Operational, Financial, and Performance Measurement

McGraw-Hill/Irwin

Copyright 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

Overview of operational and financial performance measurement

Measurement system objectives Operational assessment Financial assessment

If you dont measure it, you cant manage it.

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Measurement system objectives related to logistical operations

Monitoring system performance by establishment of appropriate metrics to track and report Controlling system performance by having appropriate standards of performance relative to metrics being monitored Directing employee focus on system performance through motivation and reward Improving shareholder value through superior logistics performance
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The Balanced Scorecard is a comprehensive system of performance assessment

Figure 16.1 The Balanced Scorecard

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Measurement focus using a balance scorecard approach

Financial perspective
Profitability and return on investment

Internal operations perspective

Process quality, efficiency and productivity

Customer perspective
Logistics service, quality and satisfaction

Innovation and learning perspective

Process improvement, benchmarking and human resource development
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Operational assessment
Functional perspectives Measuring customer accommodation Determining appropriate metrics Supply chain comprehensive metrics Benchmarking

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Functional perspective on logistics measures includes these major categories

Cost Customer service Quality Productivity Asset management

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Cost is the most direct reflection of logistics performance

Typically measured in total dollars spent Total logistics cost (aka total landed cost)
Sum of order processing + inventory + transportation + warehousing and materials handling + facility network
Few organizations have ability to measure total cost

Common to report cost as a

Percentage of sales volume
E.g. transportation cost as 15% of sales volume

Cost per unit of volume

E.g. loading cost as $5.50 per order

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Customer service requires specific measures for each element of the basic service platform
Availability
Organizations fill rate
Item fill rate Line fill rate Value fill rate Order fill rate

Operational performance
Average order cycle time is average number of days elapsed between order receipt and delivery to customer Order cycle consistency On-time delivery

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Quality measures often include service reliability performance

Accuracy of work activities performed Damage frequency is the ratio of number of damaged units to the total number of units Number of customer returns of damaged or defective goods Number of instances when information is not available on request Number of instances when inaccurate information is discovered

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Productivity is measured in terms of output of goods compared with quantities of inputs

Labor productivity
Units shipped per employee Units received per employee

Equipment downtime

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Asset management considers utilization of capital investments in facilities, equipment and inventory
Facilities and equipment
Capacity utilization
E.g. warehouse utilization of 80% is not shipping all it is capable of shipping

Downtime is the percentage of hours that equipment is not utilized

E.g. forklift with a 2% annual downtime

Inventory
Inventory turnover rate is most common measure of performance Days of supply is the amount available to meet forecasted sales volume
E.g. 50 days of supply (100 units per day forecast and 5000 units on hand)

Return on assets and return on investment

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Inventory turnover rate is measured differently by different types of firms

Vast majority of firms use this metric Some retail firms use this metric This metric is used for products whose cost or selling price changes significantly during relatively short periods of time
E.g. gasoline inventory

Critical that average inventory use as many data points as possible

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Example of common metrics by category

Table 16.1 Typical Performance Metrics

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Measuring customer accommodation requires an additional set of metrics

Perfect order measures the effectiveness of the overall integrated logistical performance
Ratio of perfect orders to the total number of orders completed during the same time period

Absolute performance provides a better indication of how a firms performance impacts customers
To us, 99.5 percent on-time delivery would mean that on a typical day, over 5,000 customers received late orders.

Customer satisfaction measurement requires monitoring, measuring and collecting information from the customer

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Determining appropriate metrics using the framework in Figure 16.2

Competitive basis reflects the fundamental choice between responsive or efficient logistics performance Measurement focus is a continuum ranging from operational metrics to strategic metrics Measurement frequency is the need to monitor day-to-day performance versus less frequent review to diagnose performance problems

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Illustration of framework use showing metric 2 is closer to measurement need

Figure 16.2 Illustration of Measurement Framework

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Supply chain comprehensive metrics

Cash-to-cash conversion time
Time required to convert a dollar spent on inventory into a dollar of sales revenue

On-shelf in-stock percentage

Percentage of time a product is available on the shelf in a store

Inventory days of supply

Calendar days of sales available based on recent sales activity

Total supply chain cost

Sum of costs across all firms in the supply chain

Dwell time
Ratio of days inventory sits idle to the days it is productively used or positioned

Supply chain response time

Time required for all firms to recognize a fundamental shift in demand, internalize that finding, replan, and adjust output to meet that demand

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Illustration of supply chain total cost extending beyond an individual firm

Figure 16.3 Total Supply Chain Cost

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Benchmarking makes management aware of stateof-the-art business practice

Critical aspect of performance measurement
Are we staying competitive? Considers metrics and processes

Which organizations should we benchmark against?

Internal groups are easier to identify
Johnsons & Johnson has 150+ business units with ample opportunity to share best practices Provides little information about performance against the competition

Nonrestricted benchmarking compares metrics and processes to best practices regardless of where the practice is found
Belief that learning is possible from any firm with outstanding performance

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High-achieving firms are more involved in benchmarking than average-achieving firms

Table 16.2 Performance Benchmarking Differential

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Financial assessment is needed to link supply chain performance to financial results

Critical tools for financial assessment
Segmentation of data
By channel, territory, customer, product, and supplier

Cost-revenue analysis Strategic profit model

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Cost-revenue analysis is needed to provide a financial view of integrated logistics

Accounting deficiencies make this difficult 3 approaches are available to identify and control logistics expenses
Contribution Net profit Activity based costing

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Accounting practices to prepare financial statements create some deficiencies

Costs are aggregated on a standard account basis rather than activity basis Inbound freight expense is deducted from gross sales Outbound freight is reported as an operating expense Freight is not reported as a specific cost
i.e. Products purchased on a delivered price basis

Failure to specify and assign inventory cost

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Contribution analysis requires all costs be identified as fixed or variable

Fixed costs are those that do not directly change with volume Variable costs are those that change as a result of volume Direct costs are those specifically incurred because of the existence of the segment of analysis
E.g. product, customer, channel

Indirect costs exist because of more than one segment of business

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Example of contribution analysis

Table 16.3 Contribution Margin Income Statement for Two Customers

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Net profit analysis requires all operating costs be charged or allocated to an operating segment
Each segment must be allocated its fair share of costs Example from Table 16.3 would require indirect fixed cost of $41,000 to be allocated to each segment
E.g. allocate based on sales volume

Disagreements arise in determining how to allocate indirect costs

Allocations are arbitrary and may result in misleading financial assessment But, many indirect expenses are not fixed
Rather they rise and fall based on business demand of operating segments

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Activity-based costing is a partial solution to arbitrary allocations

Activity-based costing (ABC) suggests costs be traced to activities
Activities are then related to product, process or customer segments

Biggest challenge with the ABC approach is identifying the activities, related expenses and drivers of expense

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Strategic profit model shows relationship of income and balance sheet to ROA
Return on investment (ROI) is critical measure of financial success
Return on net worth (RONW) measures profitability of funds invested by owners Return on assets (ROA) measures profitability generated by managing operational assets
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Illustration of strategic profit model with example data

Figure 16.4 Strategic Profit Model

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Two fundamental ways to improve return on assets

Manage net profit margin improvements
Net profit margin is net profit divided by net sales Measures portion of each sales dollar that is kept by the firm

Manage asset turnover improvements

Asset turnover is ratio of total sales divided by total assets Measures efficiency of management utilization of assets

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Applications of the strategic profit model (SPM)

Model is very adaptable to a spreadsheet Can use SPM in combination with other methods to examine ROA for customer or product segments
Table 16.4 provides an example Other segment profitability and ROI analyses can be conducted

Very useful framework for relating logistics activities to the overall financial objectives of the organization
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Product B contributes a higher return even though its gross margin is lower
Table 16.4 CMROI for Two Products

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Example showing ROA improvement if inventory cost is reduced to $300

Figure 16.5 Strategic Profit Model (Inventory Reduction)

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Requirements for financial reporting provide more supply chain visibility to management
Sarbanes-Oxley Act of 2002 (SOX)
Section 404 requires an internal control report to be filed along with corporate annual report

Firms must have internal measurement capabilities that comply with SEC requirements SOX requires disclosure of all off-balance-sheet liabilities that have material effect on financial reports
Vendor-managed inventories Long-term purchase agreements Slotting allowances

Also required to report any event that may have material effect on financial reports
E.g. shipments with long lead times that may be held a international border

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Example metrics to validate financial elements in columns 3 and 4

Adapted from Table 16.5

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Example metrics to validate financial elements in columns 3 and 4 (continued)

Adapted from Table 16.5 (continued)

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Example metrics to validate financial elements in columns 3 and 4 (continued)

Adapted from Table 16.5 (continued)

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