The inextricable link between shareholder value and supply chain performance

12 April 2019

In a new collaborative research paper from Maine Pointe and the Global Supply Chain Institute, professors J. Paul Dittmann (University of Tennessee) and Dan Pellathy (Grand Valley State University) examine how supply chain excellence can act as a powerful lever for increasing shareholder value.

Companies often underestimate the importance of supply chains to their overall success. Many lack a holistic supply chain strategy, the right logistics talent, or the appropriate supply chain technology. Surveys from the Global Supply Chain Institute found that only 16% have multiyear strategies for achieving supply chain excellence.

“Perhaps this is because the CEO doesn’t demand such a strategy,” report authors Dittmann and Pellathy state.

“Many CEOs come from a finance, commercial or marketing background and may not have a formal process in place for managing the global supply chain,” Steven Bowen, chairman and CEO of Maine Pointe, said. “This white paper provides practical and actionable insights for CEOs to help them unlock value and transform their supply chain into a competitive weapon. It is a must-read for any C-suite executive who does not come from a supply chain background.”

Dittmann and Pellathy argue that shareholder value (public share price or private company valuation) is inextricably linked to supply chain performance. “Supply chain excellence will translate into balance sheet, income statement, and cash flow improvements yielding more economic profit for the firm.” The authors define economic profit as profit less the cost of capital needed to generate that profit, and claim that it drives shareholder value. Stock prices will often depend on whether investors view the company as earning solid returns over its cost of capital over time.

According to the report, world-class supply chains create economic profit in three ways: they support higher revenue through flawless delivery to customers, enabling growth; they reduce costs with efficient operations; and they reduce capital requirements through lower inventory, lower working capital, and streamlined physical networks.

Relationship between supply chain excellence and shareholder value

An effective supply chain strategy also incorporates risk management, as supply chain disruptions can severely damage shareholder value. Few companies, however, have a formal process for managing risk in supply chains, according to another survey from the Global Supply Chain Institute.

Though companies can use new products, marketing, or acquisitions to generate economic profit, supply chains hold a less-utilized avenue to create huge upside. The authors use the case study of a consumer durable goods firm to illustrate how the company effectively improved its supply chain to drive down working capital, improve cash flow, and boost economic profit.

The white paper illustrates Maine Pointe’s Total Value Optimization framework being used to find value drivers for cost, cash and growth to produce the highest availability with the minimum cost and capital investment. In one example, a global manufacturer achieved 80% growth in volume, a 22% margin enhancement, and a working capital reduction of $30 million by reconfiguring the distribution network, building a more collaborative relationship with transportation providers, and facilitating negotiations between the company and shortlist service providers.

For those in need of a refresher, working capital is current assets minus current liabilities, or, inventory minus accounts receivable minus accounts payable. Cash flow, meanwhile, is EBITDA plus depreciation minus capital expenditures minus the increase in working capital.

An operating defenition of working capital

In a case study included in the white paper, a manufacturer first set out to reduce its finished inventory by 50%, or $250 million, without impacting product availability. To do so, they cut the number of SKUs, improved manufacturing flexibility, allocated most of their inventory space to faster moving SKUs, and matched demand to the constraints of the supply chain through an effective sales and operations planning process.

Next, the company sought to reduce raw and work-in-process inventory by nearly 70%, which they achieved through a reduction in part complexity, a reduction in non-production material like maintenance supplies, and the continued implementation of Lean manufacturing techniques.

Next up was accounts payable and receivable. The company managed to increase payment terms for suppliers from 45 days to a 90-day range, in return for a combination of increased business for core suppliers, longer-term contracts, and open sharing of data. The move increased accounts payable by $150 million, enabling the manufacturer to reduce working capital and increase cash flow.

Accounts receivable, the largest component of working capital, was the toughest area to address. Nonetheless, the company was able to use “faster resupply” as a lever to reduce payment terms by 20%, offering a 35% reduction in lead times to customers. As such, the firm reduced its accounts receivable by $175 million.

In sum, the durable goods manufacturer took $600 million out of its working capital (a whopping 50%), resulting in a significant increase in cash flow and economic profit. By improving its supply chain, the firm positively affected economic profit, which investors reward with higher shareholder value, according to Dittmann and Pellathy.

The definition of excellence

There are numerous definitions of supply chain excellence, and the report authors have their own formulation that involves five dimensions.

The first aspect is having unsurpassed talent, which requires an effective talent management strategy to recruit and retain the finest logisticians.

Second, excellence requires leveraging new technology appropriately, whether it's digital innovation, such as blockchain, cloud analytics, or physical innovation - drones, robotics, automated vehicles.

Thirdly, excellent supply chains establish win-win collaborative processes with their suppliers and customers, like the quid pro quo trade-offs utilized above by the case study firm.

Cash flow calculation

Fourth, leading firms break down supply chain silos with world-class sales and operations planning processes that allow them to better match supply with demand.

Finally, it’s imperative to have a disciplined and proven process to deliver projects on-time, on-budget, and on-benefit. “World-class supply chain strategies clearly are irrelevant unless the projects they spawn are successfully delivered,” the authors state.

An alternative definition of supply chain excellence is offered by Lora Cecere in an article in CSCMP’s Supply Chain Quarterly. By examining the financial statements of 2,000 companies, Cecere found that the best performing supply chains simultaneously drove improvements in inventory turns, operating margin, and return on invested capital. Only approximately 10% of companies were able to achieve the above criteria.

In any case, the takeaway is that companies looking for new ways to boost shareholder value can examine if their supply chains are functioning as efficiently and effectively as possible.

Related: Maine Pointe examines seven supply chain challenges facing CPG firms