CHAPTER 15: Performance Measurement McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Overview of performance measurement • Measurement system objectives • Operational assessment • Financial assessment “If you don’t measure it, you can’t manage it.” 15-2 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 15-3 The Balanced Scorecard is a comprehensive system of performance assessment Figure 15.1 The Balanced Scorecard 15-4 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 15-5 Operational assessment • Functional perspectives • Measuring customer accommodation • Determining appropriate metrics • Supply chain comprehensive metrics • Benchmarking 15-6 Functional perspective on logistics measures includes these major categories • • • • • Cost Customer service Quality Productivity Asset management 15-7 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 15-8 Customer service requires specific measures for each element of the basic service platform • Availability – Organization’s 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 15-9 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 15-10 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 15-11 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 15-12 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 15-13 Example of common metrics by category Table 15.1 Typical Performance Metrics 15-14 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 firm’s 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 15-15 Determining appropriate metrics using the framework in Figure 15.2 • 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 15-16 Illustration of framework use showing metric 2 is closer to measurement need Figure 15.2 Illustration of Measurement Framework 15-17 Supply chain comprehensive metrics • Cash-to-cash conversion time – Time required to convert a dollar spent on inventory into a dollar of sales revenue • Inventory days of supply – Calendar days of sales available based on recent sales activity • Dwell time – Ratio of days inventory sits idle to the days it is productively used or positioned • On-shelf in-stock percentage – Percentage of time a product is available on the shelf in a store • Total supply chain cost – Sum of costs across all firms in the supply chain • 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 15-18 Illustration of supply chain total cost extending beyond an individual firm Figure 15.3 Total Supply Chain Cost 15-19 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 15-20 High-achieving firms are more involved in benchmarking than average-achieving firms Table 15.2 Performance Benchmarking Differential 15-21 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 15-22 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 15-23 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 15-24 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 15-25 Example of contribution analysis Table 15.3 Contribution Margin Income Statement for Two Customers 15-26 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 15.3 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 15-27 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 15-28 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 15-29 Illustration of strategic profit model with example data Figure 15.4 Strategic Profit Model 15-30 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 15-31 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 15.4 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 15-32 Product B contributes a higher return even though its gross margin is lower Table 15.4 CMROI for Two Products 15-33 Example showing ROA improvement if inventory cost is reduced to $300 Figure 15.5 Strategic Profit Model (Inventory Reduction) 15-34 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 15-35 Example metrics to validate financial elements in columns 3 and 4 Adapted from Table 15.5 15-36 Example metrics to validate financial elements in columns 3 and 4 (continued) Adapted from Table 15.5 (continued) 15-37 Example metrics to validate financial elements in columns 3 and 4 (continued) Adapted from Table 15.5 (continued) 15-38