Navigating Supply Chain Disruptions to Safeguard Shareholder Value

1. Supply Chain Disruptions and Shareholder Value Kevin Hendricks Richard Ivey School of Business Ontario, Canada Vinod R. Singhal DuPree College of Management Georgia Institute of Technology Atlanta, GA, 30332 February 2005

2. Some thoughts • Without facts you are just another person with an opinion • unless • you are at a level of the organization where your opinion becomes fact • When research is limited or absent, anecdotes prevail

3. Accenture study (with INSEAD and Stanford) • Comparison of supply chain’s linkage to financial performance of 600 global companies over two different time period • Supply chain performance classified into four groups based on • - Inventory turns • - Return on assets • - Cost of good sold/sales (1- gross margin) • Financial performance - Industry adjusted shareholder return grouped into four groups

4. Supply chains and shareholder value • Shareholder Value = Create - Destroy • Poor supply chain performance destroys shareholder value • Practices that prevent poor supply chain performance create value by avoiding value destruction

5. Issues examined • Effect of disruptions on shareholder value • Effect of disruptions on profitability – growth in operating income, sales, cost, assets, and inventory • Effect of disruptions on risk – share price volatility

6. Approach • Sample • Measurement time period • Methods to estimate the impact of disruption on performance • Statistical tests • Results • Implications

7. Sample • 800+ announcements of supply chain disruptions (production or shipment delays) from Wall Street Journal and Dow Jones News • Sun Microsystems delays shipments of workstations and servers, Dow Jones News Service, December, 14, 2000. • Sony Sees Shortage of Playstation 2s for Holiday Season”, The Wall Street Journal, September 28, 2000. • Boeing pushing for record production, finds parts shortages, delivery delays, Wall Street Journal, June 26, 1997. • Hershey will miss earnings estimate by as much as 10% because of problems in delivering order, Wall Street Journal, September 14, 1999.

8. Distribution of sample announcements

9. Distribution of disruptions by sales volume

10. Responsibility for disruptions

11. Reasons for disruptions

12. Day before the announcement Announcement date 1st Year after Year before 2nd Year after 250 -251 -1 0 500 Measurement time period for share price changes • Sony announced a disruption on September 28, 2000 • Set September 28, 2000 as day 0 in event time • Day -1 is the previous trading day • Day 1 is the following trading date

13. Measurement time period for profitability changes • Sony announced a disruption on September 28, 2000 • Set the quarter ending after September 28, 2000 as quarter 0 Announcement date 9/28/2000 1st Year before 1st Year after 2nd Year after Quarter 8 Quarter -4 Quarter 0 Quarter 4

14. Measurement time period for share price volatility changes • Sony announced a disruption on September 28, 2000 • Set September 28, 2000 as day 0 in event time Announcement date 2nd Year before 1st Year before 1st Year after 2nd Year after 260 -509 -260 -10 0 10 510

15. Estimating stock price performance implications • Compare performance of disruption experiencing firms with portfolios of similar type of firms • Size (created 14 portfolio) • Book to market value (subdivided each of the 14 into 5 ) • Prior performance (subdivided each of the 70 into 3) • 210 portfolios of firms • Simulated 1000 benchmark portfolios • Used the simulated distribution to test statistical significance

16. Estimating stock price performance and risk implications • One to one matching • Closest in size • Closest in performance • Closest in SIC match • Estimate the difference in stock price performance between the sample firm and its benchmark • Estimate the difference in change in volatility of the sample firm and its benchmark

17. Methodology for estimating the profitability impacts • Create benchmark samples to adjust for the effect of economy and industry • Three different benchmark samples created by matching on • Sales • Assets • Standard Industry Classification (SIC) Codes • Prior Performance

18. Average stock returns on disruption announcements

19. Comparison with stock market reaction to other corporate events Operational events Increase in capital expenditure 1.0% Increase in R&D expenditure 1.4% Effective TQM implementation 0.7% Internal corporate restructuring 1.0% Decrease in capital expenditure -1.8% Plant closing -0.7% Marketing events Change in firm name 0.7% Brand leveraging 0.3% Celebrity endorsement 0.2% New product introduction 0.7% Affirmative action awards 1.6% Delay introduction of new -5.3% products Information technology events IT Investments 1.0% B2C e-commerce 10.5% B2B e-commerce 3.3% IT problems -1.7% Financial events Stock splits 3.3% Open market share repurchase 3.5% Proxy contest 4.2% Increasing financial leverage 7.6% Decreasing financial leverage -5.4% Seasoned equity offerings -3.0%

20. Average stock returns over different intervals

21. Average stock returns over three years

22. Year to year changes in equity volatility

23. Profitability impacts in the year before the disruption

24. Profitability impacts in the year before the disruption

25. Profitability impacts in the year after the disruption

26. Profitability impacts in the 2nd year after the disruption

27. Average stock returns by responsibility

28. Average stock returns by reason

29. Average stock returns by size

30. Summary • Disruptions cause significant destruction in corporate performance • It does not matter who or what caused the disruption – you still pay • Small firms suffer more from disruptions • Market always took a dim view of supply chain disruptions • Firms do not quickly recover from disruptions

31. Broader perspectives • S&P 500 has returned about 12% annually over the last 15 years • Major disruptions are associated with 35% underperformance in stock returns • One major glitch every 10 years – average return of 9%

32. Why enough attention is not paid to the possibility of disruptions? • Consequences are not known • Low frequency events • Resource shortages • Requires cross-functional effort • Short tenure of managers • You don’t get credit for fixing problems that never happened • You have not experienced one

33. Are supply chains more prone to disruptions today? • Globalization of supply chains • Increased reliance on outsourcing and partnerships • Single sourcing • Little slack in the supply chain • Competition

34. Dealing with disruptions • Reduce the frequency (probability) of disruptions • - better forecasting • - better planning • - communicate, collaborate, and share • Develop ability to predict disruptions (business intelligence) • - select, define, and track key performance indicators • - analyze disruptions to develop key leading indicators • - track leading indicators • - need visibility

35. Dealing with disruptions • Elapsed time between the occurrence and detection of glitch • - aim for zero elapsed time • - real time visibility of the extended supply chain • - event management systems • Time it takes to resolve the glitch • - quick resolution, prevent escalation and worsening • - a process for dealing/responding to disruptions • - developing capabilities to react and respond

36. Implications for making business case • Traditional approach – create shareholder value • - efficiency driven (impacts on cost and capital cost) • - cost-benefits analysis (ROI) of potential solutions • - ignores revenue, indirect benefits, and intangibles • Augment the traditional approach • - need to preserve value and avoid value destruction • - value of reliable, responsive, and robust supply chains • - prevention role of effective SCM • - effective SCM buys insurance against value destruction

37. Future research • Understand how upstream and downstream supply chain partners get affected by disruptions • Examine the impact of excess inventory on shareholder value • Product development delays • Operation glitches and cost of capital

38. Average stock returns by industry groups

39. Profitability impacts by industry groups

40. Consequences of disruptions • Lower Revenues • Higher costs • Poor asset utilization • Excess inventory, inventory write-offs, stockouts • Higher cost of capital/borrowing • Shareholder lawsuits • Management and personnel turnover • Loss of reputation and credibility, negative publicity

41. Estimating profitability impacts of disruptions • Growth in Operating Income • Sales – manufacturing costs – selling and general administration costs • Growth in return on sales • Operating income normalized by sales • Growth in return on assets • Operating income normalized by total assets • Growth in sales • Net Revenues • Growth in costs • Manufacturing costs + selling and general administration cost • Growth in total assets • Growth in inventory • Raw material + Work-in-process + Finished goods inventory

42. Median profitability impacts by responsibility

43. Median Profitability impacts by reason

44. Median Profitability impacts by size

45. Why link supply chain performance and shareholder value? • Attract and engage top management attention • Make business case for organizational changes • Make business case for investments in technology • Convince our students that OM matters

46. Supply chains and shareholder value • Efficiency • Reliability • Responsiveness

47. Lean and efficient versus risk of disruptions in supply chains • Lean and efficient supply chains • - Stretched and complex supply chains • - Outsourcing and dependency on third parties • - Single sourcing • - Low slack • Above practices can increase the risk of disruptions • Trade-off between lean/efficiency and the risk/expected cost of disruptions

48. Issues examined • Effect of disruptions on shareholder value • Effect of disruptions on profitability – growth in operating income, sales, cost, assets, and inventory • Effect of disruptions on risk – share price volatility • - cost of capital (discount rate) • more expensive and difficult to raise capital • can affect investment/acquisition plans • increase the cost of factors of production • conflict between various stakeholders