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This week, Gartner is hosting their annual supply chain conference. A major item on the agenda is the announcement of what used to be named the AMR Top 25. It is now the Gartner Supply Chain Top 25. While the name has changed, the methodology has remained fairly constant, with a only a few changes, since 2004.


The research tries to establish “who did supply chain best” by looking at a weighted formula of Year-over-Year Growth, Return on Assets (ROA), and Inventory Turns for the Fortune 500 companies.  The formula is a weighted average of three years of financial data for year-over-year growth and return on assets. (The first year is weighted at 50% and the subsequent years at 25%.) Inventory Turns values are based on an average of quarterly reporting for the past year.  These values are then rolled up into a score where all of the companies of the Fortune 500 are stack-ranked across industries. This data is then shared with Gartner's industry analysts, and the analysts vote on which companies they think exemplify supply chain excellence. The industry analysts' vote represents 25% of the score. The data is also shared with industry peers and the peer group vote represents 25% of the score.

The AMR Top 25 was the first methodology that tried to connect financial metrics with supply chain excellence. The intent was good. It elevated the discussion on supply chain excellence and drove more discipline and rigor in the use of financial metrics. But, the methodology has some basic problems. I cannot get past these hiccups:

  • Each industry is different. I feel company progress needs to be assessed within a company’s individual peer group. The methodology is biased to reward companies with few assets. As a result, asset-intensive companies like chemical or semiconductor will never win this beauty pageant. As a result, the crowned leader will always be a consumer electronics company or an e-commerce player. I strongly feel that putting all the companies in a spreadsheet, and treating them equally using the same formula, is not helpful to anyone. For example, take the information on the improvement in revenue per employee in figure 1.  See how different the progress is on this metric by industry?


revenue per employee chart


Each industry sector has a different potential and a different set of drivers. Some industries have made progress against this goal, others have made very little.

  • The approach is too simplistic.  Over the course of the last year, I have been working with Abby Mayer (@indexgirl), a Research Associate on our Supply Chain Insights team, to correlate 21 financial ratios to market capitalization data.  We have taken six years of quarterly market capitalization data and evaluated companies within Morningstar sectors. We are analyzing 36 sectors and have completed 30%. (It is our goal to release the results for all sectors on September 11-12, 2013 at our annual Supply Chain Insights Global Summit) In the course of doing these correlations, and formulating an equation to predict market valuations, we found that the industry sectors are very different and that the correlations to market capitalization are low using only these three ratios. For example, compare the financial ratios that matter in the consumer value chain.  The retail sector formula has far different metrics than the chemical industry.




  • Over-dependency on ROA. So far in our analysis, ROA has only correlated in the chemical industry; for the rest, the better correlation has been ROIC (Return on Invested Capital). What is the difference? Return on Assets (ROA) is net income/total assets. ROIC is operating income/ total liabilities and shareholders' equity.  ROIC is a better measurement of the effectiveness of capital investments. In our determination of 10 out of the 36 Morningstar sectors, we find only three industries to have a correlation between market capitalization and ROA. That's the chemical industry, medical devices and packaged food.  We find that seven out of the ten Morningstar sectors also have a correlation to ROIC. Three of the ten have correlations to Return on Net Assets which is defined as net income/(property plant equipment + total current assets – total current liabilities).
  • It should not be a Beauty Pageant. When I was an analyst at AMR Research, and a company would reel into one of our conference rooms to convince us how good they were at supply chain to improve their rating, it was hard for me to not take offense. I do believe that peer ratings matter, but I think that the impact on the financial balance sheet should represent at least 70% of the measurement.
  • The methodology should be applicable to all companies. Supply chain leaders everywhere would like a methodology that is applicable to big companies and little companies and across currencies. It is for this reason that we have focused on building the Supply Chain Index.
  • Inventory Turns is only part of the story. In our analysis, we find the correlation of market capitalization to inventory to occur in seven industry sectors; but, we also find correlations to Days of Payables in seven out of ten Morningstar sectors and Working Capital Ratio correlations in six of the ten Morning Star sectors. (Working Capital Ratio is (total current assets – total current liabilities)/revenue)
  • Capital Markets reward balance in a Portfolio of Metrics. If the goal is improving market capitalization, three financial ratios are too simplistic. Capital market and financial market capitalization rewards a portfolio of metrics that are balanced.  For more on this, see the PowerPoint slide deck on SlideShare that we will be reviewing this Thursday afternoon in our Supply Chain Index Part II - How and Why? webinar.
  • Industry progress. I am surprised that when companies are compared within a sector for a period of five to ten years, that there is marginal to no improvement in the financial ratios, that can be improved by the supply chain organization to improve market capitalization. I find clear industry leaders in consumer packaged goods, food & beverage, consumer electronics, the semiconductor industry and mass retail. However, in many industries like chemical, branded pharmaceutical, apparel, medical device, and grocery retail, I find many companies to be stalled or going backwards. I think that we need to better understand why some industry sectors are able to power growth while balancing costs, cycles and complexity. We do not have these answers yet.
  • Risk and Altman Z-score. Different industries carry a different measurement of risk. In our analysis, we find that five of the Morningstar sectors have a correlation to the Altman Z-score factor (packaged food, medical device companies, major pharmaceutical companies, generic pharmaceutical companies and medical instruments/supplies). This composite factor has the strongest correlation for major branded pharmaceutical companies.  The Altman Z-score factor is an output of a credit strength test that gauges a publicly traded manufacturing company's likelihood of bankruptcy. Can a supply chain team have a direct effect on improving the Altman Z-score? Check out the equation below, I believe that the answer is “YES!”



At the end of the day, the market will decide. The readers of this blog know that I take the definition of supply chain excellence very seriously, and just want to be sure that there is an educated audience to make the decision. While I laud AMR for taking the first step, I do not think that they have taken the research far enough.  Join us for our webinar today, and stay in touch with our work on analyzing financial ratios.

We are on a countdown for our Supply Chain Insights Global Summit in September. At that time we will launch all 36 equations for each Morningstar sector, including the analysis of industry sector performance, and let you decide.


Changing Mental Models

Posted by lcecere May 22, 2013

Over the course of the last week, I have been working on healthcare research. We finished our report on the maturation of hospital supply chains, and I have put the finishing touches on the Healthcare Supply Chain Index for this Thursday's webinar. I also had the opportunity to speak at the GHX conference and facilitate a leadership workshop on the required changes for implantable devices.  As I worked with healthcare leaders, and shared the research available on slideshare, I better understood the individuals' pain.


Here are some of the quotes from the workshop I led yesterday that helped me to better understand the industry:

  • “A process born out of chaos is chaos. The problem is us. We have to change the mental model of our organizations to move forward.” Medical Device Manufacturer
  • “Does everyone realize how bad the problem is? We cannot process map ourselves out of this problem, it requires new thinking.” New Supply Chain Leader of a Regional Children’s Hospital
  • “We have used Lean process systems and swim-laned ourselves to death. Today, we are efficiently swimming in the lanes without alignment on value-based outcomes.” Supply Chain Leader of a Large Hospital
  • “We are a large part of the problem. We cannot drive change without taking a hard look at ourselves. It starts with redefining our processes and what we reward.” Supply Chain Leader of a Large Hospital


Healthcare is at a pivotal transition point. I firmly believe that supply chain leadership can make a difference. Over the last decade, power shifted in the healthcare value chain. Originally healthcare suppliers sold to physicians. At the dawn of the decade, the supplier had the power.  In the last five years, while the physician is still important, the buying decisions transitioned from the supplier to the care provider. It is now shifting again. With the introduction of managed care, the transition of power is to the payer. It needs to shift to the patient.


No one questions the statement that managed care will dramatically affect the healthcare value chain. The change will not be incremental: It will be a step change. Hospital receivables will lengthen and supply chain roles within the hospital will become more important. The traditional focus on efficient sickness will shift to health and wellness. It requires a redesign, from inside-out to outside-in, based on value-based outcomes. The change in accountable healthcare will give more voice to the patient. Data driven discussions on patient satisfaction, readmittance rates and hospital-induced infections will be transformative.


The question in front of us is “How do we get started?” Hospitals are fragmented. They are small regional players. While processes have matured, it is hard for individual healthcare providers to get traction.


Suppliers now have a dance partner. But, the tune has changed, and they are unsure how to dance together. Hospital supply chains have matured. Seventy-five percent of hospitals have a supply chain organization. The average tenure of the supply chain professional in the hospital is six years. Hospital supply chain teams have 1/3 the tenure of the supplier’s supply chain organization. The most common reporting relationship in the organization is to the hospital's Chief Financial Officer (CFO). The most common reporting relationship in the supplier organization is to a leader of supply (focus on logistics, distribution, materials sourcing and customer service). The focus has been on sourcing and managed costs. They lack the greater understanding of planning and value network design. While hospital supply chain organizations have made progress in the last decade, the gap has widened between the supplier sectors of pharmaceuticals and medical device manufacturers and other manufacturing industries.


For suppliers, the focus has been on the supply chain organization as a function, not the building of end-to-end processes. Both sets of trading partners have concrete mental models that define the supply chain. For the hospital, the focus has been on materials management and negotiating of lower costs. While 72% have a value analysis team, they have not matured to assess value. These processes are still in their infancy. They are primarily focused on cost management on new purchase decisions. By and large, they struggle to gain cross-functional alignment on process redesign to improve outcomes. They lack the understanding of continuous improvement programs and struggle with alignment.


cost cutting efforts


Most care providers are working to get physician and clinical alignment to focus on the right balance of standardization, product utilization, and innovation. The historic practice of incentives for direct payment to physicians drives bad behavior that is hard to control.  Through employee downsizing and consignment-based sales, they have shifted costs to the suppliers. These costs now lack controls. The answers to healthcare are about much, much more than process mapping.


In contrast, suppliers are large and global players. Over the course of the last five years, they have fought the shift in power. In fighting for every sale they have become very sales-driven. They have taken on consignment-based sales without redesigning processes outside-in.  (In exchange for acceptance of a consignment model, suppliers could have redesigned processes to enable better sharing of daily usage and case scheduling on a daily basis.) The mental model is one of supply. For the supplier team, they see the supply chain as a function. They struggle to define end-to-end processes. The teams fight for recognition to participate in top-to-top meetings. In the evolution of supply chain excellence over the last decade, the gap in core capabilities to drive supply chain excellence has grown between healthcare suppliers and other industries. They have lost core talent while the industry is facing a talent shortage.


There are new challenges:

  • With managed care, in the United States, the hospital will bear the costs of infections from hospital stays. The standards for accountable care are evolving.
  • 63% of hospital operating room costs are implantable devices. The supply chain for implantable devices is complex and immature.
  • Pharmaceutical products are growing more complex. Cold chain capabilities and serialization require a redesign in product handling and supply chain execution.
  • The industry has created the most complex rebate incentives of any industry value chain. The administration of bifurcated trade is a barrier to the improvement of trading partner relationships. The changes in reimbursement make this even more complex.
  • Pharmaceutical companies are facing a patent cliff with a 24% decline in operating margins over the last decade.


What should Companies Do?


This cannot be about process mapping and improvement of the current state. It requires a shift in the mental model and leadership. New models are required. This is both an opportunity and a risk for existing organizations:


Focus on value-based outcomes of accountable care and map the processes outside in. Question conventional models. Be open to the use of new technologies, the evolution of processes, new business models and the disintermediation of existing trading partner relationships.Accept the definitions of processes and relationships of the industry. Limit your focus to the current definitions within the hospital or supplier organizations. The value chain is lacking supply chain leadership. Both sets of trading partners have grown up with a mental model of supply without an understanding of design and demand.
Balance innovation and standardization. Get clear on the difference between sales-driven and market-driven initiatives. Reward supplier companies that enable innovation. Engage in data-driven discussions and actively design and participate in pilots. Lose sight of the patient and outcomes. Use unstructured text mining and learning systems to drive data-driven discussions of innovation.
Adopt standards; work on effective connectivity, and share daily data daily with trading partners. Reward companies that use the data through the design of new opportunities and price brackets.Accept conventional practices and models.
Reduce the complexity with bifurcated trade. Eliminate rebates, direct payments and services.Buckle to sales tactics and conventional relationships policies.
Map the entire supply chain and understand the costs, drivers and waste. Be sure to not overlook the inventory carrying costs and the impact of demand latency. Have the courage to have a different discussion in top-to-top meetings.Generalize procurement of materials.  Understand the usage and the link to accountable healthcare.
Work cross-functionally to gain a common understanding of the impact of accountable healthcare. Share financial and use data and engage in active continuous improvement programs around care.Look at the purchase of materials as a buy-sell transaction.


The good news is that trading partners want to get started. There is a compelling event to move a fragmented industry forward. The challenge is changing the mental model to move from supply-centered processes focused on transactions to more holistic supply chain thinking based on value-based outcomes.

For more on healthcare, check out our recent webinar.


If you are a healthcare supplier, we would love to hear your voice in the research that we are doing on supply chain practices. Please let us know your thoughts in our confidential survey.(If you share the data with us, we will be glad to share the data with your team.)
Please use this link:

Some helpful reports include:

Supply Chain Metrics That Matter:  The Cash-to-Cash Cycle
Published by Supply Chain Insights in November 2012.

Supply Chain Metrics That Matter: A Focus on the Pharmaceutical Industry
Published by Supply Chain Insights in December 2012.

Supply Chain Metrics That Matter: Driving Reliability in Margins
Published by Supply Chain Insights in January 2013.

Supply Chain Metrics That Matter: A Focus on Hospitals
Published by Supply Chain Insights in January 2013.

Supply Chain Metrics That Matter: A Focus on Medical Device Manufacturers
Published by Supply Chain Insights in February 2013.


Taking the Hill

Posted by lcecere May 15, 2013

For most companies, growth has slowed. Profits are sluggish. Complexity reigns and cycles are longer. The challenges and opportunities of business are greater. We believe that supply chain excellence helps a company to better balance demand and supply. We also believe that it helps companies to be more resilient: weathering demand and supply volatility while maximizing opportunities and mitigating risks. We believe that supply chain excellence matters and is important to improving financial market performance. After a decade of investment, many companies are asking me, "How do I take this next hill? How do I push forward? What does the future of supply chain excellence look like?" For many, despite spending 1.7% of revenue on supply chain applications, the promise of an agile, flexible supply chain that can respond as the business changes seems like an illusion.


This week, at Supply Chain Insights LLC, we published our 11th report in the series titled Supply Chain Metrics That Matter.  Over the course of a year, we analyzed a decade of financial data to gain an understanding of how companies and industry sectors are balancing growth, profitability, cycles and complexity. These reports are available in our community and on our website.



To write these reports, I work with Abby Mayer (twitter: @indexgirl), Research Associate at Supply Chain Insights. We start by analyzing industry sector progress on company growth, profitability, cycles and complexity. Using our database of financial ratios (shown here), we analyze company and industry sector progress over the last decade. Financial ratios allow us to analyze performance across the peer group (large against small companies) and across currencies. We look for year-over-year improvement. We also look for companies that have out-performed their peer groups. When we find these two characteristics, we interview industry leaders to analyze why. We do not believe that there is much value in putting all companies into a spreadsheet and shaking them up... or looking at singular metrics without analyzing the intricate trade-offs of the supply chain when viewed as a complex system.


In developing the methodology for this series of reports, we defined supply chain financial ratios and tracked the progress of each industry sector in scaling what we term the Supply Chain Effective Frontier (carefully making trade-offs on growth, profitability, cycles and complexity to improve shareholder value in financial markets). The table shows the financial ratios that we work with. In many of our reports in this series, we show clear patterns of the trade-offs made between operating margin and cash-t0-cash cycles, and operating margin and revenue/employee. Three trends are clear:


The industries are not making equal progress.  Companies are competitive. They are constantly asking us "Who does this best? Which industry sector can we learn from?" Through this series of reports, we now can see that consumer electronics has pulled ahead of the pack. Consumer Packaged Goods (CPG) and chemical companies are close behind, but they are having difficulty "taking the hill." The hospital industry has made progress, while the pharmaceutical and medical device companies are stalled. Apparel is actually moving backwards.


Companies that are good at planning—use of supply chain design and supply chain planning technologies—are outpacing other industries. Active management of value networks and scenario planning makes a difference. When companies look at singular metrics (labor costs or inventory), they have moved backwards.


There is no substitute for leadership. Industries that have formed cross-functional leadership teams combining source, make and deliver together have made the fastest progress. In parallel, when supply chain concepts are well-integrated into the design of trading partner relationships by both sales and procurement, there is an acceleration of value. The trade-offs are easier and the value network strategies more straightforward.


Aligning metrics matters. Companies making the fastest progress have designed metrics to ensure that all functions are held accountable for operating margin, cash-to-cash cycles, growth and productivity. When this happens, proxy metrics like Return on Assets (ROA), Overall Equipment Effectiveness (OEE), Days of Payables (DOP), Material Costs, Transportation Costs or Sales and General Administrative Costs (SG&A) can be discussed and trade-offs can be made easily cross-functionally. Functional metrics in isolation degrade value.


The gaps between industry sectors have widened over the decade. I have studied supply chain excellence for the last decade as an industry analyst. As I write these reports and work with Abby, I am amazed how much these gaps have widened. It is clear basics matter. Leaders manage the supply chain as a system and improve the potential of the system to make trade-offs. Laggards let the supply chain whip them around and make unconscious trade-offs through indecision. The gaps between the two have grown.


Supply Chain Excellence Matters.  In our work on the Supply Chain Index, where we are correlating progress on the Supply Chain Effective Frontier to financial market performance, we can see that supply chain matters. The leaders that have managed the supply chain as a complete system are able to achieve better financial market valuations. We will be sharing more on the Supply Chain Index over the summer in our monthly webinar series with a final summary presentation at our Global Summit in September. It is exciting to see the correlations.


In closing, in our writings and our research, the term supply chain means the processes from the customer's customer to the supplier's supplier. Unfortunately, for many of our readers, the word supply chain is now a politically charged term. We find this unfortunate and often disheartening. The shift in definitions can be a barrier to driving progress.


How so? For software application providers, it is often reduced as a subset of applications. I find it sad, when I attend a conference where the term supply chain is only used to describe supply chain execution (SCE) or  advanced planning optimization (APS).  Likewise, I find it sad when I work with a company that had defined the supply chain organization very narrowly. It is often reduced to be the Supply Chain Department that has been functionally defined to ONLY focus on a part of the supply chain like transportation, customer service or distribution planning. These limiting definitions confine the potential.

The companies that are the furthest along in "taking the hill" have a process manager focused on managing the "end-to-end supply chain." For these companies, the mission is clear. There is no debate on what supply chain means. It is about the company's ability to manage growth, profitability, cycles and complexity to improve the potential and capabilities of the company. In the end, isn't this what matters anyway? I have little energy to debate the term supply chain. I just want to get on with driving value.


We hope to see you on our upcoming webinar series as we share more on the Supply Chain Index.


I also hope that you enjoy the Supply Chain Metrics That Matter series. We enjoy writing them! We have learned a lot through this activity.


These reports will be the foundation of the new book that we are writing for 2014. We will release preview copies as ebooks over the course of the summer.


I will be writing the first draft of the manuscript on my way to South Africa on May 30th. Talk to you soon! We will share the insights on the Index and the Metrics that Matter over the summer. And, we look forward to your feedback!