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

ROA can be written as the product of two ratios

profit margin and asset turnover

Earnings before interest

ROA (i.eProfit margin)
Sales revenue
Sales revenue
(i.eAsset turn over)
Total assets
 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

4-7
 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 These drivers need to be
Inventory structured to achieve
desired level of
Transportation responsiveness at
lowest possible cost in
3 cross functional drivers order to improve supply
chain surplus and hence
Information business performance of
the firm
Sourcing
Pricing

4-12
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

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

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.

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 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

 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
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 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.

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.

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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

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 4-27

 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 uncertainty
Seasonal inventory
Inventory built up to counter predictable variability in
demand
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 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.
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 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 inventory 4-30
 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
 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, outbound transportation

costs are typically included in selling, general and
administrative expense while inbound transportation
costs are typically included in costs of goods sold.
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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
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
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 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

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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

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

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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 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

Role in the supply chain

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
 Information
Enabling technologies
Electronic data interchange (EDI)
The Internet
Enterprise resource planning (ERP) systems
Supply chain management (SCM) software
Radio frequency identification (RFID)
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.
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Supply Chain Enablers

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Information Technology: A Supply Chain Enabler
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.
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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.

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Bar code and point-of-sale
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.

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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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Bar code and point-of-sale

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

4-48
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 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
RFID Capabilities (Radio Frequency
ID)

Small RFID chip compared to

a grain of rice incorporated in
consumer products RFID tag used by Wal-Mart

4-51
RFID Capabilities (Radio Frequency
ID)

10-52
RFID Capabilities (cont.)

10-53
 Information

Information-related metrics

Forecast horizon
Frequency update
Forecast error
Seasonal factors
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. 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
 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

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

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 to

provide desire

This helps in reducing markdowns and lost sales and

better matching of demand and supply. 4-65
 Drivers of Supply Chain Performance

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.

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 0
Wal-Mart
Drivers Interventions Affect
Inventory 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 This significantly lower inventory.
both stores and warehouses/DC.
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 This increases efficiency at each DC.
stores tp decrease nos. of facilities
Builds retail stores only where demand is This also increases efficiency of transportation
sufficient to justify having several of them
supported by a DC.
Information Invested significantly in information This allow sharing demand information with suppliers
Technology Technology. who manufacture only what is demanded. Increases
responsiveness and decreases inventory costs.
Suppliers Identifies efficient sources of suppliers for each Increased efficiency
product it sells.
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
4-67
between responsiveness and efficiency. Competitive and supply chain strategy are in harmony.