A company’s capital is a precious resource to be allocated and invested wisely in support of strategic objectives. The decisions on where, when and how much capital to invest are among the most important decisions that senior executives have to make. For this reason a robust business case and accountability for realization of benefits have become requirements in the budget planning and capital allocation processes of most companies.
For supply chain managers this can be a difficult and in some cases intimidating hurdle to overcome. Fear not – there are time-tested approaches that are comprehensive, repeatable and guaranteed to improve the chances of funding. The purpose of this article is to describe a recommended approach for evaluating, communicating and achieving the expected return on investment (ROI) from a supply chain project.
The key to the evaluation of ROI is the credibility of analysis. Beginning with the simple understanding that ROI is a calculation of the tangible benefits resulting from an investment, the level of detail and thoroughness of the analysis is critical. An appropriate level of detail in the evaluation will help demonstrate clear understanding, focus and confidence in the analysis, all of which are important to the decision-making process for allocating capital.
The benefits analysis should include details of each major benefit category, including identification of the key metrics and financial variables that will change as an outcome of the project. In some cases it can be difficult to quantify the specific financial benefits that will result but the effort should be made to do so as this will result in a more credible business case for the project. (Examples of how to do this are included in the sidebar Making it Tangible.)
The analysis of the key metrics and variables should include current performance levels as well as the degree and pace of change of these items once the benefits start accruing. A checklist of important considerations for the benefits analysis includes:
* Define the link between a capability that the project will create and the strategic priorities of the organization. An example would be transportation planning software which can lead to improved asset utilization, reduced administrative overhead and better customer service. Linking to cost reduction and/or improved customer service is usually well aligned with strategic priorities;
* Identify the owner of the benefit who is the person with accountability for achieving the benefit;
* Identify assumptions, sensitivities and dependencies that could impact the benefits. A demand forecasting example in this case would be an assumption that the SKU mix stays relatively constant (less than 10% change in product mix). It is typically more difficult to forecast new products so benefits tied to improvements in forecast accuracy need to be made with an assumption about the expected SKU mix in the future. If this assumption is not expected to hold true then a sensitivity analysis needs to be included to project the changes in forecast accuracy and benefits based on varying percentages of new products to be added to the SKU mix.
* Identify risks as well as the mitigation strategies that will be put in place to effectively manage them. For supply chain projects that are expected to reduce inventory, a frequently identified risk is negative impact to customer service. The sales department and senior management will be particularly concerned about this. A possible mitigation strategy for this risk is to alert suppliers, distribution partners, manufacturing and customer service of the need to potentially accelerate the speed of inventory through the supply chain during the time window when the new capability is brought on line and the inventory levels start to reduce. Expediting, airfreight, overtime may all have to be considered as potential mitigation strategies for this risk.
* Be careful not to double count benefits from other initiatives that are focused on the same areas of the business. Inventory reduction is a common benefit item for any number of systems and business process improvement projects.
* Validate the benefit calculations with the benefit owners and key stakeholders up front to avoid untimely or unanticipated challenges to your calculations later in the process.
The cost side needs to include anticipated project expenditures and timing for items such as software, hardware, property, plant and equipment, internal staff resources, external resources, training, travel and incidental expenses. Costs also need to include projected allowances for annual maintenance fees, additional full-time and/or contract staff expenses and ongoing support and/or technical infrastructure costs that are a direct result of the new capabilities introduced. One cost element that requires special consideration is contingency. In general it is a good practice to include 10% to 15% contingency to allow for the unplanned challenges and opportunities that are likely to emerge during the execution of the project.
With the financial benefits and costs identified, the calculation of ROI can be completed and the business case for the initiative prepared for communication to the executive decision-makers.
In communicating the business case for a recommended supply chain initiative the obvious advice is to keep the message simple and clear; the more difficult task is making it so. The reality for many executives is that their days are filled with many meetings, issues, decisions, information and tasks. The time to focus on any one item is limited and therefore the communication of the business case has to be constructed around a small number of key questions that the executives will need to consider. These questions include:
* What is the background and context of this
* What issues or opportunities does this recommended
* What are the expected financial,
strategic and intangible benefits?
* What is the implementation approach,
timing and resource requirement?
* What are the anticipated costs, risks and
sensitivities associated with this project?
* Who is responsible for achieving the
* Why is now the right time to
undertake this initiative?
A crisp message that addresses these questions backed up by appendix materials with the detailed analysis as backup will go a long way in conveying thoroughness of analysis and confidence in the individual or team recommending the implementation.
The danger in the communication step is the tendency to over complicate messages and/or provide too much information which creates information overload and confusion. Supply chain is a broad area that is not necessarily well understood at a detailed level by company executives. It would be a mistake on the part of supply chain managers to try and show their own understanding and mastery of the topic by reviewing too much information with the executives. It is highly unlikely that an executive who is having trouble understanding what is being recommended will make the decision to invest the organization’s capital. It is possible that a well-conceived idea that has been thoroughly analyzed will not get approval because it was poorly communicated. (See the Linking Recommendations to Strategic Objectives sidebar for a framework to communicating the benefits of a project.)
Once a project has been approved and is ready for delivery, the supply chain manager needs to focus on ensuring that the benefits committed to it at the outset of the process will materialize. The benefit and cost aspects o
f the business case should be revisited and updated as necessary during the delivery of the project. There are normally new insights gained and unplanned costs encountered during the delivery of a project. The unplanned costs should have been accounted for within the contingency funds.
Once the project has been completed and the new capabilities introduced into the organization, a benefits tracking mechanism should be implemented to provide the same rigour around achieving, quantifying and communicating the benefits as was applied to the project itself. This is an often overlooked aspect of supply chain projects which is unfortunate as this is normally an easy step in comparison to the original approvals of the idea and business case and the execution of the project.
Tracking of the benefits enables the supply chain manager to identify where additional executive support would help in realizing further benefits. It is important to link changes in the key metrics to the specific benefits. In the absence of this linkage there might be temptation to try and achieve the benefits in whatever manner possible rather than in the way originally intended.
Setting Up For Success
The supply chain is an area of tremendous potential for organizations from retailers, manufacturers and distribution companies to health care providers and pharmaceutical companies. The link between effective supply chain management and customer service, revenue growth, cost control and asset management is well proven. There is also a link between the ability of the supply chain manager to evaluate, communicate and achieve the return on investment for those projects that require capital and the support of top executives.
While the scope, emphasis and implementation approach will vary from one potential project to another the frameworks provided in this article have allowed projects to move ahead, companies to succeed and supply chain careers to flourish.
Documenting the link between supply chain and financial performance
There have been a number of impressive studies conducted over the past few years that have been able to show a direct link between supply chain performance and financial performance.
* A study by Accenture and Stanford University used data from more than 600 Global 3000 companies across 24 industries from 1995 to 2000 to compare the financial performance of companies considered supply chain “leaders” and of companies considered supply chain “laggards”. (Company performance in comparison to competitors in areas such as inventory turns, cost of goods sold as a percentage of revenue, and return on assets was used to determine in which camp to place companies.)
The study then calculated financial performance for each company based on its change in stock market value growth during the study period. It found that the compound average annual growth in market capitalization of the supply chain leaders was 10 to 30 percentage points higher than that of the laggards. And the results applied pretty well across the board. In 21 of the 24 industries studied, the supply chain leaders had higher stock value growth over the six-year period of the study.
* A study conducted by the University of Western Ontario and the Georgia Institute of Technology documented the real cost of a glitch in the supply chain. (A glitch was defined as anything that leads to a major production or shipment delay.) The study tracked 861 examples of major supply chain glitches announced by publically held companies over a 10-year period (1989-98). It found that, on average, the stock market penalized public companies announcing supply chain glitches with nearly a 9% drop in stock price. The average destruction in shareholder value for the 861 glitches analyzed, ranged from $120 million to $140 million. Collectively the 861 glitches analyzed accounted for an overall destruction in shareholder value estimated to be between $103 billion and $120 billion. High growth firms were treated particularly roughly by the market. Nor was this a hole that was easy to climb out of. The study found no evidence of recovery in stock price for the next 60 trading days (90 calendar days).
Making It Tangible
Demand planning is an area within the make-to-stock supply chain where many organizations are considering investments. While this seems to be an attractive functional area in which to consider investing, it is one for which it can be difficult to quantify benefits. Benefits from demand planning come from being able to make better decisions earlier in the planning process. With better visibility to demand safety stock for finished goods and raw materials, packaging and components can be reduced. Plant and warehouse labour scheduling can be done earlier and with more certainty helping to reduce overtime. Transportation requirements can be planned earlier and with more certainty creating opportunities for higher asset utilization. Another area improved demand planning can provide tangible financial benefits is in reduction of customer service fines and charges. Large customers today are increasingly in the habit of levying charges for service failures. These penalties can be reduced or eliminated by starting with an accurate demand forecast and consistently following through with the plan. While the specific opportunities offered by improved demand planning will differ from one organization to another, the requirement to quantify the benefits is a constant. It will definitely prove a challenge, but doing so will make the business case for the supply chain project being evaluated much stronger.
Stephen J. Brown, senior manager at Deloitte & Touche, consults on supply chain to leading consumer- focused organizations throughout North America. He has assisted industry leaders such as Frito-Lay, Heinz, Chiquita, Nestle, Clorox, Pepsico and Sony in improving their supply chain performance. He has 19 years of experience in both consulting and industry roles. His academic background includes an engineering degree and an MBA. He is based in Toronto.