When Motorola introduced its first camera phone in late 2003, its much anticipated marketplace success was cut short because suppliers failed to deliver enough lenses and chipsets to meet demand. "We share our customers' disappointment in the current situation," Tom Lynch, president of the company's personal communications sector said to the Wall Street Journal when the supply problem was announced.
Motorola's real disappointment showed up over the next few quarters in the form of lackluster financial performance and erratic stock prices.
According to Vinod R. Singhal, a professor of management at the Georgia Institute of Technology, hundreds of companies, such as Sony, Boeing, Hershey, Nike, Cisco, Sun Microsystems and many others, have experienced significant supply chain disruptions in recent years. In every case, these same companies have reported disappointing operating results and stock prices as a direct result of these disruptions. Singhal has studied nearly 800 instances of supply chain disruptions experienced by publicly traded firms over a 10-year period. He, and fellow professor Kevin Hendricks from the University of Western Ontario, published their research results in a paper called "The Effect of Supply Chain Disruptions on Long-term Shareholder Value, Profitability, and Share Price Volatility." As the name suggests, the research found that supply chain disruptions such as supplier failures, manufacturing delays, and quality problems all have profound and measurable impacts on a company's financial performance. The disruptions Singhal has researched are those where companies made errors in their own planning and execution, or where suppliers or customers directly caused supply chain problems.
"The examples we have analyzed are all controllable disruptions," says Singhal. "If the companies involved had planned or executed better, the disruption could have been avoided."
Supply chain managers are well aware of the impact that operational problems can have on their performance metrics, but Singhal's research has quantified this impact. His work clearly shows the long and severe negative effect that supply chain disruptions have on profitability and other operating results. The research also shows that these effects actually begin well before supply chain disruptions are so serious that they are reported in the news. According to Singhal, the average effect of disruptions in the year leading to the disruption is:
• 107 percent drop in operating income
• 114 percent drop in return on sales
• 93 percent drop in return on assets
• 7 percent lower sales growth
• 11 percent growth in cost
• 14 percent growth in inventories
These negative performance metrics often continue for two years after the disruption announcement.
"There is no doubt that disruptions cause steep drops in profitability, reduce sales growth rate, increase cost of manufacturing and selling products as well as increase assets and inventories," says Singhal. "The duration of these problems is what most companies have not fully appreciated."
One of the most common operating spikes resulting from supply chain disruptions is a large increase in total assets that have a cascading effect. Sales stagnate or decrease, inventory increases and asset turnover drops precipitously. According to Singhal, nearly 59 percent of the companies with supply chain disruptions experienced increases in total inventories that average 14 percent.
"Normally, an increase in the asset base can be considered positive as it indicates positive growth," says Singhal, "but in the case of supply chain disruptions it is bad news because sales are dropping while costs go up."
These negative operating figures are quickly reflected, and often anticipated, by the stock market. Share prices for companies with supply chain disruptions are penalized because they lead to lower profitability and growth rates, two factors that are key drivers of shareholder value.
According to Singhal's research, companies suffering from supply chain disruptions experience between 33 to 40 percent lower stock returns relative to their industry benchmarks over a three-year time period that starts one year before and ends two years after the disruption announcement date. Also, share price volatility in the year after the disruption is 13.50 percent higher when compared to the volatility in the year before the disruption.
One way that Singhal illustrates the economic significance of this level of underperformance is to compare these companies' share price returns with the 12 percent average annual return that stocks have enjoyed over the last two decades.
"Even if a firm experiences one major supply chain disruption every 10 years, the annual return for companies with disruptions will drop to about 8 percent," says Singhal. "That difference is significant when one takes into account the effect compounding over a long-time period. Clearly, it pays to avoid supply chain disruptions."
|Mitigating Chances of Disruption|
|Vinod Singhal says that companies can effectively avoid supply chain disruptions without sacrificing efficiency by following these steps: |
Improving the accuracy of demand forecasts: Consider demand forecast variance as well as expected demand itself. Long-term forecasts are inherently less accurate than short-term forecasts, so there must be dynamic adjustments to reflect changes in demand, lead times, transit time, capacity, and transportation and distribution routes, as well as events outside the organizations that could have a material effect on forecasts.
Integrate and synchronize planning and execution: Plans are often "tossed over the wall" for execution. Managers responsible for execution adjust these plans to reflect current operating conditions, but never communicate the changes to planners resulting in lack of integration between development and execution of plans. By better coordinating and integrating planning and execution many of the problems with supply demand mismatches can be avoided.
Reduce the mean and variance of lead-time: Some of the following practices can help reduce the mean and variance of lead times:
• Remove non-value-added steps and activities
• Improve the reliability and robust-ness of manufacturing, administrative and logistics processes
• Pay close attention to critical processes, resources, and material
• Incorporate dynamic lead-time considerations in planning and quoting delivery times
Collaborate and cooperate with supply chain partners: Collaboration and cooperation among supply chain partners will only happen if there is trust among the parties, upfront agreement on how to share the benefits, and a willingness to change existing mindsets. Once these elements are in place, supply chain partners can do joint decision making and problem solving, as well as share information about strategies, plans, and performance with each other.
Invest in Visibility: To reduce the probability of disruptions, firms must be fully aware of what is happening with internal operations, customers, suppliers, inventory, capacity, and critical assets. The following may be needed to develop visibility:
• Identify and select leading or forward looking indicators of supply chain performance (suppliers, internal operations, and customers)
• Collect and analyze data on these indicators
• Set benchmark levels for these indicators
• Monitor these indicators against the benchmark
• Communicate deviations from expected performance to managers at the appropriate levels on a real time basis
• Develop and implement processes for dealing with deviations
Build flexibility in the supply chain: To enhance responsiveness, companies need flexible strategies that match their operations, such as:
Product design: Standardization, modularity, and use of common parts and platforms can offer the capability to react to sudden shift in demand and disruptions in delivery in parts.
Sourcing: Use flexible contracts as well as spot markets to purchase parts and supplies. Spot markets can be used to both acquire parts to meet unexpected increase in demands as well as dispose of excess inventory if demand is below expectation.
Manufacturing: Acquire flexible capacity that can switch quickly among different products as the demand dictates. Segment capacity into base and reactive capacity, where the base capacity is committed earlier to products whose demand can be accurately forecasted and reactive capacity is committed later for products where forecasting is inherently complex.
Postponement: Delaying product differentiation at a point closer to the time orders are received reduces demand-supply mismatches. This strategy involves designing and manufacturing standard or generic products that can be quickly and inexpensively configured and customized once actual customer demand is known.
Invest in technology: Investment in appropriate technology can go a long way in reducing the chances of disruptions. Web-based technologies can link databases across supply chain partners to provide visibility of inventory, capacity, status of equipment, and orders across the extended supply chains. Supply chain event management systems have the ability to track critical events and when these events do not unfold as expected send out alerts and messages to notify appropriate managers to take corrective actions. RFID technology has the promise to improve the accuracy of inventory counts as well as provide real-time information on the status of orders and shipments in transit and what is being purchased by customers.
Sources of Problems
The sources of the supply chain disruptions among the 800 publicized incidents that Singhal researched included suppliers, customers, and internal problems as well as unspecified causes. Not surprisingly, nearly 30 percent of the companies whose supply chain problems were reported in news stories declined to reveal the reasons. However, for the incidents attributed to a source, internal problems accounted for 33.61 percent of the disruptions. The specific problems included manufacturing problems, equipment breakdowns, inaccurate inventory records, poor forecasting, quality problems and capacity or labor shortages.
"Virtually all the internal disruptions were very basic operational problems that had something to do with poor planning or execution," says Singhal.
Supplier failures accounted for 14.51 percent of the disruptions, and in most cases the specific problem was parts shortages. A related problem was failure to meet delivery schedules and lead times, especially among the companies that have committed themselves to distant suppliers.
"Companies are flocking to suppliers in China to benefit from lower cost components and finished products," says Singhal. "Few of these companies have fully factored in the longer lead times and the significantly higher variability. Companies cannot ignore these supplier risks."
Poor quality of materials and components was another common cause of supplier problems in the manufacturing sector.
Singhal found that customers were the source of supply chain disruptions in 12.81 percent of the cases. Change orders and inaccurate forecasts were the most common reasons for these supply disruptions, especially among small- and medium-sized companies that were suppliers to much larger original equipment manufacturers (OEMs).
Regardless of which specific entity was at fault for the supply chain disruption, Singhal found several common themes. In about 22 percent, part shortages were the primary reasons for disruptions. Ramp/roll-out problems, order changes by customers, and various production problems each resulted in disruptions in 9 percent of the cases. Development problems were cited in 4 percent of the cases and quality problems in about three percent of the cases.
A shortage of parts is among the most financially damaging type of disruption. Poor forecasting, poor planning, dependency on a single supplier, long lead times, and low inventory levels, are the most common culprits. Singhal found that stock prices for companies with disruptive parts shortages under-performed their benchmarks by an average of 25 percent. Parts shortages are associated with a median decrease in operating income of 31 percent, a decrease in sales of 1.2 percent, and an increase in costs of 1.7 percent. "Many companies are eager to capture the cost benefits of single sourcing and low inventory levels," says Singhal. "It is not clear if there is much awareness of how significant the cost penalty can be if these strategies fail, and instead cause severe parts shortages."
Everyone at Risk
Singhal's research looked closely at various industries to see which if any were especially prone to supply chain shortages and the resulting financial problems. He found slightly more disruption incidents in the high-tech, wholesale and retail industries, probably because of their shorter product life cycles and longer supply chains. He is quick to point out that across all of the industries studied, the differences in frequency and severity of financial impact from supply chain disruptions is not statistically significant.
"No industry is more or less at risk," says Singhal. "Even the most basic batch manufacturing companies can be impacted by supply chain disruptions and will pay a penalty in terms of their financial performance."
Singhal also looked at the size of companies to detect specific trends. He found that small companies suffer the greatest financial setbacks from supply chain disruptions. Compared to larger firms, smaller firms show a larger decline in revenue (-7.8 percent vs. 0.3 percent) and larger increase in costs (7.6 percent vs. 2.6 percent).
Smaller companies are less diversified. If a company's primary product has a supply chain problem, there are no other products to prop up performance. Nor do small companies have the financial resources to fix problems quickly when they do occur.
"Small companies can't just go out and buy a $5m technology system if their forecasting is poor," says Singhal. "They have to work things out with the resources they have."
Is 'Lean' Bad?
Small companies also have far less power to influence other supply chain partners, who may be the ultimate cause of the disruption.
"If General Motors provides its suppliers with poor forecasts or makes radical changes to its production schedules, the small supplier will suffer and is helpless to do much about the problem," says Singhal.
While Singhal's research shows the depth and breadth of the problems that supply chain disruptions can cause, perhaps the most important implication for senior managers is to understand that "good" supply chain management is a two-edged sword. For most executives, supply chain management is all about efficiency, cost cutting, outsourcing, inventory reduction and other ways to find competitive advantage with operational excellence. But what these executives often fail to factor into their plans is the very real risk of supply chain disruptions and their impact on the corporation's financial performance.
"Senior executives must recognize that lean and efficient supply chains face higher risk of disruptions," says Singhal. "There is an inverse relationship between efficiency and risk. Firms can no longer afford to focus solely on cost reduction. Major supply chain investments and initiatives must also take into consideration how these investments and changes affect the risks of supply chain disruptions."
In the past decade, software and related technology has been the most apparent investment that companies have made in their supply chain operations. The question that Singhal wants companies to ask themselves is how well this investment has helped them minimize the risks and penalties of supply chain disruptions.
"Intuitively, I see the value of the technology to avoid supply chain problems," he says. "Anytime a company can improve its supply chain visibility, gain better information about sources of supply and have access to reliable metrics, the potential for disruptions should be reduced."
From a pure research view, however, Singhal says that this correlation cannot be proved.
"No one, and no technology, can take credit for problems that never happened," says Singhal, "so it's impossible to measure how effective supply chain software is in avoiding the risk of disruptions. We only hear about instances when technology failed."
There have been a number of well-publicized examples of planning systems-or their implementation-being blamed for significant supply chain disruptions in recent years at companies such as Hershey Foods, Nike, Whirlpool and many others. Singhal believes the problem has less to do with the technology and more to do with how companies and technology vendors have used it.
"Technology vendors over-emphasize the importance of efficiency, reducing inventory and optimizing processes," says Singhal. "That may be because customers react more positively to hearing about all efficiency benefits that technology can provide."
But efficiency is only part of the challenge for supply chain management and technology vendors. Singhal says that supply chain investments and initiatives should be undertaken, not because they reduce costs, but because they increase the reliability and responsiveness of supply chains. Such investments and initiatives should be viewed as insurance against avoiding destruction of corporate performance should disruptions happen. Investments should be justified on risk as well as cost savings.
"If a company tries to become too efficient and too lean, it takes slack out of the system and disruptions are more likely," he says. "There has to be a balance."
Vinod Singhal's complete report can be ordered from the author at email@example.com.
|Drivers of Supply Chain Disruptions|
|Vinod Singhal's research shows that reports of major operational disruptions have increased at double digit rates over the last decade because the supply chain concept continues to gain wider adoption in every industry and in every part of the world. He points to the following drivers of supply chain disruption:|
Competitive environment: Today's markets are characterized by intense competition, highly volatile demand, increased demand for customization, increased product variety, and short product life cycles, and these conditions make it very challenging to match demand with supply. The main challenge has become forecasting demand and adjusting to unexpected changes in product life cycles and changing customer preferences.
Increased complexity: Global sourcing, managing large numbers of supply chain partners, the need to coordinate across many tiers of supply chains, and dealing with long lead times all increase the risk of disruptions. The risk is further compounded when various supply chain partners focus on local optimization, when there is lack of collaboration among supply chain partners, and when there is lack of flexibility in the supply chain.
Outsourcing and partnerships: Increased reliance on outsourcing and partnering has increased the chances that a disruption or problem in one link of the supply chain will quickly ripple through the rest of the chain. For these interdependencies to work well, supply chain partners must collaborate, share information and plans, and have visibility in each other's operations. Such changes require major investments in connected information systems, changes in performance metrics, commitment to share gains, and building trust among supply chain partners, all of which are not easy to achieve.
Single Sourcing: Single sourcing has reduced the purchase price and the administrative costs of managing the supplier base, but it increases the vulnerability of supply chains if the single-source supplier is unable to deliver on time.
Limited buffers: Focus on reducing inventory and excess capacity and squeezing slack in supply chains has more tightly coupled the various links leaving little room for error and make the supply chain brittle.
Focus on efficiency: Supply chains have focused too much on improving reducing costs at the expense of increasing the risk of disruptions. Strategies for improving efficiency can increase the risk of disruptions.
Over-concentration of operations: In their drive to take advantage of economies of scale, volume discounts, and lower transaction cost, firms have over-concentrated their operations at a particular location, or with their suppliers or customers. Over-concentration reduces the flexibility of the supply chain to react to changes in the environment and leads to a fragile supply chain that is susceptible to disruptions.
Poor planning and execution: Demand-supply mismatches are common because plans are too aggregated, lack details, and are based on inaccurate inventory and capacity information, especially forward looking metrics. Companies need better visibility into what is happening in upstream and downstream supply chain partners, so they can identify and manage supply chain exceptions. They also need better synchronization and feedback between supply chain planning and supply chain execution.
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