1

Supply Chain Disruptions and ShareholderValue

Kevin HendricksRichard Ivey School of Business

Ontario, Canada

Vinod R. SinghalDuPree College of ManagementGeorgia Institute of Technology

Atlanta, GA, 30332

February 2005

2

• 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

Some thoughts

3

•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

Accenture study (with INSEAD and Stanford)

4

•Shareholder Value = Create - Destroy

•Poor supply chain performance destroys shareholder value

•Practices that prevent poor supply chain performance create value by avoiding value destruction

Supply chains and shareholder value

5

•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

Issues examined

6

• Sample

• Measurement time period

• Methods to estimate the impact of disruption on performance

• Statistical tests

• Results

• Implications

Approach

7

• 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.

Sample

8

Distribution of sample announcements

12.45

18.62

32.41

36.52

0

5

10

15

20

25

30

35

40

1989-1991 1992-1994 1995-1997 1998-2000

Num

ber

of f

irms

(%)

9

Distribution of disruptions by sales volume

26.48

15.01

20.94

11.49

7.29

18.78

0

5

10

15

20

25

30

35

40

Less than$50 million

$50 millionto $100million

$100 millionto $250million

$250 milionto $500million

$500 millionto $1billion

Over$1billion

Sal

es v

olum

e of

firm

s ex

perie

ncin

g gl

tiche

s at

the

time

of th

e gl

tich

anno

unce

men

(%

of f

irms)

10

Responsibility for disruptions

33.61

12.8114.51

3.816.05

29.38

0

5

10

15

20

25

30

35

40

Internal Customer Supplier Nature andgovernment

Othercombinations

Noneprovided

% o

f Fir

ms

11

Reasons for disruptions

21.64

8.94 8.823 8.46

4.11 3.26

29.38

0

5

10

15

20

25

30

35

Partshortages

Ramp/roll-out problems

Orderchanges bycustomers

Productionproblems

Developmentproblems

Qualityproblems

Noneprovided

Num

ber

of f

irms

(%)

12

Measurement time period for share price changes

Day before the announcement

-251

1st Year after

Announcement date

2500-1

Year before 2nd Year after

500

• 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

Announcement date 9/28/2000

Quarter 0

1st Year before

Quarter -4

2nd Year after

1st Year after

Quarter 8Quarter 4

• Sony announced a disruption on September 28, 2000

• Set the quarter ending after September 28, 2000 as quarter 0

14

Measurement time period for share price volatility changes

Announcement date

-509

1st Year after

2nd Year after

2600-10 51010

1st Year before

2nd Year before

-260

• Sony announced a disruption on September 28, 2000

• Set September 28, 2000 as day 0 in event time

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• 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

Estimating stock price performance implications

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• 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

Estimating stock price performance and risk implications

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

-7.18 -7.17-6.81

-7.81

-10

-8

-6

-4

-2

0

Portfolio Matched Size MatchedPerformance

Matched Industry Matched

Ave

rage

sha

reho

lder

ret

urn

(%)

19

Comparison with stock market reaction to other corporate events

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%

Marketing events

Change in firm name0.7%

Brand leveraging 0.3%Celebrity endorsement

0.2%New product introduction0.7%

Affirmative action awards 1.6%Delay introduction of new -5.3% products

Information technology events

IT Investments1.0%

B2C e-commerce10.5%

B2B e-commerce 3.3%

IT problems -1.7%

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%

20

Average stock returns over different intervals

-13.68

-7.18

-10.45

-1.77

-15

-12

-9

-6

-3

0

Year beforeOn

announcement 1st year after 2nd year after

Ave

rage

sha

reho

lder

ret

urn

(%)

21

Average stock returns over three years

-40.66

-34.77-32.21

-38.40

-50

-40

-30

-20

-10

0

Portfolio Matched Size MatchedPerformance

Matched Industry Matched

Ave

rage

sha

reho

lder

ret

urn

(%)

22

Year to year changes in equity volatility

-1.74

13.5

2.82

15.16

-5

0

5

10

15

20

Two years beforeto one year

before

One year beforeto one year after

One year after totwo years after

Two years beforeto two years after

% C

hang

e in

equ

ity r

isk

(sta

ndar

d de

viat

ion)

23

Profitability impacts in the year before the disruption

-107.43-114.67

-92.24

-42.27-32.02

-35.82

-140

-120

-100

-80

-60

-40

-20

0

Operating Income Return on Sales Return on Assets

Performance Measures

Per

cent

cha

nge

Mean

Median

24

Profitability impacts in the year before the disruption

13.88

9.59

6.08

10.66

-6.92

3.064.29

-2.84

-20

-15

-10

-5

0

5

10

15

20

Sales Cost Assets Inventory

Per

cent

cha

nge

Mean

Median

25

Profitability impacts in the year after the disruption

-6.36

-18.09

0.94

-4.62

0.1

-6.27

-20

-15

-10

-5

0

5

Operating Income Return on Sales Return on Assets

Per

cent

cha

nge

Mean

Median

26

Profitability impacts in the 2nd year after the disruption

-25.44

-36.19

-23.09

-6.58

-3.49

-8.32

-40

-35

-30

-25

-20

-15

-10

-5

0

5

Operating Income Return on Sales Return on Assets

Per

cent

cha

nge

Mean

Median

27

Average stock returns by responsibility

-35.69

-24.93

-52.88-60

-50

-40

-30

-20

-10

0

Internal Supplier Customer

Ave

rage

sha

reho

lder

ret

urn

(%)

28

Average stock returns by reason

-25.48

-52.79

-46.59

-41.67

-60

-50

-40

-30

-20

-10

0

Part shortagesRamp/roll-out

problemsOrder changesby customers

Productionproblems

Ave

rage

sha

reho

lder

ret

urn

(%)

29

Average stock returns by size

-47.05

-64.28

-46.68

-32.35

-19.61

-70

-60

-50

-40

-30

-20

-10

0

Ist quintile(smallest) 2nd quintile 3rd quintile 4th quintile

5th quintile(largest)

Ave

rage

sha

reho

lder

ret

urn

(%)

30

• 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

Summary

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• 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%

Broader perspectives

32

•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

Why enough attention is not paid to the possibility of disruptions?

33

•Globalization of supply chains

• Increased reliance on outsourcing and partnerships

•Single sourcing

•Little slack in the supply chain

•Competition

Are supply chains more prone to disruptions today?

34

• 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

Dealing with disruptions

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• 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

Dealing with disruptions

36

• 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

Implications for making business case

37

• 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

Future research

38

Average stock returns by industry groups

-51.12-47.65

-27.31

-35.84

-60

-50

-40

-30

-20

-10

0

Process Batch manufacturing High technology Services and others

Ave

rage

sha

reho

lder

ret

urn

(%)

39

Profitability impacts by industry groups

-70.3

-4.4

5.561.91 1.7

11.93

-56.7

-32.6

-55.6

-3.5-6.5-3.6

-80

-70

-60

-50

-40

-30

-20

-10

0

10

20

Process Batch manufacturing High Technology Services and others

Per

cent

cha

nge

Operating Income

Sales

Costs

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• 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

Consequences of disruptions

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• 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

Estimating profitability impacts of disruptions

42

Median profitability impacts by responsibility

4.521.25

5.82

-43.7

-29.9

-55.0

-4.3 -1.1-5.6

-70

-60

-50

-40

-30

-20

-10

0

10

20

Internal Supplier Customer

Performance Measures

Per

cent

cha

nge

Operating Income

Sales

Costs

43

Median Profitability impacts by reason

-50.2

-3.0

1.685.65 5.69

2.81

-58.8-59.0

-31.2

-10.3

-2.6-1.2

-70

-60

-50

-40

-30

-20

-10

0

10

20

Parts ShortageRamping/Rollout

problemsOrder changesby customers

Productionproblems

Per

cent

cha

nge

Operating Income

Sales

Costs

44

Median Profitability impacts by size

0.3

-7.8

7.62.6

-22.9-25.2-29.5

-66.2-72.4

-86.4-100

-80

-60

-40

-20

0

20

OperatingIncome

Return onSales

Return onAssets Sales Cost

Performance Measures

Per

cent

cha

nge

Larger firms

Smaller firms

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•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

Why link supply chain performance and shareholder value?

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Supply chains and shareholder value

• Efficiency

• Reliability

• Responsiveness

47

• 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

Lean and efficient versus risk of disruptions in supply chains

48

• 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

Issues examined