Daily Archives: April 27, 2008

Maximum Results Come From Supply-Based Spend Management

Chief Executive recently ran an excellent article by Drew Morris on Leading Your Business to Maximum Results that noted that the best way to boost results is to first identify the best ways to boost results, and then to go and do them. It described the methodology of Insight-Based Management that takes the standpoint that a company that wants do do well should first identify the performance the owners and influential analysts expect, and then work towards achieving that goal. For a private company, this means sitting down with the owners and investors and having an open and honest dialogue. However, for a public company, it can be a bit trickier. A public company needs to analyze it’s stock price to figure out whether adding another percentage point to the revenue-growth rate is more valuable than another point of profit margin. According to the article, the answer is in RVG – Relative Value of Growth, which is determined by the following formula:

Increase in EV due to 1% higher revenue growth rate

Increase in EV due to 1% increase in operating profitablity

Once a business knows it’s RVG, it then has to identify potential actions that will increase RVG. Potential actions include:

  • Price optimization
  • Improved product/service design
  • A better marketing message
  • Cost cutting
  • Leverage of technological progress
  • A killer customer experience
  • High-value business models

All of these actions have one thing in common: supply-based spend management. Even though cost-cutting might be the only action entirely under the control of supply-based spend management, each of these actions is critically dependent on supply-based spend management for successful execution. You can’t have a killer-customer experience if you don’t get the product/service to the customer, and do so at the right place and right time. The supply chain organization is in the best position to leverage technological progress and help improve product/service design. Being able to meet an optimal price-point in a target market will depend on spend management being able to keep costs down enough to meet the target price, and a well-run supply chain organization is a high-value business model in itself, as well as a basis for a better marketing message.

Of course the key is to determine the best actions, or those that will give you the best results. This requires calculating the revenue and profit gains that will result from each potential action, based on the profit power values for a company (which define the % profit increase due to a 1% change in the primary profit drivers), as well as the up-front costs. Then the profit associated with each potential action can be compared and the best actions taken.

Since RVG is hard to calculate for a private-company, and thus hard to manage by, and since wealth creation will improve RVG, these actions can also be compared using EM – Economic Margin, a wealth creation metric that

  • allows wealth creation by an action to be accurately gauged
  • is easy for the “numbers people” to understand and calculate
  • makes intuitive sense
  • allows for comparisons
  • is applicable at all levels of a company
  • is equally suitable for public and private companies

It is calculated using the following formula:

Cash Flow from Operations – Cost of Capital

Invested Capital
= EM

Furthermore, whereas RVG-based calculations tend to maximize the RVG-weighted profit and revenue growth of a company’s existing portfolio of businesses (where each could be based on a specific product or service offering), EM easily allows for changes in the portfolio to be considered.

Although the article is quite lengthy (about 15 pages), it’s a very good read and a must for any supply chain manager who wants to understand how the senior finance people determine which business unit’s proposal is the most valuable one to the business and, thus, which proposal they should allocate funds to. Being able to back up your proposals with these calculations relative to other actions the business can take will put a lot of weight behind your proposal and possibly smooth the way to getting that budget for a new system, warehouse, or team member approved faster.