The Future of Supply Chain - 8 Megatrends (Part 1)

Introduction

The Jetson’s – Star Trek – Blade Runner.  For those familiar with these TV shows and movies, they may be more like science fact than science fiction.

In the book, 100 of the Most Exciting Future Predictions, Alex Trost and Vadim Kravetsky there are many possibilities for the future related to supply chain.¹ Here are just a few examples: 

• Robots—capable of performing an expanded set human level jobs
• Automotive–Self-driving cars – self-healing roads 
• Aerospace & Defense–exoskeletons and robots

Just as each of the TV and movie examples alone is very different its viewpoint of the future, the future of supply chain has alternatives.  These alternatives have implications on supply chain strategic plans with tangible outcomes demonstrated in financial performance. 

The outcome for supply chain leaders and organizations will hinge on the ability not to just adapt to but to embrace and lead change based on megatrends.  Here in part one of this two-part entry, four of eight megatrends will be outlined.  In the future, will look at more specific implications for supply chain specifically Design Anywhere, Manufacture Anywhere, Service Anywhere (DAMASA).

8 Megatrends

There are eight megatrends that will impact supply chain leaders over the next decade.  Any one of these topics could be written about at length.  The point here is to pull together these megatrends and being to explore their interrelationship and potential impact for supply chain leaders.    

Population growth

The current world population of 7.2 billion is projected to increase by 1 billion over the next 12 years and reach 9.6 billion by 2050.   Interesting is the distribution and location of most of that growth.  The 49 least-developed countries are projected to double in population from around 900 million people in 2013 to 1.8 billion in 2050.² As organizations think about go-to-market plans to these emerging markets, supply chain leaders will need to define a profitable strategy to meet these new opportunities.     

Environment

Political debates aside, data from NASA shows the earth is getting warmer.³ With larger, more intense weather patterns, supply chain leaders will need to have more robust risk plans in place to deal with potential supply and delivery disruption. Sustainable solutions to produce and deliver products are in discussion by leaders across industries and will continue to gain momentum if the environmental trend continues on its current trajectory. 

Open Source Design

With the growing trend to share software solutions openly, innovation is moving at a faster pace.   Free and open source software and hardware are opening the doors to new innovative products. One example is a game console.⁴  Another example is a camera.⁵  Opportunities exist for supply chain leaders to provide solutions for these burgeoning products to deliver them to markets. 

Crowdsourcing

Creative funding through crowdsourcing is also enabling innovation and new product development.  Procter & Gamble actively crowdsources new brands through their program “Connect + Develop.” When you consider open source design along with crowdsourcing, innovation cycles can be compressed resulting in the need for supply chain to be even more agile and responsive. 

More to come in part two.

(1) 100 of the Most Exciting Future Predictions, Alex Trost and Vadim Kravetsky 

(2) World Population to Increase by One Billion by 2025  

(3) GISS Surface Temperature Analysis, National Aeronautics and Space Administration    

(4) The Uzebox Project  

(5) Elphel, Inc.  

(6) P&G's Connect + Develop

ROA, EVA OMG! WTH? And other sundry TLAs

“What gets measured gets managed.” - Peter Drucker 

EBITDA, ROE, ROA, ROIC, EVA—the list goes on.  There are traditional performance measures and value-based performance measures.  Some measures are expressed in monetary terms while others are reflected as a percentage calculation.   There are measures that include the cost of debt and the cost of equity while others include neither.  There are many ways to measure business performance and no lack of opinions on which methodology is the best approach.  Upon analysis, the rabbit hole looks to go deeper than we need to go for our purposes in aligning supply chain performance to financial performance.  If you’re interested in further depth, I’ll include a few resources in the footnotes for further reading.  The balance of this entry will summarize what is found in these resources. 

Most important is to understand how your particular organization calculates financial performance.  There are important distinctions to be understood as an organization develops a common language toward improving customer delivery and achieving corporate business goals.  Again, the foundation for success is a achieving a common language.  Understanding finance as that language and understanding the particular dialect of finance is critical to aligning operations to financial performance.  The metrics determine how decisions are made. 

Return on Assets (ROA)

ROA is a traditional performance measure.  It is a profitability ratio based on absolute numbers.  In practice, ROA is sometimes used by businesses as it is easier to compute and understand and to use in comparison with other companies.

For companies using the ROA approach, it is important to understand that: 

• ROA’s primary focus is on operational profitability and utilization of assets, 
• ROA measures the Return on Investment (ROI) of assets, and 
• ROA can be thought of as an internal facing measure.

Economic Value Added (EVA)

EVA is a value-based performance measure.  It is expressed as a monetary amount.  EVA requires more computations and is a dollar amount.  The currency expression can limit comparisons with other companies.

 

For companies using this approach, it is important to understand that: 

• EVA’s primary focus is on cost of capital and shareholder value, 
• EVA measures the impact assets have on value creation, and 
• EVA can be thought of as an external facing measure.

EVA has an important distinction when compared to ROA.  EVA includes the weighted average cost of capital (WACC).  What does this means to supply chain professionals? ROA as a single metric approach will drive improvements to gross and net profits but will not align to shareholder benefits that are required through improving asset turnover.   The main difference is the way the two models handle assets.  Depreciation as it relates to assets reduces the book value of the assets as they age.   

Ram Sriram from Georgia State University¹ outlines three limitations of using only an ROA approach: 

• Encourages division managers to retain assets beyond their optimal life and not to invest in new assets which would increase the denominator. 
• Can cause corporate managers to over-allocate resources to divisions with older assets because they appear to be relatively more profitable. 
• Capital may be allocated towards least profitable divisions at the expense of the most profitable divisions.

While short-term profitability may be trending in the right direction, lack of longer-term efficiency can erode shareholder value.  There is a limit to raising prices to maintain profit ratios.² Often, there is market demand to lower prices.  In short, it is about using fewer resources to sell more products and services. 

There are entire chapters in books written on the distinctions between these two models.  A single blog entry cannot fully define all the unique characteristics of each model but can simply raise the awareness that distinctions do exist, and as a result create different measures of success.  What gets measured gets managed, and knowing some of the details behind the measure will drive improved alignment between supply chain performance to financial performance.

(1)    “Investments in Assets: Both A Strategic and a Control Issue” Ram Sriram 

(2)    “Measuring the Value of the Supply Chain” Enrico Camerinelli

Additional Resources

• Adding Enterprise Value: Mitigating Investment Decision Risks by Assessing the Economic Value of Supply Chain Initiatives, Oliver Schneider
• Financial Intelligence: A Manager’s Guide to Knowing What the Numbers Really Mean, Karen Bergman and Joe Knight
• A Note on the War of Metrics, Gunther Friedl and Tim Kettenring 

Two Financial Frameworks: Part 2 - EVA

EVA—Economic Value Added

In its simplest terms, EVA is a measurement of enterprise performance.  The model was created in 1993 by the consulting company Stern Stewart Management Services.  EVA is defined as, “a measure of a company's financial performance based on the residual wealth calculated by deducting cost of capital from its operating profit (adjusted for taxes on a cash basis).” ¹ EVA is also sometimes referred to as Economic Profit (EP). 

The EVA model is helpful in light of supply chain contribution as it comprehensively captures the causal drivers for financial performance and the interrelationship between these drivers.  Many of the operational tradeoffs in operating profit and invested capital become complex very quickly.  The EVA Model is a good tool to build a common framework and language for both financial and operational leaders in an organization.  

There are certain components that are important to the model but less applicable to our purposes related to supply chain.  The tax rate and WACC portions of the model are components excluded for our supply chain specific analysis. 

Here is a visual overview of the EVA Model:

There are distinctions between the EVA and ROA model that are important to highlight as they relate to operational performance and integration.  We will look at the differences between the models and why they are important in our next entry.

(1) http://www.investopedia.com/terms/e/eva.asp

Two Financial Frameworks: Part 1 - ROA

In an earlier entry we discussed the importance of A Supply Chain Finance Lingua Franca—a common language leading toward an integration of operational metrics and financial corporate performance.   This is possible through the linking of tools like SCOR, DuPont Model, and EVA in defining the ability for supply chain to be the strategic enabler of financial performance.  

Before we dive into the details of each of The Seven Prime Supply Chain Performance Metrics, it is important to have a working understanding of the broader context of financial performance models.   The intent is not to be cost accounting experts.  However, a fundamental understanding of basic business math is needed.  The good news is it is primarily simple addition and subtraction.  It gets a bit complicated with some division but no calculus required!  

Two models will be reviewed.

1. Return on Assets (ROA)
2. Economic Value Added (EVA)

ROA—Return on Assets

Return on Assets (ROA) looks at an organization’s profitability relative to its total asset base.  Also known as the DuPont Analysis Model, the ROA ratio was developed by F. Donaldson Brown, a financial executive at DuPont and General Motors.  The ROA model was originally designed to coordinate financial controls across the organization. ¹ ROA measures the combined effects of profit margins and asset turnover. ²

The ROA calculation looks like this:

Here is a visual depiction of the model and the related operational levers:

There is some debate over the finer points of this model as it relates to inclusions and relationships.  Some of these points are related to items like Return-on-Equity (ROE) and Return-on-Investment (ROI). As an example, is ROA the same as ROI?  That depends on various schools of thought.  It is good to be aware that there is not a uniform glossary of terms across financial models.  For our specific to supply chain purposes, we will leave those nuanced definitions out for now and focus on the model as it relates to building a common language for finance and operations professionals.  

Next, we will look at the Economic Value Added (EVA) model.  

(1) http://history.gmheritagecenter.com/wiki/index.php/Brown,_Donaldson

(2) Groppelli, Angelico A.; Ehsan Nikbakht (2000). Finance, 4th ed. Barron's 

The Seven Prime Supply Chain Performance Metrics

We will use two of the financial ratios from the profitability category and four of the financial ratios from the efficiency category for the primary gauges on our supply chain financials dashboard.

Supply Chain Profitability Ratios: 

• Gross Profit Margin Percent (GPM) 
• Return on Assets (ROA)

Supply Chain Efficiency Ratios: 

• Days Payable Outstanding (DPO) 
• Days In Inventory (DII) 
• Days Sales Outstanding (DSO) 
• Total Asset Turnover (TAT)

We will also add in Revenue Growth ($Rev) as a primary gauge for supply chain.  We will define the rationale for this metric as it relates to supply chain in future entries. 

Here is what our dashboard looks like graphically:

For each of these dashboard gauges we will connect the supply chain sensors through a common process improvement tool to help us identify the direct relationship of supply chain actions to financial performance. 

Key Financial Ratios to Measure Supply Chain Performance

“Do not worry about your difficulties in Mathematics. I can assure you mine are still greater.”  - Albert Einstein

Generally speaking, there are four primary categories of financial ratios.  There are some individuals that support the idea of three categories.  There are others that assert there are five categories.  In order to keep it simple, we’ll provide four along with a couple of examples of some of the more common ratios seen in each category.

1. Efficiency— assessment of a company's use of credit, inventory, and assets

• PP&E
• Total Asset Turnover

2. Profitability—assessment of a company’s management performance in utilizing resources

• ROA
• ROE

3. Liquidity—a company's ability to pay its current obligations

• Current Ratio
• Quick Ratio

4. Leverage—the extent to which a company has depended upon borrowing to finance its operations

• Debt-to-Equity Ratio
• Interest Coverage

Karen Bergman and Joe Knight ¹ refer to ratio categories being like windows into an organization.  Each of the categories of financial ratios provides a unique view into an organization through windows on all four sides.  Building on that idea, here is an illustration:   

In each of these categories, there a many ratios.  For an expanded list, you can refer the following Inc.com webpage: http://www.inc.com/encyclopedia/financial-ratios.html .  For the sake of what we are working to accomplish linking together supply chain specific performance to financial outcomes, we will focus on a few specific ratios from the two categories of Efficiency and Profitability.  These will be the primary gauges for our dashboard.

(1) “Financial Intelligence: A Manager's Guide to Knowing What the Numbers Really Mean” Berman, Knight, and Case  

Supply Chain Dashboards and Sensors - the SCOR Model

“The ability to simplify means to eliminate the unnecessary so that the necessary may speak.” – Hans Hofmann, 20th-century expressionist painter

What SCOR Is

The Supply Chain Operations Reference (SCOR®) is a model that provides a unique framework for defining and linking processes, performance metrics, and best practices into a unified structure across supply chain. This entry will provide a very high level overview of SCOR.  For more details please visit https://supply-chain.org .

SCOR is structured around five core supply chain processes: 

• Plan 

• Source 

• Make 

• Deliver 

• Return

A sixth process, Enable, was added to the Version 11 edition of the SCOR model in December 2012. 

Additionally, SCOR provides a set of supply chain performance attributes that correlate to a set of “Level 1” metrics. 

Performance Attribute	Definition	Level 1 Metric
Supply Chain Reliability	The performance of the supply chain in delivering the correct product, to the correct place, at the correct time, in the correct condition and packaging, in the correct quantity, with the correct documentation, to the correct customer.	Perfect Order Fulfillment
Supply Chain Responsiveness	The speed at which a supply chain provides products to the customer.	Order Fulfillment Cycle Time
Supply Chain Agility	The agility of a supply chain in responding to marketplace changes to gain or maintain competitive advantage.	Upside Supply Chain Flexibility
		Upside Supply Chain Adaptability
		Downside Supply Chain Adaptability
		Overall Value at Risk (VAR)
Supply Chain Costs	The costs associated with operating the supply chain.	Supply Chain Management Cost
		Cost of Goods Sold
Supply Chain Asset Management	The effectiveness of an organization in managing assets to support demand satisfaction. This includes all assets—fixed and working capital.	Cash-to-Cash Cycle Time
		Return on Supply Chain Fixed Assets
		Return on Working Capital

Each performance attribute contains three levels of metrics detail in a parent-child, cascading type of relationship structure.  SCOR accounts for different types of production environments including Make-to-Stock, Make-to-Order, and Engineer-to-Order.  The model goes into further detail defining how work is done.  It covers different types of flow through a company including material and information flows.

One of the powerful aspects of the SCOR model is the ability to link the interdependencies between various important metrics across a supply chain into an integrated system. 

What SCOR Is Not

SCOR does not provide active descriptions or measure for Research and Development, Sales and Marketing, Quality, or IT.

Additionally, SCOR metrics are diagnostic metrics.  This means the system alone does not tell you which changes to make or how to make changes.  Think of the vehicle you drive.  With a SCOR set of metrics embedded in your organization, you have sensors in your engine that provide you data.  The sensors alone are not all that valuable.  Those sensors needs to be connected to dials at your dashboard for you to look at as you are driving.  That is a step in the right direction but still not enough.  The limitation with SCOR metrics is they don’t tell you what to do.  Having a speedometer will tell you how fast you are going but it does not tell you how fast you should be going.  That is posted for you as a target.  You need all three: the sensor, the dashboard, and the right target.

Simplifying: Where SCOR Can Help

While SCOR can become a complicating end in itself for some organizations, there is an approach using SCOR that can simplify the understanding of real drivers for financial KPIs.  Executives need the right number of sensors connected to the right readouts on the dashboard.  The SCOR metrics will become important as we look at financial KPIs in future entries.  Many executives have dashboards but don’t have the connection to the sensor to point them toward proper corrections.  As an example, most organizations can calculate financial performance ratios from a cost accounting perspective. 

• Example: Gross Margin = Gross Profit/Revenue (dashboard)

Many organizations have yet to effectively tie together SCOR metrics to financial performance ratios to understand impacts to customers and to the business.  The measurement alone is not enough.  Some organizations measure way too much.  Measuring the right things and knowing what sensors are feeding data to the dashboards to get the desired results is the important, required link. 

• Example: Order Fulfillment Cycle Time impact to Gross Margin (sensor)

Again, the SCOR metrics are diagnostic metrics or sensors that are very good at indicating the reasons why things are the way they are. 

We will explore the link between the sensors and the dashboard.  

The Third Component - Supply Chain Analytics

"Taking action without thinking is the cause of every failure." - Peter Drucker

Supply chain analytics is the third component to blend in to enable good decision making for executives, alongside supply chain metrics and financial performance KPI’s.  Here is the model including these three components in a traditional Venn diagram.

Gartner defines supply chain analytics as "a set of techniques and technologies that incorporate advanced modeling with data management to uncover existing relationships among variables to determine the probability of a future outcome that can drive a business decision."

We’ll explore analytics in more detail in coming entries.  Ultimately the goal is to translate data into usable information that can drive better decisions.  Executives need this information to make real-time decisions based on what is seen through the windshield (foresight) rather than what is seen in the rear-view mirror (hindsight). 

Data is not hard to find.  In fact, there may be too much.  According to a Gartner 2012 study of 188 executives from supply chain companies, 66 percent of CEOs say that information overload has reached crisis proportions.  How does one sift out the usable data from the massive amount of data available?     

The answers for improved financial performance and customer service are found in the intersection of financial models, supply chain metrics, and analytics.  The first step is to drive the right link between supply chain metrics and financial performance—no small task in and of itself.  With that link defined a connection between supply chain metrics and advanced analytics— predictive and prescriptive—enable executives to take control of the steering wheel of the organization like never before and drive it in the desired direction.   It will enable executives the take action with intentional thinking. 

The Four Languages of Supply Chain

A former Secretary of Commerce liked to tell of how a high-ranking official once responded to a subordinate's request for a raise by saying, "Because of the fluctuational predisposition of your position's productive capacity as juxtaposed to governmental statistics, it would be momentarily injudicious to advocate an incremental increase."

The staff person said, "I don't get it."

The official replied, "That's right."

Say what?

Many of us have experienced funny situations when it comes to language.  This is particularly true when it comes to speaking and understanding foreign languages.  In consulting with many organizations over the last number of years, there are people talking about similar topics at the same table in conference rooms but they are speaking in different business languages.  While funny in social contexts, not understanding and speaking a common language in a business environment can create confusion and disengagement.  Often there are much more significant consequences in the form of customer, financial, and operational inefficiencies and loses. 

If supply chain is the most strategic asset available to the C-suite to achieve corporate objectives, then the team needs to be able to effectively communicate—that is talk, listen, and understand the same content with the same meaning. 

To begin getting to a common language, let’s first understand The Four Languages of Supply Chain. 

1. Dollars 
2. Metrics 
3. Process 
4. Projects

These are spoken in cascading order through the organization by four people groups.  

1. C-suite 
2. Vice presidents 
3. Managers 
4. Frontline personnel

We can look at this model in a picture format.

These languages are not contained in defined boxes.  There is some understanding across these groups but there is a primary vernacular for different segments of the business.  

So what

Different supply chain language dialects impact timely and effective business decisions.  Revenue, customer service, and profitability are all opportunities or risks.  Sales and Operations Planning (S&OP) meetings are the common place where this can be measured most easily.  Just listen to the language being spoken.  The meetings are often filled with the next 12 weeks worth of firefighting topics primarily in the languages of process and projects.  Questions are often asked about the lack of C-level sponsorship.  There is little to no content shared in the language of finance and thus little involvement.  Unfortunately, decisions are made in other limited exposure sessions that leave the balance of the supply chain team confused and frustrated. 

Gartner's executive survey identified growth as the CEO's top priority, yet this research found only 14 percent of supply chain leaders feel they are recognized as revenue growth generators.¹ While the CEO and CFO mandate growth, achieving a more strategic relationship with the rest of the business remains an elusive goal for many supply chain executives. 

Gartner research recommends strengthening and communicating the case to drive business growth to internal business partners to show how the supply chain strategy aligns with the business strategy to promote growth.² To do this, the communication will need to be in the language of finance rather than operational or process metrics such as pallets, units, boxes, or widgets. 

Speaking a common language will require an understanding of the links between operational metrics and financial performance metrics.  We will look at a few of these primary models in the coming weeks to begin building a bridge in establishing a common supply chain financial language.

  

(1)   “CEO and Senior Executive Survey 2013: Supply Chain Implications to Support Global Growth Goals” March 2013

(2)   “Survey Analysis: Chief Supply Chain Officers Conquer Organizational and Capability Challenges to Grow” November 2013

A Supply Chain Finance Lingua Franca

“If you don't know where you are going, you'll end up someplace else.” – Yogi Berra

There is no shortage of metrics for organizations today:  financial metrics, supply chain metrics.  personal objectives,  business intelligence,  dashboards, analytics.  For many companies, the challenge is not data but making the data usable to enable timely decisions.  One version of the truth would be nice, too, as represented in a single set of numbers.  In a recent conversation, an executive threw down a folder full of dozens of pieces of paper on the desk in front of me and commented with exasperation, “This is my dashboard!”  There is a challenge in aligning operational metrics with financial performance to enable sensible and timely decision making toward financial goals, shareholder return, and—oh yeah—customer service and satisfaction.

What is the goal?

Taking a breath and looking at the fundamentals, a good place to begin is the end.  What is your business goal?

• Increase revenue?
• Reduce costs?
• Increase profitability?
• Increase margin?
• Increase market share?
• Shareholder value?

This may seem simplistic, but there is a debilitating disconnect for many organizations between what companies are trying to achieve and how they are actually operating.  What gets measured gets done, and the measures or their targets do not align with the strategic goal of the organization. 

What is the measure?

Individual operational metrics may be very meaningful to a particular person or department.  However, these individual metrics are meaningless in isolation until there is a direct link to business goals through an integrated financial and operational business metrics system.  Bob in the warehouse and Sally in procurement need the right rules to play nicely together and stop being at odds with one another with competing metrics and targets.  An intentional orchestration of operational metrics cascading in rank-and-file alignment to the company objectives is required. 

What is the point?

Supply chain is the most strategic asset and potentially the most significant competitive differentiator available to the C-suite in achievement of corporate objectives.  According to Joseph Francis of the Supply Chain Council 1, supply chain generally accounts for between 60 percent and 90 percent of all company costs.  The challenge is alignment.  The trouble with alignment is language.  An integration of operational metrics to financial performance is possible through the linking of tools like SCOR, DuPont Model, and EVA in defining the ability for supply chain to be the strategic enabler of financial performance.   When the team hears ROIC or Perfect Order, the same definition and meaning should run through everyone’s heads.  As Enrico Camerinelli 2 states, the entire team needs a common language—a supply chain finance lingua franca.  In the next installment I will share what I‘ve coined, “The Four Languages of Supply Chain.”

(1) “Measuring Supply Chain Performance” Francis 

(2)  “Measuring the Value of Supply Chain” Camerinelli

Operational performance and financial objectives

Contributing analysis and insights to the supply chain and finance communities linking supply chain and operational performance to the financial objectives of corporations.