Measuring the Impact and Return on Investment of Supplier Diversity

1. Measuring the Impact and Return on Investment of Supplier Diversity Michael Verchot Director Consulting and Business Development Center University of Washington Foster School of Business October 29, 2013

2. Goals Properly Value Supplier Diversity’s Total Contribution to the Corporation Capture The Value or Acquiring Innovation Comprehensive Approach to Measuring Supplier Diversity Impact

3. Measuring Return On Investment ROI = Gain from Investment – Cost of Investment Cost of Investment

4. Supplier Diversity’s Total Contribution to the Corporation

5. Areas for Gains from Investment Total ROI includes: Revenue Enhancement Cost Savings ROIT = ROIR + ROIC

6. Perils of a Narrow ROI Focus on Supplier Diversity • The timing of recognizing the revenue gains or expense reductions • Impact of supplier diversity strategies is not immediate and thus managers with a short time-horizon will not properly value the long-term gains to the company and thus may under-invest in supplier diversity strategies • If all gains or reductions are recognized in the year a contract is signed then benefits of supplier diversity strategies are overstated in some years and under-stated in others

7. Perils of a Narrow ROI Focus on Supplier Diversity Under-valuing the contribution that supplier diversity strategies make to the entire supply chain and purchasing functions of a company

8. Under-Valuing Supplier Diversity Impact • ROISD = Diverse Spend Savings – Supplier Diversity Investment Supplier Diversity Investment • Diverse Spend Savings: Annual Savings delivered by diverse firms and by non diverse firms competing for the same business • Supplier Diversity Investment: Supplier Diversity Personnel + Supplier Diversity Budget + Additional Resources • “Additional Resources” does not include sourcing and procurement executives performing their normal work (don’t double count tasks)

9. Areas for Gains from Investment Total ROI includes: Revenue Enhancement Cost Savings Innovation Gains ROISD = ROIR + ROIC + ROII

10. Valuing Innovation

11. Perils of Valuing Innovation ROI1 When considering ideas that aren’t incremental and at early stages of development trying to determine ROI early leads to assessing the completed innovation returns when we don’t have a realistic idea of what its worth will be Incrementalism Trap: Tries to relate a new idea to an existing market in order to have some basis for comparison 1 Langdon Morris, Innovation Labs, LLC

12. Quantitative Method of Valuing Innovation2 • Real Options: Applies stock option model to nonfinancial resource investments • The cost of R&D programs can be considered the price of a call option • The cost of future investment required to capitalize on the R&D program (such as the cost of commercializing a new technology that is developed) can be considered the exercise price • The returns to the R&D investment are analogous to the value of a stock purchased with a call option 2Melissa Schilling: Strategic Management of Technological Innovation

13. Quantitative Method of Valuing Innovation2 • Real options are based on stock options • A call option on a stock enables an investor to purchase the stock at a specified price (the exercise price) in the future • If, in the future, the stock is worth more than the exercise price, the holder of the option will typically exercise the option by buying the stock • If the stock is worth more than the exercise price plus the price paid for the original option, the option holder makes a profit • If it is worth less, the option holder will typically choose not to exercise the option, allowing it to expire. The amount paid for the initial option is a loss. • If the stock is worth more than the exercise price but not more than the exercise price plus the amount paid for the original option, the stockholder will typically exercise the option. The amount lost is less than if the option were to expire. 2Melissa Schilling: Strategic Management of Technological Innovation

14. Examples of Real Call Option2 2Melissa Schilling: Strategic Management of Technological Innovation

15. Quantitative Method of Valuing Innovation2 • Options are valuable when there is uncertainty • Real options models have some limitations: • Many innovation projects do not conform to the same capital market assumptions underlying option models • May not be able to acquire option at small price: may require full investment before its known whether technology will be successful • Value of stock option is independent of call holder’s behavior, but the future returns of the of R&D investment can be significantly influenced by the firm’s capabilities, complementary assets, and strategies. • Rather than being an observer (as in the option scenario), the investor can be an active driver of the value of the investment 2Melissa Schilling: Strategic Management of Technological Innovation

16. Quantitative Methods of Choosing Innovation Projects2 • Advanced R&D Projects: develop cutting-edge technologies that often have no immediate commercial application • Take a long time to pay off (or may not pay off at all) but can position the firm to be a technological leader. • Breakthrough Projects: incorporate revolutionary new technologies into a commercial application. 2Melissa Schilling: Strategic Management of Technological Innovation

17. Quantitative Methods of Choosing Innovation Projects2 • Platform Projects: not revolutionary, but offer fundamental improvements in cost, quality and performance of a technology over preceding generations of products. • Derivative Projects: incremental improvements in products and/or processes to provide a variety in design features. • Pay off the quickest, and help service the firm’s short-term cash flow needs 2Melissa Schilling: Strategic Management of Technological Innovation

18. Comprehensive Approach to Measuring Supplier Diversity Impact

19. Contribution to Sales: • Diverse spend • Supplier diversity-based sales volume • Diverse spend on customer projects • Contribution to Cost Savings: • Top project conversion to diverse suppliers Returns Zone • Contribution to Brand • Market Place Recognition • Association Engagement • Dual Certification Opportunistic Opportunistic Layton Value Compass Internal External Internal External • Contribution to Supply • Chain Efficiency: • Profile System Usage • Supplier Profile Matches to Projects • Best Practice Implementation • Performance Awards • 2nd Tier • International Supplier Diversity • Contribution to Sustainability • Wages & Salary Impact • Employment Impact • Diverse Supplier Training • Corporate Plus Sponsorship • Multi-corporation Capacity Building • Mentor/Protégé Problem Resolution Problem Resolution Impact Zone

20. Scorecard Approach

21. Scorecard Approach

22. Key Take-Aways • Avoid Under-Valuing Supplier Diversity’s Total Contribution to the Corporation • Especially when search for innovation is a supply chain driver, the contribution of supplier diversity is part of the entire purchasing and supply chain management effort and is not evaluated separately • Capture Full-Value and Properly Assess Risk in Innovation Projects • Use a score-card approach • Some impact of supplier diversity is difficult to measure to a company’s bottom line

23. Michael Verchot Director, Consulting and Business Development Center University of Washington Foster School of Business mverchot@uw.edu 206.543.9327 Foster.Washington.edu/Consult