Supply Chain Drivers and Metrics

(Source: Supply Chain Management, Strategy, Planning

and Operation, By Sunil Chopra, Peter Meindl, D. V.
KalraPearson)
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 firms performance.

It measures the return on investment made by firms

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

Earnings before interest

ROA
Average total assets
Net income Interest expense (1 Tax rate)

Average total assets

Higher value is desirable

Financial Measures Of Performance

An important ratio that defines financial leverage is

accounts payable turnover (APT)

Cost of goods sold

APT
Accounts payable

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

Financial Measures Of Performance

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.
Higher value is desirable

Financial Measures Of Performance

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 desirable
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Financial Measures Of Performance

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 desirable
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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
C2C =

days payable (1/APT)

+ days in inventory (1/INVT)
+ days receivable (1/ART)

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

Financial Measures of Performance

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.
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Drivers of Supply Chain Performance

To achieve strategic fit requires companys supply

chain to achieve a balance between responsiveness

and efficiency that best supports the companys
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.

Drivers of Supply Chain Performance

There are six drivers of supply chain performance:

3 logistical drivers
Facilities
Inventory

Transportation
3 cross functional drivers
Information

Sourcing

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

Pricing
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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.

Drivers of Supply Chain Performance

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.

Facilities

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.

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Facilities
Components of facilities decisions:

No. of Facilities: Larger number of smaller facilities close to

customer increases responsiveness but decreases efficiency.

Role

Whether flexible, dedicated, or a combination of the two

For warehouses, whether cross-docking facilities or storage

type

Facilities
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

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Facilities
Capacity

A facilitys 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 (max. amount a facility can process)

Utilization (fraction of capacity currently being used)

Processing/setup/down/idle time(s) (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 efficiency

Tradeoff 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.

Drivers of Supply Chain Performance

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.
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Inventory
High level of inventory may increase responsiveness but

decreases efficiency.
Centralisation of inventory reduces inventory and thereby

increase efficiency but it may also decrease responsiveness.

Low level of inventory increases efficiency but can lead to

decrease in responsiveness and increase in lost sales.

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Inventory
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.

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Inventory
Throughput is output per time period. For a supply chain

it is the rate at which sales occur.

Littles law
I = DT

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

For a supply chain, Throughput is the rate at which the

sales occur
Throughput is often determined by the customer demand
and can be considered fixed.
Thus inventory and flow time are synonymous in supply
chain.
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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: Fast moving/slow moving / very slow

moving products
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Inventory

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 and supply uncertainty

Seasonal inventory
Inventory built up to counter predictable variability in
demand
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Inventory

Inventory and 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.
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Inventory

Inventory-related metrics
Inventory turnover ratio
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 inventory

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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 related costs
increases.

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Drivers of Supply Chain Performance

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, inbound transportation costs

are typically included in costs of goods sold while

outbound transportation costs are typically included in
selling, general and administrative expenses.
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Transportation

Role in the supply chain

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.
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Transportation

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

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
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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

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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
e.g. Blue Nile and Zales
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Drivers of Supply Chain Performance

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 is a key driver that can be used to provide

higher responsiveness while simultaneously improving
efficiency.

Information

Role in a supply chain

Right information can help a supply chain better meet
customer needs at lower cost
Improves visibility of transactions

Improves coordination of decisions across the supply

chain
In the financial statements, information technology

related costs are included either under selling, general

and administrative expense or under assets.

Information Technology: A Supply Chain Enabler

Technologies that enable the efficient flow of products

and services through the supply chain are called

enablers.

Enablers or Enabling technologies:

The Internet
Electronic data interchange (EDI)
Enterprise resource planning (ERP) systems
Supply chain management (SCM) software
Radio frequency identification (RFID)

Enabling technologies

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Information Technology: A Supply Chain Enabler

Electronic data interchange (EDI)
the computer-to-computer interchange of strictly formatted

messages that represent documents other than monetary

instruments- NIST, US
Structured, standardized data transmittal format

Enables businesses to exchange business documents such as

purchase orders, invoices, shipping notices and order status updates

automatically and electronically, eliminating the need for manual
processes.
Supply chain members are able to share demand information

in real time & thus able to generate more reliable forecasts,

reducing uncertainty.
Many EDI standards (including EDIFACT, X12, GS1EDI, ODETTE

etc)

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Bar code and point-of-sale

A optical machine readable representation of data

relating to the item to which it is attached.

Scanned by optical scanners called barcode readers.
Bar code contains identifying information about the item.

It might include information like product description, its

source, destination, cost, order number, special handling
procedures etc.
Originally barcodes represented data by varying the

widths and spacings of parallel lines i.e. linear or

one-dimensional (1D).
Evolved into rectangles, dots, hexagons and other

geometric patterns in two dimensions (2D).

UPC ; EAN ; GS1

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Bar code and point-of-sale

Hand Held Bar Code Scanner

A UPC Bar Code

A 2D Bar Code called Matrix Code

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Bar code and point-of-sale

When bar code information is scanned into a companys

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

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RFID Capabilities (Radio Frequency

ID)
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 not limited to line of sight.
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RFID Capabilities (Radio Frequency

ID)
Radio frequency identification (RFID)

RFID reader also called interrogator consists of

transmitter and receiver

RFID scanners transmit a radio signal via antenna to

access the tag which responds with product
information.
Tags contain 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.

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RFID Capabilities (Radio Frequency

ID)

Small RFID chip compared to

a grain of rice incorporated in
consumer products

RFID tag used by Wal-Mart

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RFID Capabilities (Radio Frequency

ID)

10-45

RFID Capabilities (cont.)

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Information

Information-related metrics
Forecast horizon

Frequency update
Forecast error
Variance from plan

Ratio of demand variability to order variability

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

Drivers of Supply Chain Performance

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.

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Sourcing

Role in the supply Chain

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

Sourcing
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

Sourcing

Sourcing-related metrics
Average purchase price
Range of purchase price

Average purchase quantity

Supply quality
Supply lead time
Days payable outstanding
Fraction of on-time deliveries
Supplier reliability

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

Drivers of Supply Chain Performance

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.
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Drivers of Supply Chain Performance

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.
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Drivers of Supply Chain Performance

With differential pricing, firm can offer its product

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

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Drivers of Supply Chain Performance

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.
This helps in reducing markdowns and lost sales and

better matching of demand and supply.

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