Battling Diminished Value

Protecting your profits and balance sheet with supply chain flexibility

The ability to deliver quality goods or services efficiently to the customer at the right time and place is one of the most basic tenets of effective supply chain management. When unforeseeable failures occur pertaining to time or place, goods in the supply chain are at risk of facing diminished value, ultimately resulting in a drop of total transaction value and a significant impact to profit and the balance sheet.

If a shipment is not delivered to the right place on time, a manufacturer may have to dramatically reduce its selling price due to delayed customer fulfillment. Higher shipping costs may be incurred in order to expedite delivery of goods. Customer satisfaction levels may decline, resulting in loss of future orders and revenue.

As unpredictable occurrences lay in wait to wreak havoc with your supply chain, companies must design supply chains that are flexible enough to quickly address potential delivery risks, protect the total transaction value of goods and play a key role in optimizing sales. How can improved supply chain management positively influence the company's income statement and balance sheet? What measures or processes can you put in place to proactively generate improved sales and reduce diminished value?

Examples of Diminished Value:

  • Missed selling season. Back-to-school children's clothing arrives after the peak sales season, resulting in 55 percent price markdown of inventory. Or, Christmas trees are delivered to the lot a week late, virtually rendering all stock worthless.
  • Deadline penalties. An electronics manufacturer faces a four-day port processing delay as the shipment is missing the proper Country-of-Origin information. Per the manufacturers' contract with its customer, the manufacturer faces a penalty of $15,000 for each day that the shipment is late.
  • Poor customer service. A highly anticipated novel is due to become available to the public on November 2, but when the shipments fail to arrive at your chain of 3,500 stores on time, customers purchase the book elsewhere. When the shipments arrive a week later, interest in the book remains strong, but not as strong as the first week of its launch. .

Is Sales Value at Risk?

In order to determine whether or not your product's sales value is at risk, you must first have a strong grasp on other key influencing factors:

  • Understand the value of the product's "seasonality." Is there a long season or short season of opportunity to make sales and profit? What happens to value once the product is out of season?
  • As sales orders progress, know the risks to inventory not being delivered on time and/or to the right place.
  • Have flexible supply chain functions that can help recover when the delivery targets are at risk.
  • Know the financial trade-offs so you can make intelligent business decisions for corrective action.

Protecting Your Profit?

Flexibility in the supply chain is required to protect sales profits and battle diminished value risk, but the more choices and options the supply chain has, the more processes need to be designed and measured. Flexible supply chain processes are by nature complex because flexibility implies the ability to change outcomes as product moves. The following are steps to consider when designing a flexible supply chain that addresses order fulfillment variability:

  • Begin by understanding the value of time, place, product quantity and assortment for a single product.
  • Determine what product lines have seasonal price sensitivity and delivery variability.
  • Measure, quantify and establish revenue erosion curves for seasonal products.
  • Establish customer fulfillment criteria for each supply chain activity. Establish order fulfillment targets, set notification messages when targets are missed, and track the order against them.
  • At each critical point in the supply chain ask three simple questions:
    — What is the current situation?
    — What if we do nothing?
    — What is the desired outcome?
  • Determine if there is a capability to make the desired outcome happen.
  • Measure and implement a corrective action program for each supply chain activity.
    — Measure the magnitude of the activity to determine its relevance.
    — Measure process quality, analyze defects and implement corrective action.
    — Measure the efficiency of the process and results of corrective actions.
    — Measure the elapsed and actual time it takes for transactions to minimize time to market.
  • Design your supply chain to be "smart" by feeding it historical and real time information so it can perform "best outcome analysis" and "talk" to you.

Arming yourself with flexibility and financial knowledge can help battle diminished value risk. To illustrate, consider the hypothetical case of a manufacturer whose shipment of two oil rig engines (valued at a gross profit of $375,000) was misrouted, causing a projected delivery delay of 22 days. Each day that the shipment was late, the manufacturer incurred a penalty of $15,000 or a total of $330,000 (22 late days x $15,000). By acting quickly and considering the financial risks, the company was able to reship two new engines that would arrive to the customer in six days. Though the manufacturer faced additional shipping costs and a penalty of $90,000 (six late days x $15,000), it was determined that, by acting quickly, the manufacturer could still retain a significant portion of its gross profit while salvaging a potentially lucrative future customer relationship.

About the Author: As the Global Product Executive for the Logistics product suite with the Global Trade Services group at JPMorgan, Bernie Hart leads a business of 650+ employees that delivers end-to-end global risk management and operational solutions that drive cost savings, increase efficiency and provide best-in-class compliance across physical and financial supply chains.