Operational, Financial, and Performance Measurement

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

McGraw-Hill/Irwin

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Overview of operational and financial performance measurement

• Measurement system objectives

• Operational assessment

• Financial assessment

“If you don’t measure it, you can’t 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 – 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

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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

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 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

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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

• 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

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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 state-of-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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Adapted from Table 16.5 (continued)

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

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

Adapted from Table 16.5 (continued)