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CHAPTER 15: Performance MeasurementCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin1Measurement system objectivesOperational assessmentFinancial assessmentOverview of performance measurementIf you dont measure it, you cant manage it.

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin2Monitoring system performance by establishment of appropriate metrics to track and reportControlling system performance by having appropriate standards of performance relative to metrics being monitoredDirecting employee focus on system performance through motivation and rewardImproving shareholder value through superior logistics performanceMeasurement system objectives related to logistical operationsCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin3The Balanced Scorecard is a comprehensive system of performance assessment

Figure 15.1 The Balanced ScorecardCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin4Financial perspectiveProfitability and return on investmentInternal operations perspectiveProcess quality, efficiency and productivityCustomer perspectiveLogistics service, quality and satisfactionInnovation and learning perspectiveProcess improvement, benchmarking and human resource developmentMeasurement focus using a balance scorecard approach

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin5Functional perspectivesMeasuring customer accommodationDetermining appropriate metricsSupply chain comprehensive metricsBenchmarking Operational assessment

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin6CostCustomer serviceQualityProductivityAsset managementFunctional perspective on logistics measures includes these major categories

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin7Typically measured in total dollars spentTotal logistics cost (aka total landed cost)Sum of order processing + inventory + transportation + warehousing and materials handling + facility networkFew organizations have ability to measure total costCommon to report cost as aPercentage of sales volumeE.g. transportation cost as 15% of sales volumeCost per unit of volumeE.g. loading cost as $5.50 per orderCost is the most direct reflection of logistics performanceCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin8Availability Organizations fill rateItem fill rateLine fill rateValue fill rateOrder fill rateOperational performanceAverage order cycle time is average number of days elapsed between order receipt and delivery to customerOrder cycle consistencyOn-time deliveryCustomer service requires specific measures for each element of the basic service platform

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin9Accuracy of work activities performedDamage frequency is the ratio of number of damaged units to the total number of unitsNumber of customer returns of damaged or defective goodsNumber of instances when information is not available on requestNumber of instances when inaccurate information is discoveredQuality measures often include service reliability performance

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin10Labor productivityUnits shipped per employeeUnits received per employeeEquipment downtimeProductivity is measured in terms of output of goods compared with quantities of inputs

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin11Facilities and equipmentCapacity utilizationE.g. warehouse utilization of 80% is not shipping all it is capable of shippingDowntime is the percentage of hours that equipment is not utilizedE.g. forklift with a 2% annual downtimeInventoryInventory turnover rate is most common measure of performanceDays of supply is the amount available to meet forecasted sales volumeE.g. 50 days of supply (100 units per day forecast and 5000 units on hand)Return on assets and return on investmentAsset management considers utilization of capital investments in facilities, equipment and inventoryCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin12Vast 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 timeE.g. gasoline inventoryInventory turnover rate is measured differently by different types of firms

Critical that average inventory use as many data points as possibleCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin13

Example of common metrics by categoryTable 15.1 Typical Performance MetricsCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin14Perfect order measures the effectiveness of the overall integrated logistical performanceRatio of perfect orders to the total number of orders completed during the same time periodAbsolute performance provides a better indication of how a firms performance impacts customersTo 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 customerMeasuring customer accommodation requires an additional set of metricsCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin15Competitive basis reflects the fundamental choice between responsive or efficient logistics performanceMeasurement focus is a continuum ranging from operational metrics to strategic metricsMeasurement frequency is the need to monitor day-to-day performance versus less frequent review to diagnose performance problemsDetermining appropriate metrics using the framework in Figure 15.2Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin16Illustration of framework use showing metric 2 is closer to measurement need

Figure 15.2 Illustration of Measurement FrameworkCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin17Supply chain comprehensive metricsCash-to-cash conversion timeTime required to convert a dollar spent on inventory into a dollar of sales revenueInventory days of supplyCalendar days of sales available based on recent sales activityDwell timeRatio of days inventory sits idle to the days it is productively used or positionedOn-shelf in-stock percentagePercentage of time a product is available on the shelf in a storeTotal supply chain costSum of costs across all firms in the supply chainSupply chain response timeTime required for all firms to recognize a fundamental shift in demand, internalize that finding, replan, and adjust output to meet that demandCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin18

Illustration of supply chain total cost extending beyond an individual firmFigure 15.3 Total Supply Chain CostCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin19Critical aspect of performance measurementAre we staying competitive?Considers metrics and processesWhich organizations should we benchmark against?Internal groups are easier to identifyJohnsons & Johnson has 150+ business units with ample opportunity to share best practicesProvides little information about performance against the competitionNonrestricted benchmarking compares metrics and processes to best practices regardless of where the practice is foundBelief that learning is possible from any firm with outstanding performanceBenchmarking makes management aware of state-of-the-art business practiceCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin20

High-achieving firms are more involved in benchmarking than average-achieving firmsTable 15.2 Performance Benchmarking DifferentialCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin21Critical tools for financial assessmentSegmentation of dataBy channel, territory, customer, product, and supplierCost-revenue analysisStrategic profit modelFinancial assessment is needed to link supply chain performance to financial results

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin22Accounting deficiencies make this difficult3 approaches are available to identify and control logistics expensesContribution Net profitActivity based costingCost-revenue analysis is needed to provide a financial view of integrated logistics

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin23Costs are aggregated on a standard account basis rather than activity basisInbound freight expense is deducted from gross salesOutbound freight is reported as an operating expenseFreight is not reported as a specific cost i.e. Products purchased on a delivered price basisFailure to specify and assign inventory costAccounting practices to prepare financial statements create some deficienciesCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin24Fixed costs are those that do not directly change with volumeVariable costs are those that change as a result of volumeDirect costs are those specifically incurred because of the existence of the segment of analysisE.g. product, customer, channelIndirect costs exist because of more than one segment of businessContribution analysis requires all costs be identified as fixed or variableCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin25Example of contribution analysis

Table 15.3 Contribution Margin Income Statement for Two CustomersCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin26Net profit analysis requires all operating costs be charged or allocated to an operating segmentEach segment must be allocated its fair share of costsExample from Table 15.3 would require indirect fixed cost of $41,000 to be allocated to each segmentE.g. allocate based on sales volumeDisagreements arise in determining how to allocate indirect costsAllocations are arbitrary and may result in misleading financial assessmentBut, many indirect expenses are not fixedRather they rise and fall based on business demand of operating segmentsCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin27Activity-based costing (ABC) suggests costs be traced to activitiesActivities are then related to product, process or customer segmentsBiggest challenge with the ABC approach is identifying the activities, related expenses and drivers of expenseActivity-based costing is a partial solution to arbitrary allocations

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin28Return on investment (ROI) is critical measure of financial successReturn on net worth (RONW) measures profitability of funds invested by ownersReturn on assets (ROA) measures profitability generated by managing operational assetsStrategic profit model shows relationship of income and balance sheet to ROA

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Illustration of strategic profit model with example dataFigure 15.4 Strategic Profit ModelCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin30Manage net profit margin improvementsNet profit margin is net profit divided by net salesMeasures portion of each sales dollar that is kept by the firmManage asset turnover improvementsAsset turnover is ratio of total sales divided by total assetsMeasures efficiency of management utilization of assetsTwo fundamental ways to improve return on assets

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin31Model is very adaptable to a spreadsheetCan use SPM in combination with other methods to examine ROA for customer or product segmentsTable 15.4 provides an exampleOther segment profitability and ROI analyses can be conductedVery useful framework for relating logistics activities to the overall financial objectives of the organizationApplications of the strategic profit model (SPM)

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Product B contributes a higher return even though its gross margin is lowerTable 15.4 CMROI for Two ProductsCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin33Example showing ROA improvement if inventory cost is reduced to $300Figure 15.5 Strategic Profit Model (Inventory Reduction)

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin34Sarbanes-Oxley Act of 2002 (SOX)Section 404 requires an internal control report to be filed along with corporate annual reportFirms must have internal measurement capabilities that comply with SEC requirementsSOX requires disclosure of all off-balance-sheet liabilities that have material effect on financial reportsVendor-managed inventoriesLong-term purchase agreementsSlotting allowancesAlso required to report any event that may have material effect on financial reportsE.g. shipments with long lead times that may be held a international borderRequirements for financial reporting provide more supply chain visibility to managementCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin35Example metrics to validate financial elements in columns 3 and 4Adapted from Table 15.5

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

Adapted from Table 15.5 (continued)Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin37

Example metrics to validate financial elements in columns 3 and 4 (continued)Adapted from Table 15.5 (continued)

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin38