Integral Logistics Management — Operations Management and Supply Chain Management Within and Across Companies

1.7.3 Scenario: Assessing the Economic Value Added (EVA) of Supply Chain Initiatives: The Supply Chain Value Contribution (SCVC)

Intended learning outcomes: Describe the supply chain value contribution (SCVC). Explain selected supply chain events and their relationship to current assets.

Supply chain managers often have problems in communicating quantitative benefits of their management decisions, which go further than reporting service level improvements and cost reductions, to the boardroom. On the other hand, financial managers have problems assess­ing the real contribution to enterprise value of supply chain initiatives (SCIs). Many assump­tions have to be made when, for instance, calculating the economic value added (EVA) of such projects. As a result, investment decisions about SCIs carry a certain level of risk.

Economic value added (EVA) is a metric for representing enterprise value. EVA is positive, i.e., value is generated, when an investment activity leads to higher NOPAT than the weighted average costs of capital (WACC) invested in the assets required for generating that income.

In other words, value is only generated when the investment is expected to provide more profit than the stockholders would get by alternative investments on the market. The equation is therefore:

EVA = NOPAT – WACC × value of fixed and current assets

Hence, the challenge is to provide transparency on the benefits and risks of the various supply chain structures and SCIs used for improving the performance of the supply chain — generally the reduction of inventory and reduction of lead time — in terms of the financial variables like EVA.

The supply chain value contribution (SCVC) method as described by [Schn10] is a tool for providing transparency about the cause and effect of SCIs on supply chain performance and the utilization of assets, with a focus on the working capital.

The integrated view of the SCVC method links logistics’ and financial managers’ perspectives on the supply chain. This provides the required common language for assessing the contribution of SCIs to enterprise value. Hence, investment decisions can be made on a more profound basis and related risks mitigated. The key element of the SCVC method is the use of the SCOR model and identified relationships between specific supply chain events and the different elements of net working capital. Figure shows an example visualization of these relationships in a make-to-stock production environment.

Fig.         Selected supply chain events and their relationship to current assets.

The upper part of the figure lists identified supply chain events with a direct relationship to the elements of working capital, displayed in the middle part, and relevant metrics used by logistics and financial management shown in the lower part. The horizontal axis represents the flow of time, which is followed by the flow of material, information, and cash. The vertical axis is relevant for the middle part and represents the valuation of material and the amount of the unpaid received or sent invoices and of the cash in- and outflows.

All material that is inventory, either in transit, raw material, in process, or finished goods, appears on the balance sheet, valued at actual total costs. This has two important consequences. First, where costs are reduced, the valuation is decreased by the same amount. Second, considering that the balance sheet is a snapshot of the company’s asset and capital situation at a given point in time, there is material in the whole supply chain, which appears as inventory in the corresponding stage. The shorter the supply chain, the less material adds up in the inventory account. In Figure, the heights of the inventory rectangles represent the actual total costs of the material until the particular stage. The widths represent the duration of time (i.e., cycle time) the material remains (on average) within the particular stage of the supply chain at a given point in time. The area of the rectangles is the value of the particular element of inventory appearing on the balance sheet. By reducing costs, the height of the rectangles is decreased. By reducing cycle times, the width of the rectangles is reduced, resulting in a smaller area and therefore a lower valuation of the particular element of inventory. So both cost and cycle time reductions reduce the amount of capital lockup within a company.

A similar logic can be applied to the accounts payable and receivable, respectively. The widths of these boxes represent payment terms, or, as a performance measure, the days payable/receivable outstanding. The heights represent the amount appearing on the corresponding inbound or outbound invoices. Cash inflows and outflows do not have a “cycle time,” but they have a value, and influence the amount of cash the company holds in the balance sheet. Figure does not show the cash pool. Because production processes are here considered a “black box,” the figure shows this element not as a rectangle but as a trapezoid. This represents the value-adding activities taking place in this phase, with costs incurred appearing in accounts payable. However, in a more detailed analysis, these aspects could be included.

Continuation in next subsection (1.7.3b).

Course section 1.7: Subsections and their intended learning outcomes