Broken Links in Supply Chain Cause Serious Damage

Like a heart-attack victim felled by poor circulation, companies who suffer a sudden blockage in their flow of products to consumers face a long road to recovery, says Vinod Singhal, professor of operations management at Georgia Tech College of Management.

"Disruptions in the supply chain devastate corporate performance," says Singhal, who recently conducted several related studies of supply-chain failure in collaboration with Kevin Hendricks, associate professor of operations management at the University of Western Ontario. Their research shows that disruptions do long-lasting damage to companies' stock prices and profitability.

"Firms continue to operate for at least two years at a lower performance level after experiencing a disruption," says Singhal, whose study, "An Empirical Analysis of the Effect of Supply-Chain Disruptions on Long-Run Stock Price Performance and Risk of the Firm," appears in the latest issue of Production and Operations Management. "It does not matter who caused the disruption, what the reason for the disruption was, what industry a firm belongs to, or when the disruption happened."

Supply-chain disruptions are on the rise in many industries, partly because of the growing reliance on overseas' suppliers for components, Singhal says. For example, when Motorola introduced its first camera phone in late 2003, the company couldn't acquire enough lenses and chipsets to meet demand for the hot product. Sony, Boeing, Hershey, Nike and Cisco are just a handful of other big companies hurt by disruptions in recent years. Small businesses are particularly vulnerable to the ill effects of disruptions because they're focused on fewer products and wield less clout with supply-chain partners, Singhal says.

Though sometimes the unpredictable result of disasters like earthquakes or terrorist acts, supply-chain disruptions often could be prevented by better risk management, he says. Symptoms of an impending disruption are usually evident well in advance, he notes. "As with a heart attack, companies suddenly feel a lot of pain, but there have long been plenty of indications that they're not doing so well," he says. "If the companies involved had planned better, the disruption could have been avoided."

Singhal and Hendricks' research shows that in the year leading up to the disruption, firms on average experience a 107 percent decrease in operating income, 7 percent lower sales growth, and an 11 percent growth in cost. They suffer 33 to 40 percent lower stock returns (relative to their industry benchmarks) over a three-year period, starting one year before and ending two years after the announcement of the disruption. Share-price volatility rises by 13.5 percent in the year after a disruption.

"Although it seems obvious that a supply-chain glitch would affect profitability, little has been done to measure the fallout," says Singhal, who analyzed more than 800 supply-chain disruptions that were publicly announced from 1989 to 2000. "We were very surprised by how much impact disruptions make."

Overemphasis on cost cutting has removed too much slack from supply chains, increasing the incidence of broken links, says Singhal, whose study, "Association between Supply Chain Glitches and Operating Performance" is due for publication later this year in the journal Management Science. "While efficient and lean supply chains are desirable objectives, they should not come at the expense of reliability and responsiveness," he says.

Executives should pay more attention to supply-chain issues because heightened scrutiny of corporate governance has made them more directly responsible for earnings forecasts, Singhal says. He recommends that they build more flexibility into the supply chain, increase the accuracy of demand forecasts, improve their risk-management strategies, and invest in available technologies that can provide early-warning of supply problems, among other steps.

For more information, contact Vinod Singhal at 404-894-4908 or vinod.singhal@mgt.gatech.edu.