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Making Finance Take Notice.

To get the investment funds needed for high-yield strategies, you need to make the connection between supply chain initiatives and financial outcomes.

A few weeks ago, I was watching one of those financial news programs that have become so popular. The featured guest that day was a prominent technology analyst. In the midst of the conversation, I heard three words that immediately captured my attention--"supply chain management." Now why would a financial "guru" specializing in technology be talking about supply chain management?

It's not at all unusual to hear Wall Street analysts and commentators grilling company CEOs about inventory productivity (or the lack thereof). But this was different. Here was a financial person using the terminology of the practitioner--and using it correctly--to describe the importance of emerging supply chain management technology. After I thought about this for a few days, the pieces began to come together. In fact, the more I thought about it, the more logical the technology analyst's interest in supply chain management became. In fact, why wouldn't a financial person be a new standard bearer for supply chain management?

Financial considerations are, of course, a critical part of supply chain management. I've talked about some of these in earlier columns, particularly when examining the financial measures of supply chain performance. In this column, I thought we might speculate on the question, How do you make financial people take notice of supply chain management?

To date, supply chain practitioners have not done a very good job of it. Yes, they know how to ask for money to fund their operations and how to justify their requests. But there is a clear difference between asking the board for operating funds and making a persuasive pitch for investment funds. As a discipline, we seem to lack the ability to connect the dots between supply chain decisions and financial investment outcomes. We look at narrow financial metrics, such as inventory turnover or the cost of carrying inventory. To be sure, these measures are useful. But they do not make the causal link to financial outcomes. And that is what the financial investors--both external and internal--are really interested in.

Making the Connection

What are some of the high-level connections between supply chain investment decisions and financial outcomes? One of the most important concentrations of assets typically is found in the acquisition, maintenance, and deployment of inventory. For most companies, if we can increase the velocity of inventory in a consistent way, we can significantly increase cash flow and reduce inventory investment requirements. Not only can we perform these miracles for our own company, but we can also spread the gain to our supply chain partners.

Accomplishing this requires carefully building relationships and integrating technology with our supply chain partners. But that is what supply chain management is all about. The ability to improve the cash-to-cash cycle is an important competitive tiebreaker for forward-thinking companies that are pushing best practice. Although there are different ways to define the term cash-to-cash cycle, our definition is the average time period from when you pay for a purchased raw material or component until you have the customer's money in the bank. Yet because of accounting limitations or lingering problems with functional boundaries, many companies are not able to use this most realistic and useful financial metric.

Another important element of financial measurement is asset level and deployment of all non-inventory assets in addition to inventory. An effective supply chain allows the participants to shift and share assets. Must both parties in a transaction have their own computer asset and throw orders over the transom to one another? Or can they share a computer? Companies need to investigate the possibilities of shifting asset ownership from their balance sheet to a partner's balance sheet in a way that improves profits for both parties.

Asset shifting is related to a concept called functional shiftability, which was discussed in an earlier column (see "Insights: The Costs of `Functional Shiftability,'" Winter 1998). Functional shiftability means assigning a function to that place in the channel where it can be performed most efficiently. Ideally, functional shiftability will result in everybody's winning--the supply chain partners and the end-consumers. Yet even in the most finely tuned supply chain, this ideal state rarely exists. Five-hundred-pound gorillas have a way of affecting the optimum solution in asset level and deployment.

Outsourcing, or third-party logistics, can be viewed as a form of asset shifting. If Company A shifts its asset to Company B, then Company B can achieve scale economies because of higher volume, and Company A's cost could be lower as a result of the shift. Even if scale economies do not exist, it might make sense for Company A to shift its volume or asset to Company B. Company A can be left with fewer assets, fewer permanent employees, or fewer underutilized assets--and thus would be better off than if it had retained an underutilized asset. Asset utilization appears to be a better model than the traditional pricing model to explain the recent increase in the scope and size of outsourcing. Another explanation is technology. With the technology that now exists, a company can control an asset that is owned by a third party (for example, through a Vendor-Managed Inventory program) as easily as if that asset were owned by the company.

Building Your Case

So what can supply chain executives do to demonstrate the relationship between supply chain decisions and financial outcomes? Importantly, the relationship has to be demonstrated to both the internal and external financial interests. One might argue that internal interests are the more important of the two, as they will provide the seed money for investing in high-yield supply chain strategies.

The first step in showing the supply chain-financial outcome connection is to understand the language and metrics of the internal financial executives. This could range from becoming more conversant with the balance sheet and P&L (profit and loss) statements to running simulation models on the impact of alternative supply chain scenarios using actual company data. Realistically speaking, it's more feasible for the supply chain managers to learn the language of the financial executives than vice versa. Regardless of what I heard from that analyst on the financial news program, we can't reasonably expect that the financial folks will experience a supply chain epiphany anytime soon.

The second step is to form alliances with other functional areas, such as information technology (IT) and marketing, to build support for supply chain decision-making across the organization. The marketing function is extremely interested in the "relationship" piece of the puzzle. The IT executives are searching for the technology solution to link the network together.

The last step is to build an audience for supply chain management at the boardroom level. Though this can be a tough assignment, supply chain professionals will need to become comfortable with such boundary-spanning activities.

Convincingly demonstrating the link between supply chain decisions and financial outcomes will be a critical part of the supply chain manager's job going forward. It will also be a critical part of a company's success in the competitive marketplace.

Bernard J. "Bud" LaLonde is professor emeritus of logistics at The Ohio State University.
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Title Annotation:getting financing for supply chain initiatives
Publication:Supply Chain Management Review
Article Type:Brief Article
Geographic Code:1USA
Date:Nov 1, 2000
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