Supply Chain Metrics and Drivers

Supply Chain Drivers and Metrics

(Source: Supply Chain Management, Strategy, Planning and Operation, By Sunil Chopra,

Peter Meindl, D. V. Kalra‐Pearson)For academic purpose and private circulation

only

Financial Measures Of Performance

• Supply Chain Performance impacts financial

performance of each member of supply chain.

• Return on equity (ROE) is the main summary measure

of a firm’s performance.

• It measures the return on investment made by firm’s

shareholders

Higher value is desirable

Financial Measures of Performance

• Return on assets (ROA) measures the return earned

on each dollar invested by the firm in assets


assets totalAverage

interest before EarningsROA

assets totalAverage

)rateTax –1(expenseInterest incomeNet


• ROA can be written as the product of two

ratios—profit margin and asset turnover

margin)Profit .(revenue Sales

interest before EarningseiROA

over)Asset turn.(assets Total

revenue Salesei


• An important ratio that defines financial leverage is accounts payable turnover (APT)

• e.g APT = 3, this means that firm is able to finance its operations by using money it owns to the

suppliers for about 52/3= 17 weeks on an average.

• Lower value is desirable

payable Accounts

sold goods ofCost APT


Key component of asset turnover are:

1. ART = Accounts receivable turnover =

Sales Revenue / Accounts Receivable

e.g ART = 20, this means that firm is able to collect money from sales in about 52/20= 2.6 weeks on an average after it had made the sales.


2. INVT =Inventory turnover= Cost of Goods

Sold / Inventories

e.g. INVT = 9, this means that inventory sat

for about 52/9= 5.8 weeks on an average in an

year

Higher value is desirable4-7


3. PPET = Property, Plant and Equipment turnover

=

Sales Revenue / PP & E (i.e Property , Plant &

Equipment )

e.g. PPET= 20, this means that each dollor/Rs

invested in property, plant or equipment supported

about 20 dollars of sales.

Higher value is desirable4-8


Financial Measures of Performance• Cash-to-cash (C2C) cycle roughly measures the average amount time from when cash enters the process as cost to when it returns

as collected revenue

• From previous figures: C2C= -17 + 5.8 + 2.6 = -8.6 (firm collects money 8.6 weeks before it had to pay to its suppliers.

• Lower or negative value is desirable

C2C = – days payable (1/APT) + days in inventory

(1/INVT) + days receivable

(1/ART)

Two other measures which are not explicitly part of financial statements are:

Markdowns (represent the discounts required to convince customers to buy excess inventory)

Lost Sales (represent customer sales that did not materialize because of absence of desired product)

Need to be minimized as they adversely affect supply chain profitability.

Better matching of supply and demand reduces markdowns and lost sales.

4-10

Financial Measures of Performance

Drivers of Supply Chain Performance

• To achieve strategic fit requires company’s

supply chain to achieve a balance between

responsiveness and efficiency that best

supports the company’s competitive strategy.

• Responsiveness and efficiency defines the supply

chain performance.

• There are six drivers of performance which

interact with each other to determine the supply

chain performance.

• There are six drivers of supply chain performance:

3 logistical drivers

Facilities

Inventory

Transportation

3 cross functional drivers

Information

Sourcing

Pricing

4-12


These drivers need to be structured to achieve

desired level of responsiveness at

lowest possible cost in order to improve supply chain surplus and hence business performance of

the firm

A Framework for Structuring Drivers

Good supply chain design, planning and operation recognize the interaction and make appropriate tradeoffs among

drivers to achieve desired level of

responsiveness and efficiency.


1. Facilities

The physical locations in the supply chain network

where product is stored, assembled, or fabricated.

Two major types of facilities are production and

storage sites

Decisions regarding role, location, capacity and

flexibility of facilities have a significant impact on

supply chain performance.

In the financial statements facilities costs show

up under “property, plant and equipment” if

facilities are owned by the firm and under

“selling, general and administrative” if they

are leased.

E.g. Amazon increased nos. of warehousing

facilities to improve supply chain

responsiveness.

4-15

Facilities

Facilities

• Role in the supply chain

The “where” of the supply chain (locations from

to or from which the inventory is transported)

Within a facility, inventory is either transformed

to another state (Manufacturing) or it is stored

(warehouses)

• Facilities and competitive strategy

Firms can gain economies of scale if product is

manufactured or stored in only one location i.e.

increased efficiency. However, cost reduction is at

the expense of responsiveness.

Larger number of smaller facilities close to customer

increases responsiveness but decreases efficiency.

4-17

Facilities

Facilities

• Components of facilities decisions:

Role Whether flexible, dedicated, or a combination of the

two

Whether product focus or a functional focus (e.g.

fabrication or assembly)

For warehouses, whether cross-docking facilities or

storage type

Location

Where a company will locate its facilities

Centralize/decentralize, centralization for gaining economies

of scale Or decentralization to increase responsiveness

Other factors also considered in location decisions are:

macroeconomic factors, quality of workers, cost of workers

and facility, availability of infrastructure, proximity to

customers, location of other facilities, tax effects etc

4-19

Facilities

Facilities

Capacity A facility’s capacity to perform its intended function or

functions

More excess capacity gives responsiveness but is costly

Little excess capacity is more efficient, high utilisation

but less responsive in face of demand fluctuations

Firm need to make tradeoff and decide right amount of

capacity at a given facility.

Facilities

Facility-related metrics

Capacity Utilization (fraction of capacity currently being used)

Processing/setup/down/idle time (fraction of time)

Production cost per unit Quality losses Theoretical flow/cycle time of production (time

taken for processing units)

Actual average flow/cycle time

Facilities

• Overall trade-off: Responsiveness versus

efficiencyTradeoff is between cost (efficiency) and the level of

responsiveness these facilities provide on account of

decisions regarding the number, location, capacity, and

type of facilities.

Increasing the number of facilities increases

facility and inventory costs but decreases

transportation costs and reduces response time.

Increasing the flexibility or capacity of a facility

increases facility costs, increases responsiveness but

decreases inventory costs & response time

2. Inventory

All raw materials, work in process, and

finished goods within a supply chain.

Exists because of mismatch between supply

and demand

In the financial statements inventory belonging

to firm is reported under “assets”.

Changing inventory policies can alter supply

chain responsiveness and efficiency.

4-23


InventoryHigh level of inventory may increase

responsiveness but decreases efficiency.

Low level of inventory increases efficiency but can lead to decrease in responsiveness and increase in lost sales.

E.g. contrasting strategy of Zara and W.W. Grainger to increase responsiveness on account of different product characteristics.

4-24

Inventory level also effects “material flow time” in a supply chain.

Material flow time is the time that elapses between the point at which material enters the supply chain to the point it exists.

4-25

Inventory

Inventory Throughput is output per time period. For a

supply chain it is the rate at which sales occur. Little’s law

Throughput is often determined by the customer demand and can be considered fixed.

Thus inventory and flow time are synonymous in supply chain.

4-26

I = DT

where, I = Inventory, T = Flow time, D = throughput

Inventory

• Inventory and Competitive strategy

Form, location, and quantity of inventory allow a

supply chain to range from being very low cost to

very responsive.

Objective is to have right form, location, and

quantity of inventory that provides the right level of

responsiveness at the lowest possible cost

E.g. Amazon

4-27

• Cycle inventory

Average amount of inventory used to satisfy

demand between shipments

Function of lot size decisions

• Safety inventory

Inventory held in case demand exceeds

expectations; to counter demand uncertainty

• Seasonal inventory

Inventory built up to counter predictable variability

in demand

4-28

Inventory

• Level of product availability

It is fraction of demand that is served on time

from product held in inventory

High level of product availability increases

responsiveness but decreases efficiency due to

increased inventory levels.

Trade off between cost of inventory to increase

product availability and loss from not serving

customers on time.

4-29

Inventory

• Inventory-related metrics

Inventory turns

Cash-to-cash cycle time

Average inventory

Products with more than a specified number of

days of inventory

Average replenishment batch size

Average safety inventory

Seasonal inventory

Fill rate (fraction of orders met on time from inventory)

Fraction of time out of stock

Obsolete inventory4-30

Inventory

• Overall trade-off: Responsiveness versus efficiency

Increasing inventory generally makes the supply

chain more responsive.

A higher level of inventory facilitates a reduction

in production and transportation costs because

of improved economies of scale.

However, by doing so, inventory holding costs

increase

4-31

Inventory

3. Transportation

Moving inventory from point to point in the supply chain.

It can take form of many combinations and routes each

with its own performance characteristics.

Huge impact supply chain responsiveness and efficiency.

In the financial statements, outbound transportation costs

are typically included in “ selling, general and

administrative” expense while inbound transportation

costs are typically included in “costs of goods sold”.

4-32


Transportation


Moves the product between stages in the supply

chain

Impact on responsiveness and efficiency

Faster transportation allows greater

responsiveness but lower efficiency

Also affects inventory and facilities

e.g. High value, low demand items transported by air

mode, low value , high demand items transported

by cheaper mode.4-33

• Transportation and Competitive strategy

Allows a firm to adjust the location of its facilities

and levels of inventory to find the right balance

between responsiveness and efficiency

• Components of transportation decisions

Design of transportation network Modes, locations, and routes Direct or with intermediate consolidation points One or multiple supply or demand points in a

single run

4-34

Transportation

• Choice of transportation mode

Air, truck, rail, sea, and pipeline

Information goods via the Internet

Different speed, size of shipments, cost of

shipping, and flexibility

4-35

Transportation

• Transportation-related metrics

Average inbound transportation cost

Average income shipment size

Average inbound transportation cost per shipment

Average outbound transportation cost

Average outbound shipment size

Average outbound transportation cost per

shipment

Fraction transported by mode

4-36

Transportation

• Overall trade-off: Responsiveness versus

efficiency

The cost of transporting a given product (affects

efficiency) and the speed with which that

product is transported (affects responsiveness)

Using fast modes of transport raises

responsiveness and transportation cost but

lowers the inventory holding cost

4-37

Transportation


4. Information

Consists of data and analysis concerning facilities, inventory,

transportation, costs, prices, and customers throughout the

supply chain.

Biggest driver of supply chain performance as it directly

affects each of the other drivers.

Information presents management with opportunity to make

supply chains more responsive and more efficient.

In the financial statements, information technology related

costs are included either under “ selling, general and

administrative” expense ” or under assets.

Information


Improve the utilization of supply chain assets

and the coordination of supply chain flows to

increase responsiveness and reduce cost.

Information is a key driver that can be

used to provide higher responsiveness

while simultaneously improving

efficiency.

Information

• Information and Competitive strategy

Right information can help a supply chain better

meet customer needs at lower cost

Improves visibility of transactions and

coordination of decisions across the supply

chain

Information sharing and coordination critical to

supply chain performance

• Enabling technologies

Electronic data interchange (EDI)

The Internet

Enterprise resource planning (ERP) systems

Supply chain management (SCM) software

Radio frequency identification (RFID)

Information

Information Technology: A Supply Chain Enabler

Technologies that enable the efficient flow of products and services through the supply chain are called “enablers”.

Information is the essential link between all supply chain processes and members.

Computers & IT allow real time , online communication throughout the supply chain

E-business replacement of physical business processes with electronic ones Supply chain transactions are conducted through variety of

electronic media including EDI, email, electronic fund transfer (EFT), bar coding, fax, internet etc.

Leads to cost savings due lower transaction costs Shorten supply chain response time Reduction or elimination of role of intermediateries.

10-42

Supply Chain Enablers

10-43

Electronic data interchange (EDI) A computer-to-computer exchange of business

documents in a standard format. Format approved by American National Standard Institute

(ANSI) & ISO Enables businesses to exchange business documents –

such as purchase orders, invoices and order status updates – automatically and electronically, eliminating the need for manual processes.

Data exchange between trading partners using internet transactions instead of paper

Helps in reducing Bullwhip Effect. Supply chain members are able to share demand

information in real time & thus able to generate more reliable forecasts, reducing uncertainty.

4-44

Information Technology: A Supply Chain Enabler

E- Procurement:Uses the internet to facilitate purchasing.E-procurement speeds, purchasing, reduce costs, integrates the

supply chain, enhancing the organisational competitive advantages.

The traditional supply chain is full of paper transactions, E-procurement reduces the barrage of paper work.

Electronic Ordering & Funds Transfer: It is a approach to speeding transactions and reducing paperwork typically using internet

Note in contrast Electronic Data Interchange (EDI) is a more structured, standardized data transmittal format for computerised communications between organisations.

4-45

A optical machine readable representation of data/ computer readable codes about the attached item.

Scanned by optical scanners called barcode readers.

Bar code contains identifying information about the item. It might include information like product description, item number, its source, destination, cost, order number, special handling procedures.

4-46

Bar code and point-of-sale

When bar code information is scanned into a company’s computer by an electronic scanner, it provides supply chain members information about item location in supply chain.

When bar codes are scanned at checkout counters, it creates an instantaneous computer record of a sale of a product called – point – of – sale – data

POS System

4-47


A UPC Bar Code

4-48

A 2D Bar Code called Matrix Code Hand Held Bar Code Scanner


RFID is a wireless non-contact use of radio frequency to identify and track items with tags.

Tags contain electronically stored information.

Tag contains electronic chip usually applied to substrate to form a tag or label that is fixed to the item.

RFID reader also called interrogator consists of transmitter and receiver

RFID not limited to line of sight.4-49

RFID Capabilities (Radio Frequency ID)

Radio frequency identification (RFID)Consists of tiny microchip and computer

often as small as thin ribbon which can be put in any form.

RFID scanners transmit a radio signal via antenna to access the tag which responds with product information.

Tags are Electronic product code (EPC) linked to databases.

Send product data from an item to a reader via radio waves

RFID makes it possible for supplier and retailer to know automatically what goods they have and where are they around the world. 10-50


Small RFID chip compared to a grain of rice incorporated in consumer products

4-51


RFID tag used by Wal-Mart


10-52

RFID Capabilities (cont.)

10-53

• Information-related metrics

Forecast horizon

Frequency update

Forecast error

Seasonal factors

Variance from plan

Ratio of demand variability to order variability

Information

Information

• Overall trade-off:

Good information helps a firm improve both efficiency

and responsiveness

More information is not always better

More information increases complexity and cost of

both infrastructure and analysis exponentially while

marginal value diminishes

Evaluate the minimum information required to

accomplish the desired objectives.

Trade-off is between complexity and value while

deciding the required information infrastructure

5. Sourcing

Who will perform a particular supply chain activity

such as production, storage, transportation or

management of information.

Sourcing decisions determine what functions a

firm performs and what function a firm outsources.

These decisions affect both responsiveness and

efficiency of supply chain.

In the financial statements, sourcing costs are

shown under “costs of goods sold” and monies

owed to suppliers under “account payable”.

4-56


Sourcing

• Role in the supply Chain

Set of business processes required to purchase

goods and services

Will tasks be performed by a source internal to

the company, or a third party

Globalization creates many more sourcing

options with both considerable opportunity and

potential risk

Sourcing

• Sourcing and Competitive strategy

Sourcing decisions are crucial because they

affect the level of efficiency and responsiveness

in a supply chain

Outsource to responsive third parties if it is too

expensive to develop their own

Keep responsive process in-house to maintain

control

Components of Sourcing Decisions

• In-house or outsource

Perform a task in-house or outsource it to a third party

• Supplier selection

Number of suppliers, evaluation and selection criteria,

direct negotiations or auction

• Procurement

The supplier sends product in response to customer

orders

Sourcing

• Sourcing-related metrics

Days payable outstanding

Average purchase price

Range of purchase price

Average purchase quantity

Supply quality

Supply lead time

Fraction of on-time deliveries

Supplier reliability

Sourcing

Sourcing

• Overall trade-off: Increase the supply chain

surplus

Increase the size of the total surplus to be shared

across the supply chain

Impact of sourcing on sales, service, production costs,

inventory costs, transportation costs, and information

cost

Outsource if it raises the supply chain surplus more

than the firm can on its own

Keep function in-house if the third party cannot

increase the supply chain surplus or if the

outsourcing risk is significant

6. Pricing

Determines how much a firm will charge for the goods

and services that it makes available in the supply chain.

Pricing affect the behavior of buyer of good and service ,

customer expectations and hence affecting supply chain

performance.

Pricing is also employed to match supply and demand e.g.

short term discounting is used to get rid of surplus or to

move the demand forward and reduce demand peaks.

4-62


Everyday low Pricing vs High Low Pricing:

Everyday low pricing results in stable demand.High-Low pricing results in peaks during discount

period and drop in demand during following periods.The two pricing strategies leads to different demand

profiles that supply chain must serve

Fixed Price versus Menu Pricing: In Menu pricing, prices vary with some attribute

such as delivery location, response time etc.

4-63


With differential pricing, firm can offer its

product and/or services at different prices (e.g.

Amazon’s shipping options)

It may provides responsiveness (at a higher

price ) to a customer who value it and low cost

to customers who do not value responsiveness

as much.

4-64


These six drivers of supply chain performance do not act independently but interact to determine the overall supply chain performance.

Good supply chain design and operation recognise the interaction and make the appropriate tradeoff to deliver the desired level of responsiveness at lowest possible cost.

Idea is to structure supply chain drivers appropriately to provide desire

This helps in reducing “markdowns” and “lost sales” and better matching of demand and supply.

4-65


E.g. Wal-Mart

Competitive strategy : To be reliable, low cost retailer for wide variety of mass communication goods

Supply Chain Strategy: Emphasis on efficiency but also maintain adequate level of responsiveness in terms of product availability.

4-66


0Wal-Mart

Drivers Interventions AffectInventory Pioneered cross-docking w.r.t. inventory, Wal-Mart favours efficiency over

responsiveness. Results in efficient Supply Chain Products are stocked only at stores and not at

both stores and warehouses/DC. This significantly lower inventory.

Maintains low levels of inventory Transportation Runs own fleet Makes supply chain more responsive. Costs are

increased but benefit of reduced inventory and increased product availability.

Facilities Uses centrally located DCs within its network of stores tp decrease nos. of facilities

This increases efficiency at each DC.

Builds retail stores only where demand is sufficient to justify having several of them supported by a DC.

This also increases efficiency of transportation

Information Technology

Invested significantly in information Technology.

This allow sharing demand information with suppliers who manufacture only what is demanded. Increases responsiveness and decreases inventory costs.

Suppliers Identifies efficient sources of suppliers for each product it sells.

Increased efficiency

Gives large orders Allow suppliers to exploit economies of scale

Pricing Practices EDLP for its product. This reduces fluctuations in demand because of price variations

Thus entire supply chain focuses to meet demand in an efficient manner and achieve right balance between responsiveness and efficiency. Competitive and supply chain strategy are in harmony.4-67

Documents

Supply Chain Metrics and Drivers