Supply chain risk management’s impacts to shareholder value are substantial and enduring.
A groundbreaking academic study offers an eye-opening quantification of the magnitude and duration of the costs that publicly listed companies bear from major supply chain disruptions. The authors estimate that during the year leading up to a public announcement of a supply chain disruption, organisations, on average, experience a 107% drop in operating income, a 114% decline in return on sales and a 93% reduction in return on assets. “More importantly, firms do not quickly recover from the negative economic consequences of disruptions,” the authors conclude. “During the two-year time period after the disruption announcement, the changes in operating income, sales, total costs, and inventories are insignificantly different from zero.” While this study was published in 2003, it underscores the structural flaws in most supply chain risk management approaches today. Moreover, the disruptions evaluated in this research are not of the same scale and impact as more recent supply chain upheavals.
The focus on costs has been all-consuming and incomplete.
The traditional view of supply chains as a cost center produced substantial efficiencies but, at the same time, created substantial risks. In many organisations, treating cost of goods sold as the dominant performance measure drove a series of decisions and behaviors that ultimately resulted in relying on a core contract manufacturer in one country — frequently, that country was China. Decisions to decrease inventory levels, use a sole-source or single-source supplier or vendor in countries on the other side of the world, and adopt just-in-time manufacturing and delivery techniques saved money; that is, until a major disruption — an earthquake, trade tariffs, a global pandemic, a regional ice storm, a fire in a single manufacturing plant, a new COVID-19 outbreak, and so on — inflicted expensive losses in organisations without more diverse supplier bases and other “just-in-case” buffers.
Measures such as cost of goods sold reflect an incomplete accounting of total costs because they fail to address costs related to business continuity management, logistics workarounds, customer satisfaction declines in response to delays, and more. Additionally, a cost-dominant approach to supply chain risk management tends to neglect or, at the very least, short-change the significant value derived from designing and operating more reliable and responsive supply chains.
A lack of transparency stems from low levels of trust.
Over the years, the supplier and vendor community developed resistance to requests for information-sharing issued by their sourcing counterparts inside customer companies — often because this information was used, or perceived to be used, to extract lower prices and other concessions from suppliers. Vendors avoided these requests or responded with vague information in order to protect themselves in subsequent negotiations. The good news is that a growing number of supply chain leaders and CEOs recognise that communication and collaboration models are fundamentally broken and need to be redesigned to enable greater reliability and responsiveness.
Lawmakers and regulators are taking actions to ensure more reliable, responsive and secure supply chains.
Global rules-makers and regulators continue to increase and enhance requirements for greater visibility into internal practices related to cybersecurity; national security; ESG standards, including specific measures and policies as well as human trafficking concerns; and other business practices among all tiers of suppliers. Institutional investors, shareholder activists, consumers, employees and regulators are driving companies to look upstream at their supply chain as well as downstream to their distribution channels to reduce the carbon footprint in their value chains and product lifecycles. Similar attention and pressure focus on human rights abuses in global supply chains, driving the need for more robust human rights due diligence.
The SEC’s recent carbon footprint disclosure proposal will potentially have a direct impact on shareholder valuation and require much greater supply chain visibility and more detailed reporting. The evolving global sanctions against Russia implemented as a result of its war on Ukraine must be monitored not just by financial services organisations but also those in most industries, as there are far-ranging impacts on supply chains. Recent supply chain-related price increases also have stimulated investigations into accusations of price gouging and monopolistic practices designed to keep supply constrained and prices high. This concern motivated the U.S. Federal Trade Commission to perform months-long audits of nine large consumer products companies in late 2021 and earlier this year.
Boards and senior leaders should recognise that supply chain risk management increasingly affects the customer experience. Customers dissatisfied by the lack of reliability and sustainability in cost-dominant approaches to supply chain management inevitably will turn to alternatives that may cost more but deliver higher levels of service, increasingly real-time visibility into supply chain and logistics activities, reduced ESG footprints, and on-time delivery guarantees.
Supply chain oversight equates to shareholder value
From a strategic oversight perspective, boards need to know whether the organisation can get goods to market when disruptions strike. Addressing that risk raises other governance-related questions about the organisation’s fundamental approach to supply chain risk management:
Given their accountability for shareholder value, boards also will want updates from their CEO, CFO and COO regarding how tradeoffs involving supply chain cost increases affect profitability. Are higher costs eaten from a margin standpoint, or are they passed on to customers? If the latter option is used, how is that projected to affect customer experience and profitability?
Intelligent supply chain risk management
Another question looms large for boards and executive management: What approaches and practices distinguish leading supply chain risk management capabilities from the rest of the herd? RAAD360 research on supply chain risk management exemplars and Protiviti’s experience working with boards and C-suites to help improve and optimise supply chains show that organisations with leading supply chain risk management capabilities typically do the following:
- Look beyond traditional cost evaluations: While cost is an important risk consideration, it should be evaluated and monitored in conjunction with supply chain reliability and responsiveness. Managing the supply chain based on revenue assurance requires a comprehensive understanding of the costs of disruptions as well as the investments needed to ensure access to supplies.