Supply Chain: A Game of Horseshoes?

Supply chain is not like a game of horseshoes. Or is it?

When I was a teenager in the mountains of West Virginia we would close a good BBQ by playing a game of horseshoes. In a horseshoe game there are two ways to score. The first is by throwing "ringers" (the center of the horseshoe is on the  stake). The second is throwing and getting closest to the stake.

Winning at Horseshoes

A ringer is a thrown horseshoe such that the horseshoe completely encircles the stake. Sometimes it is not clear if the throw is really a ringer. When a player throws a ringer the score increases by three points.

Disputes are settled by using a ruler to touch the two points at the ends of the horseshoe, called "heel calks." If the ruler doesn't touch the stake then the horseshoe is a ringer. A live shoe that is not a ringer, but comes to rest six inches (6”) or closer to the stake, has a value of one (1) point. If both of one player's horseshoes are closer than the opponent's, two points are scored. In the case of one ringer and a closer horseshoe, both horseshoes are scored for a total of four points. If a player throws two ringers, then that player scores six points. If each player throws a ringer, the ringers cancel and no points are scored. If two ringers are thrown by one player, and one ringer by the opponent, the player throwing two ringers scores three points. This is typically called "two dead and three" or "three ringers three" for score-keeping purposes. Such occurrences are called "dead ringers" and are still used toward the pitcher/ringer average. Backyard games can be played to any number of points that is agreed upon, but are usually to 21 points. The win happens when the final score is hit and by more than two. This scoring system gives rise to the popular expression "Close only counts in horseshoes." An elaborate scoring system by most standards, but well defined for backyard play.

What Defines Winning in Supply Chain?

Traditionally the supply chain leader was measured by cost reduction. Today supply chain leaders are being asked to deliver value. However, unlike the game of horseshoes, there is no industry standard definition for value or supply chain excellence.

This bothered me. In 2012, when I wrote the book Bricks Matter, Keith Harrison, Director of the Product Supply team for P&G told me, “How do you define value?”  I sighed and thought, “What sounds so easy is not easy at all.” My response to Keith was, “I am building a system to help supply chain leaders maximize market capitalization.” (Number of shares outstanding by the price of the shares.) He responded by saying, “I am not so sure. There are many factors that affect market capitalization which are beyond the supply chain leader’s control.”

I left the call uncertain. Was Keith right? Was market capitalization the right proxy for supply chain value??? In my course at Temple University for my DBA, I thought that it would be a good summer project. I did an intense academic research study over four months to gain insights on how to determine how to define supply chain value. Surprisingly, I found no common answer; but in the process, I learned some valuable lessons:

-What Can We Learn from Others? The industry analyst community rarely uses academic research as a basis for discovery. Academics use published research as the starting place. When I was a Gartner and AMR Research analyst, I never did a literature search. I also never correlated my research studies to financial results. (The data was just too hard to obtain.) The definitions of research in the analyst and academic communities are very different. The only thing the two have in common is the name “research.” So when someone uses the term research in conversations, stop and ask for the definition. Research projects should always start with an understanding of prior research.

-What Is Research? The academic research lags the reality of business processes by five to seven years. Most of the best academic research on supply chain excellence is from Europe with a focus on manufacturing or transportation planning. It is simplistic. The work we are doing at Supply Chain Insights on the correlation of quantitative studies to financial performance is unique. And, I must add, it is hard. The work we are doing on the Supply Chain Metrics That Matter reports during April through September this year will be a deep analysis of 32 industries for the period of 2006-2012. We will include all public companies in the analysis. In the process, we will mine the trends. Our goal is to publish our third Supply Chains to Admire report in July. Each company will get an award at the Supply Chain Insights Global Summit.

-What Is Value? There is no academic definition of supply chain value. In the process, I stumbled on the concept of Price to Book. Since I had previously used market capitalization as an objective function, I searched for the definition of this new measure. When I did, I discovered two ratios: Price to Book, and Price to Tangible Book Value. Within the firm, 60-80% of total costs are controlled by the supply chain team. In parallel, most of the physical assets are driven and/or defined by supply chain strategy. While market capitalization is often driven by economic cycles we find Price to Tangible Book Value (PTBV) is a more disciplined look at value. Price to Tangible Book Value is calculated by dividing the share price of a public company by its tangible book value per share. It is a ratio depicting what investors are paying for each dollar of physical assets. For example, let's assume that Company XYZ has 10,000,000 shares outstanding which are trading at $3 per share. Let’s assume that the same company’s tangible book value was $15,000,000 last year. The calculation would be:  

Price to Tangible Book Value = $3 / ($15,000,000/10,000,000) = 2.0

The PTBV ratio excludes intangibles: intellectual property, patents, goodwill and other intangible assets. It is a representation of what debt holders or investors would receive if the company liquidated all physical assets. As a result, I feel that it is a measure which supply chain leaders can impact. In my analysis of the Supply Chain Metrics That Matter, to use a horseshoe analogy, I am using Price to Tangible Book Value as my stake for a “ringer.” During the next three months we will take a closer look at 32 industries, as defined by NAICS codes, to understand which companies have driven the greatest value using an analysis of supply chain performance, improvement and the correlation to Price to Tangible Book Value.

A Closer Look at Industries: What Is Value?

Unlike other methodologies that put all industries in a spreadsheet and sort the spreadsheet by growth, days of inventory and Return on Assets; and then take the answer to a popularity vote (50% of the final answer is driven by popularity or supply chain leader input), we at Supply Chain Insights have focused on understanding the trends by industry and ranking progress by performance on the metrics that have the highest correlation to market capitalization and measuring year-over-year improvement for the period of 2006-2015, and then comparing the results to Price to Tangible Book Value.

Results for the Pharmaceutical and Medical Device Industries.

Our first analysis is to take a hard look at value chains, and the relative players within the value network. When we take the healthcare value chain, we find no company exercising power to drive value network excellence. This would include defining industry standards, building trading networks, redefining delivery platforms and streamlining value to the patient. Instead, we find that within the healthcare value network that the focus is on traditional buying and selling relationships. [Examples of a powerbroker improving supply chain excellence in a value network would be TMSC in the semiconductor industry (sharing digital information on new chip performance in the die banks with upstream designers), Airbus in A&D (building of a value network with SupplyOn for Suppliers), Walmart’s building of RetailLink to share information with suppliers and P&G/Smucker’s/Wegman’s and Coca-Cola’s work on building GS1 standards.] When we take a look at the value network, pharmaceutical companies are making the most progress; but overall, the network is not making progress overall. There is no company in the healthcare value chain taking leadership to drive overall value network improvement. Instead, it is about enterprise efficiency. (Comparison of industry averages in the value network for 2006 (pre-recession) as compared to full-year 2015 reporting (post-recession results).

To read the chart in Table 1, let's start with a look at pharmaceutical growth. For the period of 2006-2015, the average growth was 10%; but when we compare the growth rate of 2006 with the growth rate of 2015, the industry growth rate is up 40%. There is a marked increase in growth post recession. In a similar fashion, the pharmaceutical companies have a very high average operating margin  of 22% for the period of 2006-2015 (highest in the value network). When we compare the average of 2006 to 2015 the growth rate increased 5%.

Table 1. Industry Progress on Value Networks

The analysis of industry excellence needs to be industry specific. As will be seen in the analysis, the results for the medical device supply chain are vastly different than those in the pharmaceutical supply chain industry. This is true even though the two industries serve the same customer.

Who did it the best? In the pharmaceutical industry there are no ringers. However, when we look at improvement and performance for the decade, we see that Biogen and Novo Nordisk are the top performers. They have driven higher levels of improvement as measured by the Supply Chain Index, and they are also higher performing on Price to Tangible Book Value.

Table 2. Price to Tangible Book Value as Compared to Relative Supply Chain Improvement

Table 3. Performance and Relative Improvement of the Pharmaceutical Industry Supply Chains for 2006-2015

There is a higher value on Price to Tangible Book Value when the portfolio of growth, operating margin, inventory turns and ROIC is improved together. Higher levels of value are about portfolio management: it is not about singular metrics.

In comparison, when we evaluate the medical device industry, we can see that Becton Dickinson is the top performer. They beat the industry average on the Supply Chain Metrics That Matter and are Driving Supply Chain Improvement. They also have higher values of Price to Tangible Book Value. They outperform  on all the metrics and will make the list of our Supply Chains to Admire 2016.

In horseshoe scoring terms, Becton Dickinson, in the medical device industry, is a "ringer", and Novo Nordisk and Biogen in Pharmaceuticals are "live shoes."

Table 4. Price to Tangible Book Value as Compared to Relative Supply Chain Improvement for Medical Device Supply Chains

Table 5. Performance and Improvement for Medical Device Companies for the Supply Chain Metrics That Matter in the Medical Device Industry for 2006-2015

So the next time that you share a supply chain strategy with your team and use the word "supply chain excellence" or "value," realize that you may need a ruler to measure which supply chain is closer on the Supply Chain Metrics That Matter. After this realization, take your team to play a game of horseshoes. You may find that the rules are easier. (For more on this analysis check out our full reports on SlideShare. And if you are in a different industry, sign up for our newsletter. We will let you know when it publishes.) Then take a deep sigh that there are now some rules to help you drive value. We hope you can celebrate with us that these rules are objective and not subject to a vote in a beauty contest. (I would certainly hate to tie my career to a popularity poll. Or explain the rationale to a shareholder activist that wants tangible value.)

We look forward to getting your thoughts on the methodology. The more research I do, the more I learn. At ISM this week, one of the participants told me, "Lora, I love your methodology, but it is not easy to understand. It takes some studying, but when you get it I believe it is the superior methodology in the industry. I think that you need a class to explain it." I agree. I will be teaching the methodology at the ISCEA conference in Chicago on July 20-21 and I have just finished building a program using CorpU's guided learning platform. I am looking for ambassadors to stress test this guided learning program. (If interested, send me an email through LinkedIn.)

Until then, I will be traveling/speaking to CSCMP in Barcelona and Peru to gain their insights.

About Lora

Lora Cecere is the Founder of Supply Chain Insights. She is trying to redefine the industry analyst model to make it friendlier and more useful for supply chain leaders. Lora has written the books Supply Chain Metrics That Matter and Bricks Matter, and is currently working on her third book, Leadership Matters. She also actively blogs on her Supply Chain Insights website, at the Supply Chain Shaman blog, and for Forbes. When not writing or running her company, Lora is training for a triathlon, taking classes for her DBA degree in research, knitting and quilting for her new granddaughter, and doing tendu (s) and Dégagé (s) to dome her feet for pointe work at the ballet barre. Lora thinks that we are never too old to learn or to push for excellence.