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Supply chain and finance–what’s the connection?

Image by Flickr user Public Domain PhotosAsk any executive or board member in almost any industry what their top financial goal for their company is this year and you are likely to hear “grow revenue” as the answer.  If you follow up and ask how they plan to do it, you’re less likely to hear them mention supply chain management (SCM) as a key focus area.  Unfortunately, many companies still think the primary impact of SCM is taking out costs like transportation and warehousing which, in turn, improves profitability.  This is a pretty incomplete view of the power of SCM.   Companies that have a more holistic view of the true impact of better supply chain management and understand its ability to drive revenue growth, possess a distinct competitive advantage.

Let’s begin exploring the connection between top line growth and SCM using the retail industry as an example. Research by FinListics shows that for retail department stores in North America, the average revenue growth is around 4% per year- with the top performers growing closer to 7%. In dollars, a retailer with $1 billion in revenue (think Jos A Bank, Overstock.com, or Vitamin Shoppe) growing at 7% vs. 4% adds $30 million to the top line and close to $10 million in gross profit.

To most companies, that’s significant enough to get their attention – and that’s per $1 billion in revenue.  Just imagine what that number would be for Wal-Mart or CVS.  While some of the difference in growth rates is due to unique company factors like the number of new store openings, at least some of the difference reflects how well the business processes underlying growth are managed, including supply chain management.  In this article, we’ll use stockouts, new product speed-to-market, and asset utilization as examples.

Stockouts

Stockouts have an obvious impact on revenue – if you don’t have an item to sell to a customer, or a key component required to assemble your item and make it available for sale, your customer will buy the item from another store or not buy the item at all, resulting in lost revenue for you either way.  SCM has a significant impact on stockouts. Stockouts average about 2% of revenue in retail while the better performers are closer to 1%.   Some sources have the average number for retailers as high as 4% of sales.  For that same $1 billion company, improved SCM practices that move stockouts to 1% from 2% add as much as $10 million to revenue, which would deliver over $3 million in gross profit.

New Product Speed-to-Market

New product speed-to-market is another key driver of top line growth for retailers and is also an area where SCM adds value. The average time to market in retail is 240 days, with better performers being about twice as fast at 126 days. Every day a product isn’t in the market is a day of revenue lost.  Is better supply chain management going to close this entire gap? Not likely. But what if better coordination between a company’s buyers, suppliers, SCM, and store operations closed just 10% of the gap? According to FinListics research, if we’re still talking about that same $1 billion retailer, the value of that 10% improvement is close to $20 million in revenue, and would mean a $7 million increase in gross profit.  If your client is a $10 billion retailer, that’s $200 million in incremental revenue and $70 million more profit.  And if they’re only $500 million – it’s still $10 million more to the top line.

The numbers scale, but for any size are meaningful enough to get someone’s attention, and although different in different industries, improvement at some level is possible for nearly all companies in all industries.

Thinking Outside the Box

In the case of stockouts and speed-to-market, the connection between SCM and revenue is direct.  There are a number of opportunities within companies, however, where the connection is less direct, but no less significant.  In this next section, we’ll review a few of these key financial metrics, or what’s also referred to as key performance indicators (KPIs), that are affected by SCM and ultimately drive revenue growth.

Asset Utilization

One such example is return on assets (ROA), which measures how effectively a company is using its investment in assets to generate profits; it’s calculated by dividing net income by the company’s total assets. Most business executives, particularly in asset-intensive industries like telecommunications or retail, are under constant pressure to not only grow the top line, but also to show a strong return on assets.  Doing both is tough because often incremental top line growth comes at the expense of reduced profitability (from things like lowering prices, entering emerging markets, or including more services), which reduces ROA. But better supply chain management can help your clients grow the top line with lower margin products while still earning a good ROA. The secret is using better supply chain management to use fewer assets to generate revenue.

Key operating assets include working capital – inventory and accounts receivable; and fixed assets – warehouses, fleets, manufacturing, and stores. Better SCM practices can help improve the utilization of all these assets and, in turn, help a client grow the top line with lower margin products.

Editor’s Note: This is post is excerpted from a longer article by Finlistic’s solutions.