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Stuck in neutral: Few supply chain organizations are driving value across their networks
Over the past 20 years, companies have invested a great deal of resources into improving their supply chain performance. For example, manufacturing companies with annual sales greater than $1 billion have spent 1.7 percent of their revenue on supply chain-related information technology. But has there been any improvement in balance-sheet performance during that time? Have those efforts resulted in improved levels of value?
At Supply Chain Insights, we define supply chain excellence as the ability to improve customer service levels, operating margins, and inventory levels while also growing revenue. Based on our analysis of balance sheet patterns for more than 2,000 public companies in 35 industries from 2006 to 2015, we believe that nine out of 10 companies are stuck when it comes to supply chain improvement. They are unable to deliver on a growth agenda while improving customer service, operating margins, and inventory levels. We find that most companies can make improvement in one or two of the metrics, but they struggle to improve the entire portfolio.
Why are companies struggling to drive improvement? We believe the main reason is a belief in historic best practices. These functional processes drive improvement within a function but have failed to produce balance sheet improvements and increase value across the entire supply chain. In most organizations, we find that the functions are not aligned horizontally within the company, and they lack strategic direction of how to maximize value within the firm and within a value network.
It is important to note that a value network and a supply chain are very different concepts. While a supply chain focuses on the improvement of supply chain management within the firm, a value network strategy defines how the firm drives value through interactions with trading partners in a global economy.
In theory, if a value network is driving value, all parties should see an improvement in margin, inventory, and cash-to-cash cycle times. If there is true collaboration, then there should be a long-term win/win value proposition.
But while business leaders speak of collaboration with external supply chain partners, the connections between firms are largely buy/sell relationships. The focus is largely on price without a definition of value. We can see that in the technologies that companies have invested in to automate the front office, termed customer relationship management (CRM), and the back office, termed supplier relationship management (SRM). These technologies automated contracts and price but ironically did not improve relationships. We have largely automated buy/sell relationships not driven value in trade.
When companies buy and sell opportunistically based on price, there are winners and losers, and the lack of collaboration leads to increased inefficiency due to the bullwhip effect with the demand signal growing more and more distorted as it moves downstream.
To drive overall improvement, then, the network must be designed for value, and power brokers in the network must own and drive end-to-end thinking. There are few examples in the value network where this has happened. (The examples include Taiwan Semiconductor's design network, which fosters collaboration between customers and suppliers on the design of new products, and Wal-Mart's Retail Link, which shares daily data on sales and other customer and store information with its supplier network.)Has value chain performance improved?
To understand why we believe that value chain performance has not improved, let's take a look at our evaluation of four value networks: automotive, consumer, health care, and high tech (See Figures 1, 3, 4, and 5). In this analysis, we compare the average value of the industry sectors within those networks for 2006 to the average value for the industry for 2015 on what we call the "Supply Chain Metrics That Matter. " The Supply Chain Metrics That Matter are the financial metrics that correlate—as a portfolio—to market capitalization. This includes year-over-year revenue growth; operating margin; inventory turns; cash-to-cash cycle time; return on invested capital; revenue per employee; and sales, general, and administrative (SGA) expenses. This allows the comparison of pre-recession (2006-2009) and post-recession (2010-2015) results and gives a comparison of relative industry improvement in the period of 2006-2015.
What we find is disturbing. The overall performance of each value network on these metrics is declining, with the most adverse impact on suppliers. (If the industry is making progress, it is marked with a green arrow showing a percentage improvement for the comparison of 2015 to 2006. If the arrow is red, there is a decline in performance.)
Let's start with the automotive industry (Figure 1). First-tier automotive is making improvements in margin, inventory turns, cash-to-cash cycle times, and return on invested capital (ROIC). Supplier performance, however, is declining. This discrepancy suggests that first-tier automotive companies are winning at the expense of suppliers, and that, over time, those suppliers will become less viable. First-tier automotive companies have the opportunity to be power brokers and improve overall value, but instead they have focused on improving efficiency. In other words, the industry's focus on lean has not driven value for the entire value chain. In a healthy value network, all parties are improving performance.
If lean practices were driving improvement, then Toyota and Honda would not be at the same place in margin and inventory turns in 2015 that they were in 2006 (see the orbit chart in Figure 2). Similarly, kaizen events would have improved the entire value chain. What we are really seeing is the automation by the buyer of buy/sell relationships. It is taking longer to set up a supplier in the transactional system, and payables are being elongated to improve cash-to-cash performance for the buyer. The downside is that there is a limit on how far payables can be elongated before suppliers go out of business.
In the case of the consumer value chain (Figure 3), the tier closest to the consumer again has the best performance when the 2006 average performance is compared to 2015. The consumer products industry is currently experiencing many changes and challenges, including the disruption caused by e-commerce pure-play retailers and an increase in complexity of items (38 percent in the last five years). This increasing complexity has resulted in a "double whammy" for the companies in this sector in terms of higher cost and increased inventory. It also intensifies the bullwhip effect, increasing waste for downstream suppliers, such as chemical and packaging companies. As companies sort through the changes, manufacturers with a supply chain strategy that focuses on reducing costs will see diminishing returns, while companies with a strategy focused on improving overall value will fare better.
In the health care value chain, the pharmaceutical companies are winning at the expense of the rest of the value chain. While many big pharmaceutical companies trumpet their commitment to value, what we find is that none has stepped up to drive value-based outcomes through the redesign of processes from the patient back through the chain.
Within health care there is even confusion about who the customer is. Is the customer the physician? The payer? The hospital? The patient? The group purchasing organization? The focus on buy/sell relationships that do not provide any transparency to the rest of the channel in regards to sales at the hospital or pharmacy is a detriment to this industry. In addition, this industry has the most complex trade agreements for rebates and promotions. These bifurcated, multiparty trade deals coupled with legacy distributor relationships create barriers to improvement. Pharmaceutical and medical-device supply chain leaders lag other industries in network design, business-to-business (B2B) integration, and the use of analytics. The focus on marketing, clinical trials, and drug discovery in the pharmaceutical industry forces supply chain strategy to the back burner.
The fastest moving and most innovative network is in the high-tech industry. Increasing price pressure and the scarcity of materials have forced this industry to adopt analytics and improve B2B integration more quickly than other industries. Within high tech, the industrial sectors are faring better than the consumer-focused businesses. However, all of high tech is dependent on a contract manufacturing relationship that has very low margins and lacks resiliency. The lack of viability of this model is a risk for the industry.
Five steps forward
In the last decade, have we added value in the value network? I think the answer is no. The extended supply chain is dependent on e-mail and spreadsheets, and for 98 percent of companies, value chain collaboration is largely a matter of talk, with little or no action. Companies today talk about value but focus on efficiency and cost-based buy/sell agendas. There is an opportunity for traditional manufacturers to step up and redefine value-network business models in a way that will improve value. The evolution of technology makes this feasible. However, it will never happen if it is not a focus area.
What steps should companies take? Here are five that come to mind:
1. Actively design value networks. Incorporate supply chain professionals into sales teams and measure cost-to-serve and network flows to improve value. Align incentives and trade terms with value. Simplify marketing programs to reduce deductions and improve cash-to-cash matching of orders and invoices.
2. Own the value chain. If you are a power broker within the industry, then you should drive change. Lifting all "boats" in the value chain will also lift yours.
3. Build strong supplier-development programs and close alignment gaps with finance. We cannot save our way to value, nor can we improve cash flow through payables without hurting suppliers. Today, technology allows money to move much faster than in the past, yet payables to suppliers have lengthened precipitously. Take ownership of cash flow in the value chain and reward strategic relationships.
4. Rethink traditional processes. The traditional supply chain process focuses on improving a company's efficiency, not on driving value throughout networks. We reap what we sow.
5. Build value chain leadership. Move away from buy/sell transactional definitions for procurement and sales. Build outside-in processes with a focus on the customer and improving value.
How do you believe that we put true value in the value chain? Let me know either by e-mail or by using the comment function at the end of this article. I look forward to hearing from you.
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