Today’s guest post is from Robert A. Rudzki, President of Greybeard Advisors LLC, who has (co-) authored a number of acclaimed business books, including Beat the Odds: Avoid Corporate Death and Build a Resilient Enterprise, On-Demand Supply Management, and the just published text on Next Level Supply Management Excellence that is a follow up to the now-classic Straight to the Bottom Line.
Every CPO or chief supply chain officer needs to be conversant with the performance improvement framework shown in the following figure.
This is one of my favorite charts, and is the essence of relating supply management to improved corporate performance. Let’s walk through this framework briefly — a more involved discussion appears in Chapter 4 of my new co-authored book “Next Level Supply Management Excellence“.
Two important measures of corporate performance are return on invested capital (ROIC) and cash flow. ROIC is calculated by taking the annual earnings of a business and dividing it by the total capital invested in that business (long term debt and stockholder’s equity). ROIC is important because it is an indicator of the current health of a business. For a business to deliver value to its shareholders, ROIC needs to exceed the corporate cost of capital. A company that operates where its ROIC is lower than its cost of capital is essentially liquidating itself.
Improving profits helps to improve both ROIC and cash flow. Reducing the capital intensity of your business also helps to improve ROIC and cash flow. Improving profits while also reducing the capital needed to run the business has a powerful compounding effect on ROIC and cash flow.
So how do we go about improving profits? There are two fundamental ways: revenue enhancements and cost reductions. Supply management can — and should — play an important role in each of those areas, as indicated with examples shown in the Figure above.
Supply management should, for example, take a leadership role in creating a more responsive supply chain, thereby helping the company to win more business (and increase revenues) from customers. Supply management should also take the lead applying good processes to better manage all areas of spend, not just those typically assigned to procurement.
So far so good, but how do we reduce capital intensity? Again, there are two ways: working capital improvements and capital expenditure improvements. Once again, supply management can play an important role in each of those areas. In many companies, for example, there is no clear responsibility for analyzing and coordinating supplier payment terms. This area is ideally suited for supply management to take a lead role (as detailed in Chapter 15 of “Next Level Supply Management Excellence“).
With regard to capital expenditures, experience demonstrates that the sooner Procurement is involved in new projects (even at the concept stage), the better the overall project economics and ramp-up time will be.
A thorough opportunity assessment for supply management requires a careful evaluation of the improvement opportunities in each of the four categories shown on the exhibit. Then, to tie it together for the executive audience, you relate those improvement opportunities to the company’s income statement and balance sheet. Going that extra step allows you to demonstrate the impact of supply management on net income, earnings per share, ROIC and cash flow — all key areas of interest for senior executives. It’s a powerful way to communicate the enormous potential of a transformed supply management organization in the language of senior executives and in a manner relevant to your company.
And, based on our experience, it can pave the way for significant executive support for your agenda.