are companies stuck?” asked Joe.
“The leader of operations knows that inventory cycles and costs need to be managed together. Each industry has a different set of rhythms and cycles. When complexity increases, these change. It is an industry-specific response. Over the past decade, the progress of industries has varied. Most companies are plateaued. Progress in corporate performance is stalled. Companies in the consumer electronics and consumer packaged-goods industries have made the most progress. Other industries, like apparel and automotive, are going backward and losing ground,” I said as I showed him Figure 1.4.
Figure 1.4 Performance Plateau
Source: Supply Chain Insights Metrics That Matter Series (www.supplychaininsights.com).
“It is easy to slip,” Joe said as he gazed into the parking lot. The sun shone brightly as the bus stopped to let children off onto the sidewalk across the street in front of his office. “One of our issues is alignment. Every meeting is like the first day in school where we're trying to find our place. We have similar tasks but we are competing with each other.”
“Yes, I know,” I said following his gaze out the window. “To drive organizational alignment, companies need to understand the trade-offs, and what is possible, while defining the Effective Frontier and managing it as a complex system. It's like knowing what needs to be done to graduate to the next grade. They also need to choose the right metrics. It requires going back to school to rethink the basics of business.”
“These trade-offs cannot be determined just by setting up a spreadsheet. It requires the use of more advanced analytics. The use of modeling techniques allows companies to determine the appropriate targets in each metrics area to align against potential. To understand the concept of metrics balance, my research team has been evaluating the progress of each industry based on peer group metrics from each of the areas of the Effective Frontier,” I said, while pushing the sheet shown in Table 1.4 across his desk. “These are available from corporate balance sheets and income statements; but we find that there are few repositories of this data to enable analysis of multiple years of data and to capture the patterns, so we've put together a unique data repository of our own from our research.”
Table 1.4 Financial Ratios Analyzed to Understand the Effective Frontier
Source: Supply Chain Insights LLC.
“Yes,” Joe said. “I'm glad the metrics are available, but I'm too busy to try to sort out what's relevant to us. I'd like to take a look at what you've put together on this so we can do some benchmarking.” The discussion then turned to a review of the research and what we could do together with his leadership team to build a guiding coalition to support the company's expansion into Brazil. I gave him an excerpt from a new book I was writing about the Effective Frontier to read when he got a minute.
Defining the Research Methodology to Understand Progress on the Effective Frontier
The definitions of ratios most commonly used in the analysis of corporate performance in this book are provided in the Appendix.
This book is the culmination of a three-year research project to understand effectiveness. To write this book, we built a database using public sources of information. We then grouped the data by NAICS codes, and began plotting the intersections of the Effective Frontier manually using orbit charts to understand the trends. We then began to review the patterns of the plots with industry leaders to gain insights into the drivers of the trends.
An orbit chart may seem abstract at first – like a modern art painting of wavy lines – but we have found that it is the best way to study the patterns, or progression, of operational metric performance over time.
Let's take a closer look. Figure 1.5 is an orbit chart example. This is the pattern, or progression, for Walmart for the period of 2002–2012 at the intersection of two metrics: inventory turns and operating margin. The averages for the period are shown in the box along with the stock ticker symbol. In each orbit chart, because the metrics can get confusing, we identify which corner of the chart points toward the best scenario. Note that Walmart has made great improvements on inventory, but not in margins. As we will see later, Walmart is an example of a company that has made great strides in improving the efficiency of operations, but not in driving overall effectiveness.
Figure 1.5 Example of an Orbit Chart
Source: Supply Chain Insights LLC, Corporate Annual Reports 2000–2013 from One Source.
I continued, “Joe, as we have mined the data, we find three intersections of the financial ratios to have the most interesting patterns. Each offers a distinctly different view, and you cannot assess improvement without looking at the three together.” I wrote the three intersections on the whiteboard in his office:
1. Inventory turns versus operating margins
2. Year-over-year growth versus return on invested capital
3. Revenue per employee versus inventory turns
Joe hurriedly scribbled them down. As I worked with Joe, I found that he was writing more and more notes to himself in his black notebook. His intensity amused me. He was such an eager and willing student.
Details Matter: The Nitty-Gritty of the Analysis
“It's hard work,” I continued. “In fact, we underestimated the amount of work to do the analysis of corporate balance sheet data and the determination of the Effective Frontier. When we started the analysis, we used absolute numbers, but we ended up using financial ratios. This shift enabled the comparison of companies across currencies and enabled us to better understand the trends of companies of differing sizes. After plotting the trends, we partnered with an operations research team at Arizona State University to help define the methodology to determine balance and resiliency. The data is complex, and we wanted to define a simple methodology to translate abstract patterns into meaningful insights.”
“I have difficulty doing this type of analysis, but when I see your research, I love it. I am a fan,” said Joe. “It's one thing to talk about corporate performance, and another to understand how it transforms a balance sheet. When I get to the point when I understand this, I will feel real pride.”
I smiled and nodded in agreement. “Let me share some insights. One of our first big insights when we started looking at performance results was the danger of using compound metrics in a vacuum. Let me explain: A compound metric is the result of a combination of individual metrics. For example, the two most commonly used compound metrics that one finds in corporate measurement systems are ‘cash-to-cash’ and ‘perfect order.’ Let's take cash-to-cash.” I then turned to his board and wrote, “Cash-to-cash (C2C) = Days of receivables (DOR) + Days of inventory (DOI) – Days of payables (DOP) outstanding.”
Continuing, I said, “So, when you look at progress in C2C, as a leader, you must ask a series of questions:
• What drove the change?
• Did we change the policies with our customers, resulting in a change in DOR, or did we make the terms longer with our suppliers, increasing DOP? Or did we make improvements in inventory (DOI)?
• How have these
