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. 1.7.3.1, 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 1.7.3.2.
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. 1.7.3.2 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 1.7.3.1. 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
1.7 Scenarios and Exercises
Intended learning outcomes: Describe improvements in meeting entrepreneurial objectives. Differentiate between entrepreneurial objectives and the ROI. Assessing the Economic Value Added (EVA) of Supply Chain Initiatives. Derive rough-cut business objects from detailed business objects.
1.7.1 Exercise: Improvements in Meeting Entrepreneurial Objectives
Intended learning outcomes: Identify several problems with regard to the entrepreneurial objectives for an example company that manufactures a single product. Disclose and discuss possible measures in each of the four target areas (quality, costs, delivery, and flexibility).
1.7.2 Scenario: Entrepreneurial Objectives and ROI
Intended learning outcomes: Explain, using examples, how to determine exactly whether the increase in revenue will be cancelled out by the increased costs for improvement measures in the four target areas (quality, costs, delivery, and flexibility).
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.
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).
1.7.4 Exercise: Rough-Cut Business Objects
Intended learning outcomes: Explain how to determine the process plan, the rough-cut process plan, and a possible load profile for an example product P.
