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

1.7.3b Scenario: An Example Representation of the Economic Value Added (EVA) of a Supply Chain Initiative

Intended learning outcomes: Explain an example representation of the value of a supply chain initiative (SCI) in the form of the Economic value added (EVA).

Continuation from previous subsection (1.7.3).

Any supply chain can be displayed according to Fig., providing an integrated view of operational supply chain performance and the resulting utilization of working capital. Using this visuali­zation to display a change in supply chain performance, resulting from the implementation of an SCI, makes it possible to calculate the contribution of the initiative to enterprise value, based on EVA. This is done by entering the data of the corresponding analysis into the structure as shown in Figure

The data in the figure are based on an example scenario fully described in [Schn10]. In short, the scenario describes an SCI in which a logistics service provider takes over supply and inventory-related management activities. From a logistics perspective, this increased the reliability of shipping and storing processes, with shorter lead times at lower costs per product. Because of lower return rates and higher product availability, the number of sold products and therefore turnover increased by $22,980. The higher volume results in higher total SC cost of $4,589 and higher taxes of $5,517. From a financial perspective, the NOPAT is disproportionately higher ($12,874).

Fig.         Example representation of an SCI value in the form of the EVA.

In addition to the perspective of the profit and loss statement, EVA integrates the changes on the balance sheet. The logistics performance improvements described above affect working capital in two dimensions. Shorter lead times reduce the cash-to-cash cycle time, representing the time capital is locked up as material in the supply chain. In addition, because costs per product could be reduced at several stages of the supply chain, the valuation of the material in the different inventory accounts is reduced, too. These relations are visible in Figure Both effects result in reduced capital lockup of $54,713. After being multiplied with the WACC of the company of 15%, this value and the NOPAT effect make up the total EVA contribution of the SCI of $21,081.

Consider the following scenario: A central distribution center (CDC) located in Switzerland wants to evaluate whether it would be beneficial to change the mode of transport to the regional distribution center (DC) located in the south of Norway. Currently, transportation is by truck in order to achieve short transportation cycle times (3 days). Transportation by ship would take 7 days but is cheaper. The title of inventory is transferred as soon as the products arrive at the DC. The relevant average inventory value at the CDC is $300,000 in the finished goods warehouse, plus average $25,000 in-transit inventory with transpor­ta­tion by truck. The average in-transit inventory would double when chang­ing the transportation to ships. At the same time, the annual trans­portation cost would decrease from $20,000 to $15,000, with pay­ment terms toward any carrier of 60 days. The WACC of the firm is 8%.

What is the effect of the change of the mode of transport on NOPAT and EVA after one year? Would you advise changing the transportation mode? Include a sensitivity analysis in your reasoning, as the values of the initial variables can vary in practice. Hint: As the SCVC method only calculates the change of the EVA contribution from a baseline to a changed scenario, you need to consider only values that differ between the scenarios. Solution:

  • NOPAT: +$5,000 (same sales – $5,000 less transportation cost)
  • Average value of accounts payable: from $3,333 ($20,000 / 12 months * 2 months payment terms) to $2,500
  • Capital lockup: +$25,833 ($25,000 higher average in-transit inventory plus $833 lower accounts payable)
  • EVA change: $5,000 - $25,833 * 8% (WACC) = +$2,933

Approaches for sensitivity analysis:

  • Sales could drop because of longer order fulfillment cycle time
  • Higher/lower WACC

Course section 1.7: Subsections and their intended learning outcomes