Supply Chain Disruptions and Shareholder
Value
Kevin Hendricks
Richard Ivey School of Business
Ontario, Canada
Vinod R. Singhal
DuPree College of Management
Georgia Institute of Technology
Atlanta, GA, 30332
February 2005
1
Some thoughts
• Without facts you are just another person with
an opinion
unless
you are at a level of the organization where your
opinion becomes fact
• When research is limited or absent, anecdotes
prevail
2
Accenture study (with INSEAD and Stanford)
• Comparison of supply chain’s linkage to financial
performance of 600 global companies over two
different time period
• Supply chain performance classified into four
groups based on
- Inventory turns
- Return on assets
- Cost of good sold/sales (1- gross margin)
• Financial performance - Industry adjusted
shareholder return grouped into four groups
3
Supply chains and shareholder value
• Shareholder Value = Create - Destroy
• Poor supply chain performance destroys
shareholder value
• Practices that prevent poor supply chain
performance create value by avoiding value
destruction
4
Issues examined
• Effect of disruptions on shareholder value
• Effect of disruptions on profitability – growth in
operating income, sales, cost, assets, and
inventory
• Effect of disruptions on risk – share price
volatility
5
Approach
• Sample
• Measurement time period
• Methods to estimate the impact of disruption on
performance
• Statistical tests
• Results
• Implications
6
Sample
• 800+ announcements of supply chain disruptions (production or
shipment delays) from Wall Street Journal and Dow Jones News
 Sun Microsystems delays shipments of workstations and
servers, Dow Jones News Service, December, 14, 2000.
 Sony Sees Shortage of Playstation 2s for Holiday Season”, The
Wall Street Journal, September 28, 2000.
 Boeing pushing for record production, finds parts shortages,
delivery delays, Wall Street Journal, June 26, 1997.
 Hershey will miss earnings estimate by as much as 10%
because of problems in delivering order, Wall Street Journal,
September 14, 1999.
7
Distribution of sample announcements
40
36.52
Number of firms (%)
35
32.41
30
25
18.62
20
15
12.45
10
5
0
1989-1991
1992-1994
1995-1997
1998-2000
8
Sales volume of firms experiencing gltiches at the time of the
gltich announcemen (% of firms)
Distribution of disruptions by sales volume
40
35
30
26.48
25
20.94
18.78
20
15.01
15
11.49
10
7.29
5
0
Less than
$50 million
$50 million
to $100
million
$100 million $250 milion $500 million
to $250
to $500
to $1billion
million
million
Over
$1billion
9
Responsibility for disruptions
40
35
33.61
29.38
30
% of Firms
25
20
15
12.81
14.51
10
6.05
3.81
5
0
Internal
Customer
Supplier
Nature and
government
Other
combinations
None
provided
10
Reasons for disruptions
35
29.38
Number of firms (%)
30
25
21.64
20
15
10
8.94
8.823
8.46
4.11
5
3.26
0
Part
Ramp/rollOrder
shortages out problems changes by
customers
Production Development
problems
problems
Quality
problems
None
provided
11
Measurement time period for share price changes
• Sony announced a disruption on September 28, 2000
• Set September 28, 2000 as day 0 in event time
• Day -1 is the previous trading day
• Day 1 is the following trading date
Day before the announcement
Announcement
date
1st Year after
Year before
-251
-1
0
2nd Year after
250
500
12
Measurement time period for profitability changes
• Sony announced a disruption on September 28, 2000
• Set the quarter ending after September 28, 2000 as quarter 0
Announcement
date 9/28/2000
1st Year
before
Quarter -4
1st Year
after
Quarter 0
2nd Year
after
Quarter 4
Quarter 8
13
Measurement time period for share price volatility
changes
• Sony announced a disruption on September 28, 2000
• Set September 28, 2000 as day 0 in event time
Announcement
date
2nd Year
before
-509
1st Year
before
-260
-10
0
10
1st Year
after
260
2nd Year
after
510
14
Estimating stock price performance implications
• Compare performance of disruption experiencing firms with
portfolios of similar type of firms
- Size (created 14 portfolio)
- Book to market value (subdivided each of the 14 into 5 )
- Prior performance (subdivided each of the 70 into 3)
• 210 portfolios of firms
• Simulated 1000 benchmark portfolios
• Used the simulated distribution to test statistical significance
15
Estimating stock price performance and risk
implications
• One to one matching
- Closest in size
- Closest in performance
- Closest in SIC match
• Estimate the difference in stock price performance between
the sample firm and its benchmark
• Estimate the difference in change in volatility of the sample
firm and its benchmark
16
Methodology for estimating the profitability impacts
• Create benchmark samples to adjust for the effect of economy
and industry
• Three different benchmark samples created by matching on




Sales
Assets
Standard Industry Classification (SIC) Codes
Prior Performance
17
Average stock returns on disruption announcements
Portfolio Matched
Size Matched
-7.18
-7.17
Performance
Matched
Industry Matched
Average shareholder return (%)
0
-2
-4
-6
-8
-6.81
-7.81
-10
18
Comparison with stock market reaction to other
corporate events
Operational events
Marketing events
Increase in capital expenditure
Increase in R&D expenditure
Effective TQM implementation
Internal corporate restructuring
Decrease in capital expenditure
Plant closing
1.0%
1.4%
0.7%
1.0%
-1.8%
-0.7%
Information technology events
IT Investments
B2C e-commerce
B2B e-commerce
IT problems
1.0%
10.5%
3.3%
-1.7%
Change in firm name
Brand leveraging
Celebrity endorsement
New product introduction
Affirmative action awards
Delay introduction of new
products
0.7%
0.3%
0.2%
0.7%
1.6%
-5.3%
Financial events
Stock splits
3.3%
Open market share repurchase 3.5%
Proxy contest
4.2%
Increasing financial leverage
7.6%
Decreasing financial leverage -5.4%
Seasoned equity offerings
-3.0%
19
Average stock returns over different intervals
Year before
On
announcement
1st year after
2nd year after
Average shareholder return (%)
0
-1.77
-3
-6
-7.18
-9
-10.45
-12
-15
-13.68
20
Average stock returns over three years
Portfolio Matched
Size Matched
Performance
Matched
Industry Matched
Average shareholder return (%)
0
-10
-20
-30
-34.77
-40
-40.66
-32.21
-38.40
-50
21
% Change in equity risk (standard deviation)
Year to year changes in equity volatility
20
15.16
15
13.5
10
5
2.82
0
-1.74
-5
Two years before One year before One year after to Two years before
to one year
to one year after two years after to two years after
before
22
Profitability impacts in the year before the disruption
Performance Measures
Operating Income
Return on Sales
Return on Assets
Percent change
0
-20
-40
-32.02
-35.82
-42.27
Mean
-60
Median
-80
-100
-120
-92.24
-107.43
-114.67
-140
23
Profitability impacts in the year before the disruption
Sales
Cost
Assets
Inventory
20
13.88
15
Percent change
10.66
9.59
10
4.29
5
6.08
3.06
0
-2.84
-5
-10
Mean
Median
-6.92
-15
-20
24
Profitability impacts in the year after the disruption
Operating Income
Return on Sales
Return on Assets
5
0.94
0.1
Percent change
0
-5
-6.27
-6.36
-10
-4.62
Mean
Median
-15
-20
-18.09
25
Profitability impacts in the 2nd year after the disruption
Operating Income
Return on Sales
Return on Assets
5
Percent change
0
-5
-3.49
-10
-6.58
-8.32
-15
-20
Mean
-25
Median
-23.09
-25.44
-30
-35
-40
-36.19
26
Average stock returns by responsibility
Internal
Supplier
Customer
Average shareholder return (%)
0
-10
-20
-24.93
-30
-40
-35.69
-50
-52.88
-60
27
Average stock returns by reason
Part shortages
Ramp/roll-out
problems
Order changes
by customers
Production
problems
Average shareholder return (%)
0
-10
-20
-30
-25.48
-40
-41.67
-50
-46.59
-52.79
-60
28
Average stock returns by size
Ist quintile
(smallest)
2nd quintile
3rd quintile
4th quintile
5th quintile
(largest)
Average shareholder return (%)
0
-10
-20
-19.61
-30
-32.35
-40
-50
-46.68
-47.05
-60
-70
-64.28
29
Summary
• Disruptions cause significant destruction in corporate
performance
• It does not matter who or what caused the disruption – you still
pay
• Small firms suffer more from disruptions
• Market always took a dim view of supply chain disruptions
• Firms do not quickly recover from disruptions
30
Broader perspectives
• S&P 500 has returned about 12% annually over the last 15
years
• Major disruptions are associated with 35% underperformance
in stock returns
• One major glitch every 10 years – average return of 9%
31
Why enough attention is not paid to the
possibility of disruptions?
• Consequences are not known
• Low frequency events
• Resource shortages
• Requires cross-functional effort
• Short tenure of managers
• You don’t get credit for fixing problems that never
happened
• You have not experienced one
32
Are supply chains more prone to disruptions
today?
• Globalization of supply chains
• Increased reliance on outsourcing and partnerships
• Single sourcing
• Little slack in the supply chain
• Competition
33
Dealing with disruptions
• Reduce the frequency (probability) of disruptions
- better forecasting
- better planning
- communicate, collaborate, and share
• Develop ability to predict disruptions (business intelligence)
- select, define, and track key performance indicators
- analyze disruptions to develop key leading indicators
- track leading indicators
- need visibility
34
Dealing with disruptions
• Elapsed time between the occurrence and detection of glitch
- aim for zero elapsed time
- real time visibility of the extended supply chain
- event management systems
• Time it takes to resolve the glitch
- quick resolution, prevent escalation and worsening
- a process for dealing/responding to disruptions
- developing capabilities to react and respond
35
Implications for making business case
• Traditional approach – create shareholder value
- efficiency driven (impacts on cost and capital cost)
- cost-benefits analysis (ROI) of potential solutions
- ignores revenue, indirect benefits, and intangibles
• Augment the traditional approach
- need to preserve value and avoid value destruction
- value of reliable, responsive, and robust supply chains
- prevention role of effective SCM
- effective SCM buys insurance against value destruction
36
Future research
• Understand how upstream and downstream supply
chain partners get affected by disruptions
• Examine the impact of excess inventory on
shareholder value
• Product development delays
• Operation glitches and cost of capital
37
Average stock returns by industry groups
Process
Batch manufacturing
High technology
Services and others
0
Average shareholder return (%)
-10
-20
-30
-27.31
-35.84
-40
-50
-47.65
-51.12
-60
38
Profitability impacts by industry groups
Process
Batch manufacturing
High Technology
Services and others
20
11.93
10
5.56
1.91
1.7
Percent change
0
-3.6
-10
-4.4
-3.5
-6.5
-20
-30
Operating Income
-32.6
-40
Sales
Costs
-50
-60
-55.6
-56.7
-70
-70.3
-80
39
Consequences of disruptions
• Lower Revenues
• Higher costs
• Poor asset utilization
• Excess inventory, inventory write-offs, stockouts
• Higher cost of capital/borrowing
• Shareholder lawsuits
• Management and personnel turnover
• Loss of reputation and credibility, negative publicity
40
Estimating profitability impacts of disruptions
• Growth in Operating Income
 Sales – manufacturing costs – selling and general administration costs
• Growth in return on sales
 Operating income normalized by sales
• Growth in return on assets
 Operating income normalized by total assets
• Growth in sales
 Net Revenues
• Growth in costs
 Manufacturing costs + selling and general administration cost
• Growth in total assets
• Growth in inventory
 Raw material + Work-in-process + Finished goods inventory
41
Median profitability impacts by responsibility
Performance Measures
Internal
Supplier
Customer
20
4.52
Percent change
10
5.82
1.25
0
-10
-1.1
-4.3
-5.6
-20
Operating Income
-30
-40
-50
-60
Sales
-29.9
Costs
-43.7
-55.0
-70
42
Median Profitability impacts by reason
Ramping/Rollout Order changes
Parts Shortage
problems
by customers
Production
problems
20
10
5.65
5.69
2.81
Percent change
1.68
0
-1.2
-10
-3.0
-2.6
-10.3
-20
-30
Operating Income
-31.2
Sales
-40
Costs
-50
-50.2
-60
-59.0
-58.8
-70
43
Median Profitability impacts by size
Performance Measures
Operating
Income
Return on
Sales
Return on
Assets
Sales
Cost
20
2.6
Percent change
0.3
7.6
0
-7.8
-20
-40
-22.9
-25.2
-29.5
Larger firms
-60
Smaller firms
-80
-100
-72.4
-66.2
-86.4
44
Why link supply chain performance and
shareholder value?
• Attract and engage top management attention
• Make business case for organizational changes
• Make business case for investments in
technology
• Convince our students that OM matters
45
Supply chains and shareholder value
• Efficiency
• Reliability
• Responsiveness
46
Lean and efficient versus risk of disruptions in supply
chains
• Lean and efficient supply chains
- Stretched and complex supply chains
- Outsourcing and dependency on third parties
- Single sourcing
- Low slack
• Above practices can increase the risk of disruptions
• Trade-off between lean/efficiency and the risk/expected
cost of disruptions
47
Issues examined
• Effect of disruptions on shareholder value
• Effect of disruptions on profitability – growth in operating
income, sales, cost, assets, and inventory
• Effect of disruptions on risk – share price volatility
- cost of capital (discount rate)
- more expensive and difficult to raise capital
- can affect investment/acquisition plans
- increase the cost of factors of production
- conflict between various stakeholders
48