis on supply chain and operations grows, CEOs are beginning to more commonly use supply chain phrases such as:
- Operational flexibility
- Risk mitigation
Why are these ideas so important to CEOs? It is because consumers, shareholders, and government officials demand it. However, the real challenge is in implementing these ideas, moving from discourse to action. Because supply chain and operations is still considered a functional area that exists in silos for many companies, implementing these ideas to achieve true company value is difficult. However, companies that moved their supply chains from functional department to value generator were rewarded. In 2013, PwC did a survey showing leading companies are more than twice as likely to treat their supply chain as a strategic asset.2
CEOs continue to grow in their understanding of supply chains and the impact to organizations, thanks in part to news outlets and business publications producing content on the topic. News articles or video segments related to supply chains have several common themes. Some themes that consistently appear are natural disasters and the resulting supply interruptions, the idea that supply chains should be more flexible and agile to meet customers’ changing needs, and the need to use technology to manage the flow of information more effectively. Rarely does the conversation entertain ideas about how supply chain activities drive sales, affect revenue targets, impact shareholder value, how the stock price is affected, or the effect on financial ratios. Although these types of conversations are gaining traction, the specifics are generally left out of the dialog surrounding supply chains.
Emerging topics in supply chain today revolve around sourcing goods and services for organizations that directly impact financial performance. The costs of commodities are increasing or are in a constant state of flux. For example, we have a tough time getting our heads wrapped around fluctuating fuel prices. In addition, we see greater instances of companies unable to deliver products and services due to weather interruptions. One prime example is the Northeastern United States from 2012 to 2014. Hurricane Sandy and winter snowstorms crippled transportation systems, resulting in major delivery delays of goods and services. This led to shortages of raw materials coming to production facilities and supply shortages for customers. Of course, this isn’t confined to the United States. Tsunamis, hurricanes, and flooding occur globally, affecting companies everywhere. In 2011, floods in Thailand and the earthquake and tsunami in Japan caused massive supply disruptions affecting supplies of raw materials, subassemblies, and finished goods in the computer and automobile industries.
Another important area impacting financial performance is conflict minerals, which has been a topic of discussion for quite some time. These are minerals mined from areas of the world where armed conflict and human rights abuses occur. Recently, this topic has gained special attention. Section 1502 of the Dodd–Frank Act requires certain companies using conflict minerals in their products to disclose the source of these minerals. Even though an estimated 6,000 companies will be directly impacted by this rule, many private companies within the supply chains of those companies will also be affected. The U.S. Securities and Exchange Commission expects the cost of compliance to be substantial for all involved. For primary companies and their suppliers, initial estimates for cost of compliance are between US$3 billion and US$4 billion, with annual costs thereafter of between US$207 million and US$609 million.3
A third area of discussion that can affect financial performance is outsourcing. This includes the rights, safety, and health of workers employed by suppliers located in low cost countries. In 2012, the collapse of one Bangladesh factory and a fire in another led to more than a thousand deaths. These tragic events have resurrected the discussion around outsourcing to find the lowest-cost supplier. The backlash retailers face when it is reported that people were treated poorly or put in harm’s way can be devastating. Not only are events like these terrible situations for the families that lost loved ones, the companies can suffer a drop in sales, loss of brand value, and reduced stock prices. These are only a few of the many consequences faced by companies using suppliers where human rights are an afterthought.
The examples have been provided for two reasons: (1) to show that supply chain, particularly sourcing has a great deal of responsibility in managing and controlling costs in the face of enormous challenges and (2) to highlight that while knowing how to manage and control costs are essential, it is also important to know how these costs impact the business. What do we need to learn from all of this? Supply chain professionals need to become comfortable explaining how or by how much each of these significant issues can affect your organization. These issues can affect total return to shareholders, earnings per share, free cash flow, return on invested capital, net income, and other financial aspects of the organization. Remember, it is our responsibility to help our CEOs demonstrate success during earning calls.
Supply chains and operations functions are important for organizations. If you ask anyone in a supply chain or operations role, they will tell you that what they do each day is incredibly vital—and it is. Those in the field understand the importance of their roles and can articulate why, usually from the standpoint of operational performance. They can tell you the rate of defects, fill rates, order accuracy, inventory turns, and many other operational performance measures. After all, this is how their performance is measured. What is often missing from their explanations is how their actions directly affect the financial performance of the organization. Other than describing their key economic role in the organization as cost reduction, there is little more financial depth to the explanation. With the information and discussion provided by this book, we can change this.
The majority of supply chain professionals perform well in their functional roles. At the same time, many of these professionals find it difficult to see the company’s larger goals or to see how their actions affect other functional areas. Furthermore, supply chain professionals fail to see how their decisions or actions connect to and affect the financial goals and objectives of the firm. Pointing this out is not to degrade supply chain professionals; they are measured by operational performance metrics, which, by all accounts, are plastered on most shop walls. These metrics are what they know and live by. Because the management of supply chains is critical to the long-term prosperity and sustainability of any firm, supply chain professionals who intend to become managers or executives with increasing responsibility must reach a new level of financial aptitude. We will accomplish this from a supply chain and operations perspective. Having this knowledge will help you understand why, how, and what you do every day is important and how it affects the firm’s financial performance.