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

ratiosprofit margin and asset turnover
ROA

Earnings before interest

(i.eProfit margin)
Sales revenue

Sales revenue
(i.eAsset turnover)
Total assets

Financial Measures Of Performance

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.

Cost of goods sold

APT
Accounts payable

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
4-8

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)

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
markdowns and lost sales.

and

demand

reduces

4-10

Drivers of Supply Chain Performance

To achieve strategic fit requires companys supply

chain

to

achieve

responsiveness

and

balance

efficiency

between
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
Pricing

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

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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

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

Production cost per unit

Quality losses

Theoretical flow/cycle time of production

taken for processing units)

Actual average flow/cycle time

(fraction of time)

(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
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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 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 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
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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, outbound transportation costs
are

typically

administrative

included

in

selling,

general

and

expense while inbound transportation

costs are typically included in costs of goods sold.

4-32

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
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

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
efficiency.

simultaneously

improving

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.

10-42

Supply Chain Enablers

10-43

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.
4-44

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

Bar code and point-of-sale

A optical machine readable representation

of data/ computer readable codes about

the attached item.

Scanned

by optical
barcode readers.

scanners

called

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

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
4-47

Bar code and point-of-sale

A UPC Bar Code

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

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 byWalMart

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.

4-62

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.

4-64

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.
4-66

Wal-Mart
Interventions

Affect

Pioneered cross-docking

w.r.t. inventory, Wal-Mart favours efficiency

over responsiveness. Results in efficient
Supply Chain
This significantly lower inventory.

Facilities

Makes supply chain more responsive.

Costs are increased but benefit of reduced
inventory and increased product
availability.
This increases efficiency at each DC.

Drivers
Inventory

Products are stocked only at stores

and not at both stores and
warehouses/DC.

Maintains low levels of inventory

TransportationRuns own fleet

Information
Technology
Suppliers

Uses centrally located DCs within its

network of stores tp decrease nos. of
facilities
Builds retail stores only where
demand is sufficient to justify having
several of them supported by a DC.
Invested significantly in information
Technology.

This also increases efficiency of

transportation

This allow sharing demand information

with suppliers who manufacture only what
is demanded. Increases responsiveness
and decreases inventory costs.
Identifies efficient sources of suppliers Increased efficiency
for each product it sells.
Gives large orders
Allow suppliers to exploit economies of
scale
4-67