Over these past weeks, Supply Chain Matters has been providing specific commentary noting that recent corporate profitability has been attributed directly to specific cost savings initiatives in and across supply chain areas.  The latest of these notations were our posts reflecting on recent profitability results for Wal-Mart and The Hershey Company.

In today’s Wall Street Journal, a rather insightful Abreast of the Market article by Tom Lauricella, Earning Are Strong, Sales Are Another Story (subscription required), validates the notion that a record number of U.S. companies have indeed beat earnings expectations in the third quarter,  and a big portion of these profits have come from cost-cutting vs. any substantial revenue growth. Thus far, revenues are on track to fall 10% overall, and without an upturn in U.S. sales, cost-cutting can only boost profits for so long.  A further notion from Wall Street is that companies are running so lean that should revenue growth pick-up in the coming months, operating margins would likely surge, giving an ever higher boost to profits.

Another key observation came from a Goldman Sachs analyst noting that most revenue surprises were heavily concentrated among health-care and technology companies, and more broadly among “intermediary” companies that make products such as semiconductors, rather than companies that sell finished goods.  If I paraphrase that statement, any revenue growth thus far has been concentrated in the lower tiers of value-chains, where inventory re-stocking has driven the bulk of incremental business activity vs. end-customers. An UBS analyst takes the opposite view, noting that a 3.8 percent rise in revenues measured against the second quarter is positive: “People have been unduly negative about the profit picture“.

I would caution certain Wall Street players not to be so optimistic about the potential for surging operating margins when sales do increase. All the evidence that I see leads me to believe that overall, supply and value-chains are at a very critical point in terms of their ability to support any rapid ramp-ups in revenue growth.  Similar to our commentary last Friday about the current warning signs in high-tech supply chains, many companies in manufacturing industries may have cut back too much in headcount and resources, and it make take months for dormant factories or fragile suppliers to be able to ramp-up and support any sustained sales growth. Instead of financial headlines praising increased margins and profitability, there may well be those that point to a breaking point in the ability of supply and value chains ability to support revenue growth.  Certainly there will be individual exception, but I suspect that on the whole, there have been too many cutbacks among industry supply chains to be able to quickly respond to a sudden upturn in revenues.

What’s the situation in your environment?

Have cutbacks in supply chain activities gone too far and cut too deep?

Please share your specific observations in the Comments section below this post, or participate in an interactive survey regarding 2010 supply chain budgets.

 Bob Ferrari