IntroductionWe are observing unprecedented emphasis on the use of analytics to improve supply chain operations influenced by COVID and the resulting macro-economic conditions. Demand uncertainty, a rapidly evolving landscape of distribution systems and the transition to online platforms (e.g., buy online and pick up at store for retail, ecommerce outlets for CPG, online and app-based platforms for Auto, etc.) are challenging supply chains more than ever before.
In the haste to address the supply chain opportunities, many organizations have skipped objectively evaluating the impact on business and the resulting prioritization opportunities. I believe that the most important KPI for any business is the shareholder’s value or stock price. While there’s been a huge push on widening the aperture to all stakeholders, as referenced in this WSJ article, the commitment made by many boards seems to wane in times of crisis. I will be evaluating the impact of adjusting various supply chain levers on the stock price based on several financial valuation techniques. Adopting this technique will improve enterprise resiliency by optimizing cost structures and agility in objective decision making. Therefore, I will stick to the area that seems to persevere in and out of crisis – shareholder value.
Primary Supply Chain DomainsAs part of this analysis, I will be focusing on the foundational measures that need to be monitored as part of a successful supply chain. They are - Forecast Accuracy, Inventory Levels (FG + RM + WIP), Asset Productivity – Machine Asset and HR Productivity, Sourcing Strategy, Stock out sales losses, Quality, Cost of Manufacturing (influences the location and size of capacity allocation) and Logistics Cost.
Some of the measures may have a counter effect on each other (e.g., inventory levels and stock out losses need to be balanced).
Impact of Supply Chain Domains on Corporate FinancialsInventory levels are represented on the balance sheet as short-term assets. These assets are representing an unproductive use of valuable capital. At weighted average cost of capital (WACC) levels of between 7% and 10% for most consumer goods and manufacturing organizations, the direct impact is on free cash flow. Productivity and sourcing strategy influences Cost of Goods Sold (COGS) in the income statement. COGS is made up of fixed cost and variable costs. Fixed cost can be most impacted by the right sourcing strategy while productivity management may have the most impact to variable cost. Lost sales due to stock outs have a direct impact to top line revenue. Quality impacts both the top line revenue, return reserves and warranty reserves. One of the largest automotive manufacturers has a warranty reserve of over $5B which speaks to financial relevancy and priority.
Valuation ImpactFree Cash Flow (FCF) model – This technique leverages the present value of the free cash flow for 4-5 years at weighted average cost of capital (WACC). The free cash flow is influenced by net Income and capital expenditure. Inventory, quality and stock out losses have the biggest impact to this valuation technique. As an example, leveraging FCF method, I modeled the valuation / stock price impact for a $6B consumer goods organization: a 5 % reduction in inventory will drive ~9 % increase in stock value. I have been able to leverage Linear Mixed Model (LMM) to model the impact of various measures on financial statements and establish scenario-based models to prioritize efforts.
Enterprise Value Analysis (EVA) Model – This modeling technique accounts for the cost of goods sold as it leveraged the EBITDA and capital at the rate of WACC. This technique may obfuscate the impact of inventory reduction as highlighted in FCF model; however, it offers a more comprehensive valuation as it accounts for direct impact of cost reductions. Exercising this valuation technique for the same $6B consumer goods organization suggests in a 4% increase in the stock value for a 5% reduction in inventory.
Multiples – Multiples compare companies in similar businesses, sizes and markets. The comparisons are drawn based on earning per share and return on invested capital. This technique is most subjective, and its accuracy is influenced by having the best representative sample set to drive the valuations.
ConclusionCFO analytics capabilities to enable effective investments decisions features need to include these five critical capabilities:
- Aggregate and decompose the financial impacts to the organization to brand / segment and business geo levels.
- Have a minimum of three years of transaction details to assess the future impacts. The pro-forma financial statement creation is automated which incorporates the business strategies, growth plans and consolidation opportunities.
- Have robust analytics capabilities including discovery analytics and predictive “scenario-based analytics” modeling capabilities. Many AI / ML techniques can be deployed to automate the decision-making capabilities.
- Auto-adjust recommendations to account for changing business and market conditions. This means that the models need be refreshed / adjusted based on actual data accounting for impact of prior decisions.
- Have an override mechanism to account for strategic choices made to influence strategic market differentiation.