07 Aug 2012Working Paper Summaries

When Supply-Chain Disruptions Matter

by William Schmidt and Ananth Raman

Disruptions to a firm's operations and supply chain can be costly to the firm and its investors. Many companies have been subjected to such disruptions, and the impact on company value varies widely. Do disruption and firm characteristics systematically influence the impact? In this paper, the authors identify factors that cause some disruptions to be more damaging to firm value than others. Insight into this issue can help managers identify exposures and target risk-mitigation efforts. Such insights will also help investors determine whether a company is exposed to more damaging disruptions. Key concepts include:

The type of disruption matters in identifying the magnitude of a disruption's impact on a firm's share price.
Disruptions attributed to factors within the firm or its supply chain are far more damaging than disruptions attributed to external factors.
A higher rate of improvement in operating performance aggravates the impact of internal disruptions but not external disruptions.
Management should be prudent about decisions to streamline operations and to reduce buffers and excess capacity.
Some efficiency improvements may be attractive during periods of relative operational stability, but firms with high rates of improvement in operational performance could face distressing reductions in market value if they subsequently experience an internal disruption.

Author Abstract

Supply-chain disruptions can have a material effect on company value, but this impact varies considerably and countermeasures can be costly. Thus, it is important for managers and investors to recognize the types of disruptions and the organizational factors that lead to the worst outcomes. Prior research remains unsettled as to whether improvements to firm operational efficiency aggravate or alleviate the impact of disruptions. Improved operational efficiency may leave firms more exposed when a disruption occurs, or it may improve firms' agility and allow them to respond more effectively to a disruption. We hypothesize that the impact of improved operational efficiency depends on whether the disruption is due to factors that are internal versus external to the firm and its supply chain. Examining more than 500 disruptions, we find that a higher rate of improvement in operating performance aggravates the impact of internal disruptions but not external disruptions. This supports the theory that firms which improve operation performance may do so at the cost of increased operational fragility, and this fragility is revealed to investors by the occurrence of an internal disruption.