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Putting a Price on Supply Chain Problems Study links supply chain glitches with falling stock prices. By T.J. Becker |
WHEN A COMPANY ANNOUNCES a supply chain
malfunction such as production or shipment delays, its stock price tumbles nearly 9 percent and losses can be as great as 20 percent over six months, according to a study by Vinod Singhal, an associate professor of operations
management at the Georgia Institute of Technology, and Kevin Hendricks, associate professor of operations management at the University of Western Ontario.
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"Supply chain management (SCM) is on everyone's mind. But any data about its payoff
has been anecdotal or based on case studies," Singhal says. And that makes it tough to get buy-in from managers. An expensive and time-consuming process, SCM can require anything from new software to new infrastructure.
"If I'm a manager, I want to know what's the real value of SCM," Singhal explains. "Why should I invest millions of dollars to improve the effectiveness of my supply chain?"
Because information about a company's supply chain performance is typically off-limits to researchers, Singhal and Hendricks found another way to benchmark the value of SCM. They searched for articles in The Wall Street Journal and Dow Jones News Service from 1989 to 1998, looking for news of supply chain problems. Finding examples for 861 public companies, Singhal and Hendricks then analyzed how those glitches affected stock prices, using three different models to adjust for normal stock market movements.
When a supply chain malfunction is announced, stock prices plunge an average of 8.62 percent, and shareholder wealth decreases by $120 million or more per company.
"Everyone intuitively knows that having problems with your supply chain will affect performance, but people have been hard-pressed to know exactly what that impact is," says Soumen Ghosh, a professor of operations management at Georgia Tech. "Vinod's and Kevin's study is one of the first that quantifies the detrimental impact."
Even the researchers were surprised by the results. "I didn't expect it to be this dramatic," says Singhal, who anticipated decreases would be in the 2 to 3 percent range.
Yet fallout was even more far-reaching than the 8.62 percent loss. In the 90-day period before a supply-chain problem was reported in the press, stock prices eroded 9 percent, which researchers attribute to news of the glitch leaking out to investors before the formal announcement.
What's more, when Singhal and Hendricks examined stock performance 90 days after the announcement, prices continued to slip. For the entire 180-day period, supply chain glitches caused a 20 percent drop in stock value.
"If the market overreacted to the news, then stock should have regained some of its value," Singhal says. "So this is a fundamental loss. It tells you that the market takes a very dim view of supply chain problems."
In another surprise, it didn't matter who or what caused the problem, stock prices still dropped.
The six most common causes of supply chain glitches include: parts shortages, changes requested by customers, new product ramp/rollouts, production problems, development problems and quality problems. Researchers expected investors to be more punitive if the malfunction was caused by internal company problems. But stock plunged 8.29 percent when internal problems caused the glitch, compared with an 11.97 percent decrease when a supplier caused the problem and an 8.48 percent drop when customers caused the problem.
"Even if it's not your fault, you're still going to pay," Singhal observes.
And fickle customers are a fact of life. "If you can't respond to their demands, they'll find someone that will," he adds. "Similarly, suppliers will not always perform to your expectations."
Even if companies have perfect internal operations, they can't relax; it's crucial to collaborate with supply chain partners and share information. "You can't go it alone," he says.
Supply chain glitches hit some companies harder than others. High-growth firms saw their stock drop 10.81 percent on the day a supply chain problem was reported in the media, compared to a 5.89 percent decrease for low-growth firms. Small firms lost 9.85 percent in stock value, while large firms slipped 7.68 percent.
High-growth firms are vulnerable because they typically have short product lifecycles, high margins and require short delivery times. Smaller companies are more at risk because the glitch is likely to affect a greater fraction of their sales. Also, they may not have the resources to put technology in place that could speed recovery.
With all the hype about SCM, the researchers expected to see recent supply chain problems take the greatest toll on firms. But when Singhal and Hendricks compared glitches that occurred after December 1995 with previous snafus, there was little difference. "The market has always placed a premium on a well-functioning supply chain," Singhal says.
"In some sense, we're presenting the darker side by showing what happens if you don't take action or your efforts aren't effective," he adds. Yet building responsive supply chains requires substantial time and money. Top management must be involved, and one of the best ways to grab their attention is to show how SCM impacts the bottom line - for better or worse.
"By showing them the negative consequences, you can make a case," Singhal explains.
T.J. Becker is a Florida-based freelance writer.
For more information, contact Vinod Singhal, College of Management, Georgia Tech, Atlanta, GA 30332-0520. (Telephone: 404-894-4908) (E-mail: vinod.singhal@mgt.gatech.edu).
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Last updated: Nov. 12, 2001