The Weakest Link

March 1, 2004
Like the summer 2003 East Coast blackout, supply-chain malfunctions may not happen often, but when they do, the repercussions are costly and widespread.

Like the summer 2003 East Coast blackout, supply-chain malfunctions may not happen often, but when they do, the repercussions are costly and widespread.

A shortage of parts or other production and supply problems that delay production and shipping can take a big bite from a company's bottom line, according to a new study by Vinod Singhal, professor of operations management at the Georgia Institute of Technology's DuPree College of Management, and Kevin Hendricks, associate professor of operations management at the University of Western Ontario.

The researchers recently presented a paper on the subject at the Council of Logistics Management's 2003 annual conference in Chicago and have submitted two papers for journal publication.

"Although it seems obvious that a supply-chain glitch would affect profitability, little has been done to measure the fallout," Singhal says. In earlier research, Singhal and Hendricks had discovered that announcements of supply-chain failures were linked with a 10 percent decrease in stock-market prices. The researchers were curious if this price deterioration was due to the stock market overreacting or a true reflection of fallout from supply-chain disruptions.

With that in mind, the researchers studied 885 public companies that announced supply-chain problems during an eight-year period (1992 to 1999), examining those firms' operating performance one year before the announcement and two years after. In the year leading to the announcement of a supply-chain disruption, average operating income of companies dropped 107 percent, return on sales plummeted 114 percent and return on assets dropped 93 percent.

What's more, the study revealed that companies with supply-chain problems averaged about 7 percent lower sales growth, 11 percent higher costs and a 14 percent increase in inventories. To control for economic and industry influences, Singhal and Hendricks benchmarked the results of affected companies with firms of similar size that hadn't suffered supply-chain problems. The verdict: The supply-chain glitches were, indeed, responsible for the atrophy in earnings.

"When companies can't respond to demand, customers take their money and loyalty elsewhere," Singhal says. "A number of costs go up, such as expediting, shipping and customer penalties. Loss of reputation may even require a company to increase its marketing expenditures."

The researchers were surprised to discover how long it took companies to recover from a supply-chain malfunction. Their research showed that operating income, sales, total costs and inventories remained flat during the two-year period after a company announced its supply-chain problem.

"The supply-chain disruption lowers the level of operating performance for a company, and then firms continue to perform at that lower level for the next couple of years," Singhal says. "Like a heart attack that cuts off the flow of blood, a supply-chain glitch cuts off the flow of information or supplies. And, similar to a heart attack, it has lasting effects on a company's health."

Other key findings of the study:

• Industry sector doesn't matter. Supply-chain glitches often receive more attention in the high-tech arena, but companies are negatively affected regardless of their industry.

• Small firms get hit harder. Average operating income dropped 150 percent for small firms compared to an 86 percent decline for large companies.

• Fault doesn't matter. Even when suppliers and customers caused the supply-chain disruption, companies were still negatively affected.

The new study provides more evidence why companies should pay attention to supply-chain management. "When people talk about supply-chain management, they may agree that it's important, but they're not investing in solutions," says Singhal, noting that the lack of investment has become more pronounced the last couple of years due to the economic downturn.

Another problem: Companies aren't always investing in the right supply-chain solutions. There are two key aspects of supply-chain management -- efficiency and robustness -- and the trend has been to focus on efficiency.

"Even though a supply chain may be efficient, if it's not robust, it could still malfunction," Singhal points out. "One reason supply-chain problems occur is because there isn't enough slack in the system. As companies try to make their supply-chains more efficient, they take away slack because it's expensive." To reduce the frequency and probability of glitches, the researchers recommend:

• Better forecasting and planning.

• Collaborating with supply-chain partners.

• Identifying and tracking key indicators that can provide early warning of supply-chain problems.

• Developing strategies to respond to problems when they arise.

"Timing is critical," Singhal says. "Quick resolution prevents escalation of the problem. It's also important because there are more global supply chains today, which increases the odds for more companies to suffer from a disruption."

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