Your Supply Chain and Your Stock Price

One of the things that gets overlooked when the pundits talk about IT’s growing importance in business strategy is the scrutiny that will come with it. Today, IT is opaque in most companies and is mostly ignored by Wall Street analysts. (Ask Wall Street analysts a series of tough questions about IT and they’ll punt more often than the Houston Texans.)

For companies that make or sell physical products I can’t think of an area where IT has more direct impact on performance than supply chain and more specifically, inventory management. As U.S. manufacturing companies make the choice–for better or worse–to shift their emphasis from inventing and making things internally to relying on outsiders or satellite operations in low-cost labor countries to do that work for them, the essence of their worth is distilled down to their ability to move product around the world in sync with customer demand. Companies like Dell in manufacturing and Wal-Mart in retailing are hollowed out shells of companies whose competitive differentiation relies almost entirely on their ability to move and assemble inventoried products in the right amounts at the right time and in the right place.

Wall Street is starting to get it. More importantly, Wall Street is beginning to demand visibility into supply chain operations not simply out of curiosity, but out a growing sense that it is being hoodwinked–that traditional sales forecasts and quarterly profits are less and less reliable insights into a company’s long-term competitiveness than its ability to move stuff around well. A prominent article in the New York Times Business section last Sunday called out former internet darling Amazon on this very point. The article says Amazon is reluctant to reveal anything about its supply chain–especially after four consecutive quarters of declining profits. In Amazon’s most recent earnings call, company executives promised to keep spending heavily on its web site and free-shipping programs for customers, but “dropped the blackout curtains” on its operations, says the article. But what analysts and shareholders really want to understand is how Amazon is doing at moving product among its distribution centers.

Ironically, Amazon has gained a reputation among the analysts for being less efficient than its offline competition. That wasn’t supposed to be the case when Amazon’s stock price was riding high. When Amazon first started in 1995, according to the Times, “A single centralized distribution center in Seattle meant that many customers found that a speedy one-click purchase online would be followed by a frustrating wait offline for the order to arrive. To reduce delivery times, Amazon had to make colossal investments building a network of distribution centers — 15 in North America alone. Amazon “is not as efficient” as the most efficient offline retailers, said Scott W. Devitt, an analyst at Stifel, Nicolaus in Manassas, Va., last weekend. Nervous investors are starting to bail, says the article, with Amazon’s stock price down 22 percent since the holidays.

But researchers are trying to lift the veil on supply chain effectiveness and, by extension, the IT that supports it. In this article, Serguei Netessine Wharton operations and information management professor offers a metric that could bolster the share prices of companies like Amazon or reveal them to be supply chain charlatans. He calls it “supply chain elasticity.”

Based on data from 772 different companies, Netessine’s findings argue that inventory alone does not offer any real insight into the performance–i.e. profitability–of a company. “In fact, in some industries the more inventory you hold, the more profitable you are,” says Wharton researcher Serguei Roumiantsev in the article. Netessine says profitability is associated with the responsiveness of a supply chain to changing demand. This shouldn’t be confused with lean inventory management, which aims to keep inventory as low as possible for any given demand scenario. Elasticity is about speed.

According to the Wharton article, elasticity is a measure of the speed of change in inventory in terms of lead time, sales, sales uncertainty and gross margin. “Elasticity, for example, measures a change in inventory associated with a 1% change in demand,” says Netessine. “It shows how quickly a company can adjust inventory relative to other environmental variables.”

Netessine says so far only one Wall Street analyst, David Berman, a hedge fund manager in the retailing sector, has tried to track elasticity. His portfolio has been so successful that the Harvard Business School did a case study on him. The researchers are careful to point out that elasticity is not the only metric that should be used to judge value, but the evidence seems to be that it is certainly helping–at least in Berman’s case.

How does this link to IT? Elasticity seems like another way to say real-time supply chain visibility–a goal of IT supply chain geeks for years. If you have a clear line of sight into operations and customers and partners, you can respond more quickly to shifts in demand. It is the core of the Wal-Mart supply chain IT model. But as any supply chain geek will tell you, they haven’t been rewarded for their efforts. Until now, companies with supply chain visibility have only gotten indirect rewards from Wall Street via the balance sheet: if elasticity helps raise quarterly profits or sales, then it is rewarded. But there is no sign that companies are rewarded directly for supply chain responsiveness, except for notable exceptions like Wal-Mart and Dell. But even in these cases, supply chain excellence is only vaguely understood and the rewards that Wall Street gives these companies are based more on a sort of herd mentality, a consensus, constantly flayed by the press, that these two companies are supply chain champs–without much hard proof. “Everyone knows that Dell and Wal-Mart are good,” says Netessine, “but beyond that it is hard to tell if one company is better than the other in its supply chain management.”

But if this elasticity measurement takes hold–and the Amazon story seems to demonstrate a blunt demand for it among investors and analysts–then IT can expect to be increasingly rewarded for–and increasingly measured on–its ability develop visibility and responsiveness in the supply chain. Can your ERP vendor do this for you?

We all know what Deep Throat said: “Follow the money.” If the money–Wall Street valuation–begins leading to supply chain elasticity, CIOs had better be ready.

What do you think?