Supply Chain Drivers and Metrics

(Source: Supply Chain Management, Strategy, Planning

and Operation, By Sunil Chopra, Peter Meindl, D. V.
Kalra‐Pearson)
For academic purpose 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 firm’s performance.
• It measures the return on investment made by firm’s
shareholders

 Higher value is desirable

 Financial Measures of Performance

• Return on assets (ROA) measures the return earned

on each dollar/Rs 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 / Avg. Inventory

 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 = – weeks payable (1/APT)

+ weeks in inventory (1/INVT)
+ weeks 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 company’s supply

chain to achieve a balance between responsiveness
and efficiency that best supports the company’s
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

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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 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.

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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.
E.g. Amazon increased nos. of warehousing facilities to
improve supply chain responsiveness.

 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 facility’s 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
 Avg. production batch size
 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
 Little’s law

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

 Throughput is output per time period.

 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.
 Higher inventory means higher flow time.

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 Inventory

• Components of Inventory Decisions

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 4-27
 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
 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
 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

• 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

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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 or human intervention.

 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) 4-38
Electronic data interchange (EDI)

EDI

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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 company’s
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 waves 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)

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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”. 4-50
 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. Amazon’s
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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 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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 Drivers of Supply Chain Performance
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 to 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
4-60
between responsiveness and efficiency. Competitive and supply chain strategy are in harmony.