Dr. Jarrod Goentzel is Director of the Massachusetts Institute of Technology (MIT) Humanitarian Response Lab and a Lecturer at the MIT Center for Transportation and Logistics.
James B. Rice Jr. is Deputy Director of Massachusetts Institute of Technology (MIT) Center for Transportation and Logistics, Director of the MIT Supply Chain Exchange, and a lecturer at MIT.
Shareholders invest their hard-earned money in corporations with the expectation that the enterprises will make smart investments in operational assets that grow the company and deliver dividends. Most of these assets reside in the supply chain, which is why supply chain professionals need to be able to speak like financial analysts. Executives have a much better chance of making decisions that keep shareholders happy if the supply chain function can explain how asset investments affect margins, turnover, and, ultimately, cash flow.
For the past few years, we have been teaching a graduate-level course focused on supply chain finance at the Massachusetts Institute of Technology (MIT) Center for Transportation & Logistics. Our aim is to seed the supply chain profession with graduates who have basic fluency in the language of finance. This knowledge quickly proves valuable; students report that they have more engaging discussions during their job interviews, even after just a few sessions in the course. But financial fluency is useful long after the job interview is over. It provides long-term benefits by allowing operations professionals to better assess and communicate the value of the supply chain initiatives they seek to implement.
For those of you who cannot take nine months off from work to pursue a graduate degree, here are seven takeaways from our course that we believe will help you to be both financially savvy and articulate.
1. Understand the financial impact of supply chain activities. Supply chain managers need to understand the correlation between supply chain management activities and key financial statements such as the corporate balance sheet and income statement.
The balance sheet is a single-point-in-time "snapshot" of a company's assets, liabilities, and shareholders' equity, and includes inventory, accounts receivable, and accounts payable. The income statement provides a summary of the company's revenues and costs over a defined period of time, and includes a listing of the direct and indirect costs at a high level. These are not the only important financial statements, but they are two of the more important ones for the business as a whole and for the chief financial officer (CFO).
Recognizing those connections is critical because the supply chain manager has to "speak the language" of the CFO in order to get senior executive support. Senior executives do not want to hear about cost structures and inventory turns; they want to understand the supply chain's impact on gross profits and working capital. To make your case, you need to be able to quickly and clearly communicate that information.
2. DuPont analysis distinguishes the role of profitability and turnover in creating returns. DuPont analysis is a fundamental approach to financial management that is couched in a simple formula:
Return on Assets (ROA) = Profit Margin * Asset Turnover1
Used by the chemical manufacturer DuPont since the 1920s, this formula helps a company find the right "chemistry" between the financial statement (focused on profits) and the balance sheet (focused on asset turns).
Focusing on these measures can help broaden supply chain initiatives beyond cost and inventory reductions, since those measures can demonstrate that higher prices (perhaps achieved through better service delivery) also improve margins and better asset utilization (perhaps by loading trucks with more freight) also improves asset turns. In addition, although we always seek the win-win of improving both margins and turnover, often there is a trade-off between the two. For example, refusing to discount slow-selling items results in higher margins but lower turnover, because inventories remain on the books longer.
Supply chain professionals can assess decisions at a high level if they can map them to the DuPont ratios and (continuing the example above) determine when discounting might actually improve the ROA. Recently some companies have turned to economic value added (EVA) as an alternate way to evaluate trade-offs between profitability and assets. This concept is also dated, as General Electric (GE) used it in the 1950s under the term "residual income."
3. Be aware that accounting is a practice, not a science. We often think of accounting as an exact science because it involves numbers that are clear and documented. But since accounting is the practice and method for recording and classifying the sources and uses of funds, it involves both an objective and a subjective element.
The recording process is rigorous and highly structured, almost always involving tangible items with discrete values associated with them. The classifying process, however, is less exacting, with industry guidelines such as Generally Accepted Accounting Principles (GAAP) giving the accountant some discretion as to how to classify transactions. A business therefore has several options to consider for recording various transactions. Should we record this purchase as a period expense, or as a capital asset purchase? When should we record the official date of sale? How long will this capital asset last, and how fast should we depreciate the asset? Should we record assets on a last-in-first-out (LIFO) or first-in-first-out (FIFO) basis? What internal costing method should we use, and how should we allocate overhead costs?
Giving the accountant options for classifying various transactions makes sense because the same period expenditure may represent different things to different companies. A computer that serves as a standard office-support device in one company, for instance, could be classified as a critical corporate asset in another. However, this level of discretion can also get some executives and companies into costly scandals, many of which involve supply chain managers as unwitting partners. Consider, for example, the 2004 case of the pharmaceutical company Bristol-Meyers Squibb, which had to pay a US $150 million settlement fee for inflating its financial results by "stuffing its distribution channels with excess inventory near the end of every quarter," according to the U.S. Securities and Exchange Commission.2 Who made those shipments? Supply chain managers, of course.
Supply chain managers need to be aware of these potential pitfalls, and should be prepared to probe cost "data" supplied by the accounting department. For instance, does the company use LIFO or FIFO methods of recording inventory assets? That matters a lot if you are responsible for inventory because, depending on which method is used, a specified dollar amount of inventory may represent very different unit volumes. This is because the LIFO method records inventory-asset costs using the most recently purchased materials, and FIFO records inventory assets using the oldest inventory on the books. In most cases the purchase cost for additional inventory assets increases over time, which means that for the same number of units in inventory, the dollar value of that inventory on the books tends to be lower using LIFO than if the company used FIFO. For example, if you bought five units last week for $10 each, and five units this week for $20 each, you would have 10 units on hand at a total cost of $150. If you then sold five units, the remaining inventory of five units on hand would be recorded as $50 using LIFO, and $100 using FIFO.
Another thing to keep in mind is that the cost-accounting system that the company uses to allocate direct and indirect costs to products and customers provides critical operating information that can sway supply chain decisions. Different cost systems make different assumptions about how costs should be recorded (for example, how overhead costs such as utilities should be allocated to products or the processes used by products), and they use different granularity of data. As a result, one product may have much more overhead allocated to it than another. In that case, the manager may choose to focus attention on that product because it is a higher-cost unit. Under a different cost system, however, that same product may have a lower total cost, and the manager may choose to address a concern about another product instead. Deciding where to focus improvement efforts, then, depends in large part on the nature and the quality of the information provided by the costing system.
4. Activity-based costing requires a big investment but may also offer big benefits. Choosing the right cost-accounting method to support internal management decision making involves a trade-off: the amount of time and effort it takes to capture and record cost data versus the benefit that can be derived from that data. This is a consideration for any company that uses activity-based costing (ABC), a structured method for associating costs with business activities that continues to grow in popularity. ABC can more accurately tie the costs of activities conducted in production or delivery of a product or service to the potential revenues from those activities.
The information obtained by applying ABC can be extremely powerful and can help to identify inequities arising from the use of traditional "average costing" methods. These traditional practices overstate some internally reported product costs and understate others, leading decision makers to invest in the wrong products and services.
Here is just one example of the kind of difference ABC can make. Transportation service providers can benefit by applying ABC to their operations because it allows them to properly associate the real drivers of cost with the delivery of their services. The decision by both UPS and FedEx to adopt dimensional-weight pricing on all parcels in part reflects their recognition that pricing small parcels solely on the weight of the box did not accurately reflect what it costs them to ship and handle those boxes.
The challenge in adopting ABC is finding the right level of detail so that the cost to acquire the information does not exceed the benefit of collecting it. If that balance is maintained, the extra effort involved in ABC should reward managers with better information and the ability to make better decisions across the supply chain.
5. Don't hold on to holding cost. Many supply chain professionals (and business students in general) are introduced to the concepts of inventory holding cost, also known as inventory carrying cost, when they are taught how to calculate economic order quantity (EOQ). This is an essential parameter for setting inventory policies by estimating the cost of maintaining stock, which is a combination of capital and storage costs. Often, this holding cost parameter, which can range from 10-40 percent of the product value annually, is also used to calculate the savings from an inventory reduction. However, this "grab bag" of financial components can lead one to miscalculate (and often underestimate) the value of an inventory reduction.
Lowering the inventory level required to run your business reduces working capital requirements in perpetuity, not just in the year that reduction is implemented. Also, changes in the non-capital components of holding cost, such as warehouse facilities, equipment, labor, and shrinkage, among others, can affect the financial statements in multiple places. For example, lower costs lead to higher profits and thus, higher taxes.
Calculating projected cash flows using pro forma financial statements better captures the impact of the non-capital costs; these future cash flows can then be transformed into a current value by discounting them to consider the "time value" of money. (The "time value" concept recognizes that money available now is worth more than the same amount in the future, because it has greater earning capacity.) This discounted cash-flow (DCF) analysis of projected cash flows can also incorporate the perpetuity of reduced working capital and is the right approach for calculating the value of an inventory reduction. DCF also happens to be a language that your finance colleagues are more comfortable speaking when discussing any capital request that enables your inventory initiative.
6. Cash flows are relevant. As mentioned above, DCF analysis is a common approach for making capital-allocation decisions. The challenge is determining which cash flows are relevant. Our class sessions on DCF are not focused on how to do the calculations (although we do encourage our students to create an Excel template with the sophisticated sensitivity analysis that everyone uses for making such decisions). Instead, we consider one supply chain situation after another—software purchases, transportation mode options, make-versus-buy decisions, and so forth—and ask students which cash flows should be included in their DCF spreadsheet.
There are two key tests to determine whether a cash flow is relevant: (1) ensuring that there is actually a cash transaction, and not just an accounting calculation such as depreciation, and (2) confirming that the cash really does make a difference if the capital project is implemented, and is not a cognitive concept like sunk cost (a cost that has already been incurred and can't be recovered).
7. Supply chain has a big influence on working capital. When financial managers are looking to reduce working capital—that is, the difference between current assets and current liabilities—they often ask supply chain managers to reduce inventory. But supply chain managers also impact the other components of working capital: receivables from customers and payables to suppliers.
By virtue of their close working relationships with both suppliers and customers, supply chain managers can exercise great influence on terms and performance in each of these areas, putting themselves at the heart of capital and cash management. For example, Dell Computers famously operated on negative working capital back in the 1990s. The company popularized make-to-order computer sales, which relied on prepayments from customers and also consignment inventory from suppliers, enabling Dell to essentially operate on other people's money. Supply chain strategy and management, of course, played an indispensable role in making that possible.
Optimize your portfolio
The supply chain is the driver of value creation for most companies. While supply chain professionals are not financial advisors picking stocks for shareholders, they do make the key decisions about where to invest much of the capital that investors provide. And although picking finished-goods stocks for inventory is not as glamorous as picking Wall Street stocks, optimizing the portfolio of finished goods can have a significant impact on investors' financial portfolios.
Our graduate course provides a foundation for future professionals to connect their actions in the supply chain with business performance. We hope that you will take a cue from our students and increase your fluency in finance. It can turn into cash ... for your company and for your own wallet.
Notes: 1. Traditional DuPont analysis does consider ROE (Return on Equity) = Profit Margin * Asset Turnover * Financial Leverage, but as supply chain professionals do not have much influence on financial leverage, we focus on the ROA terms. 2. U.S. Securities and Exchange Commission, "Bristol-Myers Squibb Company Agrees to Pay $150 Million to Settle Fraud Charges" (August 4, 2004).
Supply chain planning (SCP) leaders working on transformation efforts are focused on two major high-impact technology trends, including composite AI and supply chain data governance, according to a study from Gartner, Inc.
"SCP leaders are in the process of developing transformation roadmaps that will prioritize delivering on advanced decision intelligence and automated decision making," Eva Dawkins, Director Analyst in Gartner’s Supply Chain practice, said in a release. "Composite AI, which is the combined application of different AI techniques to improve learning efficiency, will drive the optimization and automation of many planning activities at scale, while supply chain data governance is the foundational key for digital transformation.”
Their pursuit of those roadmaps is often complicated by frequent disruptions and the rapid pace of technological innovation. But Gartner says those leaders can accelerate the realized value of technology investments by facilitating a shift from IT-led to business-led digital leadership, with SCP leaders taking ownership of multidisciplinary teams to advance business operations, channels and products.
“A sound data governance strategy supports advanced technologies, such as composite AI, while also facilitating collaboration throughout the supply chain technology ecosystem,” said Dawkins. “Without attention to data governance, SCP leaders will likely struggle to achieve their expected ROI on key technology investments.”
The U.S. manufacturing sector has become an engine of new job creation over the past four years, thanks to a combination of federal incentives and mega-trends like nearshoring and the clean energy boom, according to the industrial real estate firm Savills.
While those manufacturing announcements have softened slightly from their 2022 high point, they remain historically elevated. And the sector’s growth outlook remains strong, regardless of the results of the November U.S. presidential election, the company said in its September “Savills Manufacturing Report.”
From 2021 to 2024, over 995,000 new U.S. manufacturing jobs were announced, with two thirds in advanced sectors like electric vehicles (EVs) and batteries, semiconductors, clean energy, and biomanufacturing. After peaking at 350,000 news jobs in 2022, the growth pace has slowed, with 2024 expected to see just over half that number.
But the ingredients are in place to sustain the hot temperature of American manufacturing expansion in 2025 and beyond, the company said. According to Savills, that’s because the U.S. manufacturing revival is fueled by $910 billion in federal incentives—including the Inflation Reduction Act, CHIPS and Science Act, and Infrastructure Investment and Jobs Act—much of which has not yet been spent. Domestic production is also expected to be boosted by new tariffs, including a planned rise in semiconductor tariffs to 50% in 2025 and an increase in tariffs on Chinese EVs from 25% to 100%.
Certain geographical regions will see greater manufacturing growth than others, since just eight states account for 47% of new manufacturing jobs and over 6.3 billion square feet of industrial space, with 197 million more square feet under development. They are: Arizona, Georgia, Michigan, Ohio, North Carolina, South Carolina, Texas, and Tennessee.
Across the border, Mexico’s manufacturing sector has also seen “revolutionary” growth driven by nearshoring strategies targeting U.S. markets and offering lower-cost labor, with a workforce that is now even cheaper than in China. Over the past four years, that country has launched 27 new plants, each creating over 500 jobs. Unlike the U.S. focus on tech manufacturing, Mexico focuses on traditional sectors such as automative parts, appliances, and consumer goods.
Looking at the future, the U.S. manufacturing sector’s growth outlook remains strong, regardless of the results of November’s presidential election, Savills said. That’s because both candidates favor protectionist trade policies, and since significant change to federal incentives would require a single party to control both the legislative and executive branches. Rather than relying on changes in political leadership, future growth of U.S. manufacturing now hinges on finding affordable, reliable power amid increasing competition between manufacturing sites and data centers, Savills said.
The number of container ships waiting outside U.S. East and Gulf Coast ports has swelled from just three vessels on Sunday to 54 on Thursday as a dockworker strike has swiftly halted bustling container traffic at some of the nation’s business facilities, according to analysis by Everstream Analytics.
As of Thursday morning, the two ports with the biggest traffic jams are Savannah (15 ships) and New York (14), followed by single-digit numbers at Mobile, Charleston, Houston, Philadelphia, Norfolk, Baltimore, and Miami, Everstream said.
The impact of that clogged flow of goods will depend on how long the strike lasts, analysts with Moody’s said. The firm’s Moody’s Analytics division estimates the strike will cause a daily hit to the U.S. economy of at least $500 million in the coming days. But that impact will jump to $2 billion per day if the strike persists for several weeks.
The immediate cost of the strike can be seen in rising surcharges and rerouting delays, which can be absorbed by most enterprise-scale companies but hit small and medium-sized businesses particularly hard, a report from Container xChange says.
“The timing of this strike is especially challenging as we are in our traditional peak season. While many pulled forward shipments earlier this year to mitigate risks, stockpiled inventories will only cushion businesses for so long. If the strike continues for an extended period, we could see significant strain on container availability and shipping schedules,” Christian Roeloffs, cofounder and CEO of Container xChange, said in a release.
“For small and medium-sized container traders, this could result in skyrocketing logistics costs and delays, making it harder to secure containers. The longer the disruption lasts, the more difficult it will be for these businesses to keep pace with market demands,” Roeloffs said.
Jason Kra kicked off his presentation at the Council of Supply Chain Management Professionals (CSCMP) EDGE Conference on Tuesday morning with a question: “How do we use data in assessing what countries we should be investing in for future supply chain decisions?” As president of Li & Fung where he oversees the supply chain solutions company’s wholesale and distribution business in the U.S., Kra understands that many companies are looking for ways to assess risk in their supply chains and diversify their operations beyond China. To properly assess risk, however, you need quality data and a decision model, he said.
In January 2024, in addition to his full-time job, Kra joined American University’s Kogod School of Business as an adjunct professor of the school’s master’s program where he decided to find some answers to his above question about data.
For his research, he created the following situation: “How can data be used to assess the attractiveness of scalable apparel-producing countries for planning based on stability and predictability, and what factors should be considered in the decision-making process to de-risk country diversification decisions?”
Since diversification and resilience have been hot topics in the supply chain space since the U.S.’s 2017 trade war with China, Kra sought to find a way to apply a scientific method to assess supply chain risk. He specifically wanted to answer the following questions:
1.Which methodology is most appropriate to investigate when selecting a country to produce apparel in based on weighted criteria?
2.What criteria should be used to evaluate a production country’s suitability for scalable manufacturing as a future investment?
3.What are the weights (relative importance) of each criterion?
4.How can this methodology be utilized to assess the suitability of production countries for scalable apparel manufacturing and to create a country ranking?
5.Will the criteria and methodology apply to other industries?
After creating a list of criteria and weight rankings based on importance, Kra reached out to 70 senior managers with 20+ years of experience and C-suite executives to get their feedback. What he found was a big difference in criteria/weight rankings between the C-suite and senior managers.
“That huge gap is a good area for future research,” said Kra. “If you don’t have alignment between your C-suite and your senior managers who are doing a lot of the execution, you’re never going to achieve the goals you set as a company.”
With the research results, Kra created a decision model for country selection that can be applied to any industry and customized based on a company’s unique needs. That model includes discussing the data findings, creating a list of diversification countries, and finally, looking at future trends to factor in (like exponential technology, speed, types of supply chains and geopolitics, and sustainability).
After showcasing his research data to the EDGE audience, Kra ended his presentation by sharing some key takeaways from his research:
China diversification strategies alone are not enough. The world will continue to be volatile and disruptive. Country and region diversification is the only protection.
Managers need to balance trade-offs between what is optimal and what is acceptable regarding supply chain decisions. Decision-makers need to find the best country at the lowest price, with the most dependability.
There is a disconnect or misalignment between C-suite executives and senior managers who execute the strategy. So further education and alignment is critical.
Data-driven decision-making for your company/industry: This can be done for any industry—the data is customizable, and there are many “free” sources you can access to put together regional and country data. Utilizing data helps eliminate path dependency (for example, relying on a lean or just-in-time inventory) and keeps executives and managers aligned.
“Look at the business you envision in the future,” said Kra, “and make that your model for today.”
Turning around a failing warehouse operation demands a similar methodology to how emergency room doctors triage troubled patients at the hospital, a speaker said today in a session at the Council of Supply Chain Management Professionals (CSCMP)’s EDGE Conference in Nashville.
There are many reasons that a warehouse might start to miss its targets, such as a sudden volume increase or a new IT system implementation gone wrong, said Adri McCaskill, general manager for iPlan’s Warehouse Management business unit. But whatever the cause, the basic rescue strategy is the same: “Just like medicine, you do triage,” she said. “The most life-threatening problem we try to solve first. And only then, once we’ve stopped the bleeding, we can move on.”
In McCaskill’s comparison, just as a doctor might have to break some ribs through energetic CPR to get a patient’s heart beating again, a failing warehouse might need to recover by “breaking some ribs” in a business sense, such as making management changes or stock write-downs.
Once the business has made some stopgap solutions to “stop the bleeding,” it can proceed to a disciplined recovery, she said. And to reach their final goal, managers can use the classic tools of people, process, and technology to improve what she called the three most important key performance indicators (KPIs): on time in full (OTIF), inventory accuracy, and staff turnover.