Can Seprod overcome complexity in order to improve their position on the Effective Frontier?

sclaimer

This article makes reference to Seprod Limited's financial data, retrieved from the Seprod Limited Audited Financial Statements (2010 - 2020) available on www.jamstockex.com

To be clear I am not a financial analyst, although I try my best to discern useful information from the available data. This article and the opinions therein are not intended to give guidance on investment or any form of speculation and should not be treated as such. It is instead a review of financial statements with a particular interest into the insight to be gained into supply chain management.

Any modern for profit organization must align its strategic objectives with its supply chain capabilities and values. The firm must strike a balance between efficiency and responsiveness, the key to managing this delicate balance resides within the interactions between logistical and cross functional drivers that drive supply chain performance.

Because these drivers influence the financial measures that show a firm's financial performance, the financial statement is always a good place to start looking for supply chain issues; if you know what you're looking for.

The Intersection of Cash-to-Cash Cycle and Inventory Turnover Ratio

Seprod Limited C2C v. ITR (2010 - 2020)

The diagram pictured above is called an Orbit Chart, think of it as a diagrammatical representation of a firm's path relative to the intersection of two indicators (metrics); in this instance Cash-to-Cash Cycle (C2C) and Inventory Turnover Ratio (ITR).

But, how can an orbit chart give us insight into the Seprod supply chain? Holistic management is the management of wholes, John Adair writes about it in his book Effective Decision Making. Supply management is the most holistic of management sciences, it's also about managing trade-offs.

What trade-offs did Seprod have to make in order to achieve their strategic supply chain objectives? By looking at the inter-relatedness of key indicators we can learn more about their operations. Inventory Turnover Ratio measures how well a company generates sales from its inventory. It measures how many times during a given period a company buys and then sells it's inventory.

Inventory Turnover Ratio (ITR) = Cost of Goods Sold (Direct Expense)/ Average Annual Inventory*

* - see Note 1

Cash-to-Cash Cycle is a compound indicator that is a combination more than one indicator, mathematically it is:

C2C = (Days Inventory + Days Receivable) - Days Payable

C2C Cycle shows on average how long it takes a firm to convert cash as an input to revenue as an output. Why is the inter-relatedness or intersection of these two key indicators important to us and more so to Seprod? Because when firms profit seek it adds complexity to their supply chains due to the fact that firms can only grow revenue through improved sales (it must be noted that revenue growth is however not the only way to improve margins) they can do this in a couple of ways either by increasing prices, volumes or market share.

We have seen where Seprod has undertaken a growth initiative absorbing the operations of two former competitors dramatically increasing their product mix, market share - and complexity. Complexity decreases margins and contributes to reduced inventory turns, when you decrease C2C Cycles you increase inventory turns; another side-effect is an increase in working capital. A good understanding of these inter-relations (trade-offs) and their outcomes is key to supply chain strategic alignment and the creation of surplus within the supply chain.

Between 2015 and 2019 Seprod's Gross Revenues grew by an astonishing 58.18%, during that same period Profit Margin averaged 4.27% moving from a high of 5.55% in 2016 to 2.98% in 2019; such is the impact of complexity within supply chains.

According to the orbit chart we can see where Seprod's best overall performance was in 2015 with ITR of 6.36, a C2C Cycle of just +58.41 days, Days Payable was 65.08 Days [9.29 Weeks] and Days Receivables 46.11 Days [6.58 Weeks] essentially what this means is that Seprod were able to use money owed to its suppliers to finance its operations which is not just good for their operations but good for working capital as well. By looking at the chart we can see where the impact of complexity started to affect Seprod's C2C Cycle causing a 47.01% increase when we compare 2016 to 2015.

Obviously something had to be done about this issue as I am certain the management was aware, however without this sort of holistic approach to managing trade-offs it would be difficult for them to foresee the outcomes. C2C Cycle increased to +158.99 Days or 63.26% more than their previous best performance; except that this time added complexity was also beginning to impact ITR which was down 25.19% when compared to their previous best performance.

By 2017 the management at Seprod had begun to turn the corner on their runaway C2C Cycle, no doubt through strong fiscal policy and astute management. By 2020 they had brought it to heel at +102.37 Days still 42.94% off their previous best performance but some feat considering the sheer complexity that was added to their supply chain during the same period.

Seprod Limited v. Competitor - C2C v. ITR (2013 - 2020)

In the diagram above we can see a comparison between Seprod and a competitor, it can be seen that the spread [Range] for the C2C and ITR data is narrower with the competitor; this is because of the competitor's position on the effective frontier - they manage growth, profitability, cycles and complexity better than Seprod. They have been operating with complexity longer and have adapted mental models, systems and processes to compensate for it. Seprod must move to quickly learn and improve their position on the effective frontier if they are to erode the competitor's advantages by adopting new mental models as well that will allow them to look at supply chain issues holistically.

Non the less I expect Seprod to continue the trend established in 2018 into 2021 as they improve on the efficiency of their supply chain operations. Recently their CEO Richard Pandohie has been very vocal about the impacts of supply chain issues on their operations and it seems that he's made supply chain a top priority. They've committed to the construction of a world class logistics facility, the integration and alignment of their business units and processes as well as improvements in talent density that will allow them to improve on their supply chain performance. There has also been a significant push towards digitalization and the creation of an e-commerce channel - the investments in infrastructure will only serve to reduce their cost-to-serve and impact the bottom line directly.

The Intersection of Operating Margins and Inventory Turnover Ratio

Seprod Limited OM v. ITR (2010 - 2020)

The Orbit Chart above illustrates the performance over time of the intersection of Operating Margins and Inventory Turnover Ratio for Seprod Limited. The Operating Margin indicates the share of a firm's revenues that remains after paying for the variable costs of production relative to the revenues that the firm is able to generate - essentially it is a measure of the efficiency of the supply chain operations.

From the chart it can be seen that Seprod has struggled to balance strategic objectives with performance, it is quite difficult in fact to drive year-over-year improvements in performance metrics. Essentially Seprod's Operating Margin in 2020 [12.40%] is right where the story began in 2010 [12.34%] - Does this mean that they have not improved?

Quite the contrary; Seprod's complexity is significantly greater than it was 10 years ago, for them to be able to produce margins of that kind must be commended. Furthermore it can be seen that improving operating efficiency is a key strategic objective for Seprod and is clearly one of their main values.

However, because operating margin is a main objective it will influence their decision making; that drive to improve margins will push firms to increase revenues. As discussed earlier the methods used to arrive at those increases in revenues can have a significant impact on complexity, costs and ultimately margins.

Recently Seprod has made significant improvements in operational efficiency although corresponding improvements in Inventory Turnover Ratio have not been forthcoming. This may be due to the fact that Seprod does not appear to be a demand driven operation but rather sales driven. Other factors that impact low inventory turnover include misaligned S&OP planning, misaligned metrics, and channel stuffing.

Demand Driven strategies require the creation of outside-in processes, this can tend to rock the boat in terms of the distribution of the power dynamics in firms but it's necessary if they are to improve. In order to change Seprod must:

1. Use demand sensing technologies
2. Better management of demand shaping activities (price, promotions, trade incentives, etc.)
3. Reduce Demand Latency

Revenues v. Operating Margin - Seprod Limited 2010 - 2020

Notwithstanding Seprod has been able to improve their revenues consistently over the ten year period under review - this speaks directly to management's commitment to their strategic objectives. They have only since 2019 started to see the impacts of what is known as the Growth Trap where firm's revenue growth gains are eroded by complexity resulting in declining operating margins. But this is nothing new and all firms must wrestle with this phenomenon at some point and given Seprod's resilience and track record for consistency, I can only see a positive outcome for them in this regard.

Let us compare Seprod's OM v. ITR performance with that of a competitor to see how resilient Seprod's supply chain is.

Seprod Limited v. Competitor - OM v. ITR (2010 - 2020)

As can be seen from the orbit chart the competitor's spread [Range] for Operating Margins is wider than Seprod's. This means that they have struggled more to come up with a definitive strategy to improve on operating efficiency. However the competitor has the edge on Seprod with regard to Inventory Turnover Ratio having improvements year-over-year for three years ending 2020.

This is either a clear indication of a superior procure-to-pay process or a benefit of scale economies. That is however not the full story as the spread of the data points indicates that Seprod is more resilient than the competitor - this is perhaps due to the level of internationalization of supply chains. The competitor's performance is clearly more susceptible to changes in the context of business. It may also speak to supply chain innovation, sustaining v. disruptive and the competitor's willingness to try new things relative to Seprod's more restrained approach for incremental improvements.

As is evidenced by this report Seprod must maintain a balanced scorecard of inter-related metrics, redefine how value is created, charged for and eroded within their organization, improve their competitive advantages and redefine their processes to reduce demand latency thereby improving C2C cycles, ITR and customer service levels. They must manage growth, profitability, cycles and complexity and continue to innovate if they are to move their firm up the effective frontier.

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Appendix

Seprod Limited Metrics That Matter (2010 - 2020)

Financial Statements 2010 - 2020 (Source www.jamstockex.com)

Notes:

1. Annual Average Inventory was not used in the calculation of Inventory Turnover Ratio. Instead the inventory amount used was that for the current year as stated in the audited financial statements.