Posts Tagged ‘Key performance indicators’

Today we announced our free Supply Chain Performance Benchmarking service (more on that below), so it seems an apt time to discuss the issue of benchmarking.

I wrote a blog post recently about how to use supply chain KPI’s to assess, diagnose, and correct supply chain performance, and the importance of benchmarking against your competitors.  In my blog I referred to a post by John Westerveld in which he comments on visibility titled “Visibility in the supply chain: What you can’t see can hurt you”, making the point that visibility and performance management are tightly linked.

It is always good to get validation of one’s ideas.  Well, I listened to a webinar hosted by Supply Chain Standard in which the registrants were asked what visibility means to their organization.  Most of the respondents replied that it was to obtain “End-to-End supply chain performance against key performance indicators”.  A point made by Mawgan Wilkins of Cisco (Cisco is one of our customers) is that in today’s supply chain in which outsourced manufacturing is prevalent, most of this information does not exist in the organization, but rather external to the organization.  Yet so much of your supply chain performance is dependent on how your contract manufacturers perform.If you don’t measure it you can’t manage it.

Measuring performance is valuable in and of itself, but knowing how your performance compares with your competitors is crucial to determining where improvements are required.  Not knowing how you compare against your competition is a “fool’s paradise”.  There is no way to assess the health of your supply chain without knowing how you are doing against your competitors.  Being able to track the KPI’s over time and see how they are trending against your competitors is crucial to both determining when negative or positive trends are developing, and in being able to drill to more detailed metrics in order to diagnose the cause.

Correcting the issue requires an even deeper dive into operational KPI’s.  What I find interesting about the graph above is that the more operational aspects of visibility are given a lower priority.  I think this an issue of supply chain process maturity.  What I mean is that of course performance management is the most important aspect of visibility when you don’t have any visibility.  However, I contend that once companies are able to measure supply chain performance, their instinct is to improve, or correct, their performance, which is where the other elements of the survey become more important: global view of inventory, consolidated view of demand, etc.

We are proud to announce that we have developed a free benchmarking service that uses publically available data extracted from the submission of financial statements.  Clearly the KPI’s that we can generate based on the financial statements are focused on the “Assess” and “Diagnose” levels.  The operational KPI’s required at the “Correct” level typically use data that is not available from financial statements.

Since we focus on manufacturing industries, there is a graph available in the benchmarking service that compares companies on the elements of cash-to-cash (C2C) – days of sales outstanding (DSO), days of inventory (DOI), and days of purchasing outstanding (DPO) – and return on net assets (RONA).    The C2C elements are represented by inventory turns and the ratio of DPO/DSO.  Even though many companies have outsourced manufacturing RONA is still a good way of comparing companies on the presumption that a company that outsources a lot should have a higher RONA.  In the graph below we are averaging these value over the past 4 quarters.  As is usual with these types of graphs, top right is “good”, bottom left is “bad”, and big is better.

What is interesting is to compare how this changes over time.  The graph below shows the values for the previous quarter.

To view how these values have changed over longer periods, a different graph can be used.

Yet a different graph can be used to drill down in to the C2C components in order to start the Diagnose phase.  If we look at Eli Lilly as an example, clearly they should focus on inventory in order to reduce C2C.  On the other hand it is quite clear that GlaxoSmithKline has been able to negotiate much more advantageous payment terms with their suppliers giving GSK a clear competitive advantage.

We would really appreciate your feedback, so please go to our supply chain expert community  to try it out. 

In order to use the free benchmarking service, you will need to register as a community member.   

Once you have registered, click on “Benchmark my Company” from the menu bar on the left.

When you click on the benchmarking service, you will be taken through the configuration of the benchmark groups of interest to you – Peers, Customers, and Suppliers are created for you by default – and select from the 30-odd KPI’s that are of specific interest to you.

One of my colleagues, John Westerveld, recently wrote a blog about visibility titled “Visibility in the supply chain: What you can’t see can hurt you.”    The key point John is making is that if you can’t see it you can’t manage it.
There is a related issue discussed in a LinkedIn group on supply chain KPI’s, which can be loosely interpreted as “You can’t change what you don’t measure”.  What I find interesting in the discussion is that there is very little mention of financial metrics.  Nearly all the discussion is focussed on detailed operational metrics.  In addition, there is little or no discussion of the relative importance of specific KPI’s.  There is some discussion of target setting, but almost none of benchmarking.  There is no point of being proud of achieving an inventory turn target if all you competitors exceed the target by a lot.

At the AMR Supply Chain Executive Conference in 2008, Jane Barrett and Deborah Hoffman’s presentation “Benchmarking Your Own Supply Chain” included the  the following slide:
 

What I find most interesting in the diagram is the implicit approach to using the supply chain KPI’s of Assess, Diagnose, Correct.  First of all, assess if your supply chain is healthy,  then find out where the problem lies, and finally correct the problem.  I agree with this approach, but I would put cash-to-cash at the top of the pyramid.  I can only assume that AMR placed the demand forecast at the top to promote their concept of a demand driven supply chain.  What is most interesting when comparing the AMR hierarchy with the LinkedIn discussion is that almost all of the metrics proposed in the LinkedIn discussion are at the bottom of the hierarchy, at the “Correct” stage of using the KPI’s.  Clearly we supply chain need to up our game to become relevant to senior management.

There can be no greater measure of a supply chain than the efficiency with which purchased raw material is converted to cash, which is why I suggest you use cash-to-cash to assess the health of your supply chain.  The usual objection I have heard regarding cash-to-cash is that much of accounts receivable and accounts payable is outside the control of the supply chain organization.  This is a fair point except that the supply chain should be managed in a manner consistent with the payments terms agreed with customers and suppliers.  For example, if short payment terms have been agreed with suppliers, there should be a strong focus in the supply chain organization to reduce raw material inventories because of the associated risk of excess and obsolete inventory is increased.  The company will have paid for the inventory earlier so the financial cost of holding the inventory will be greater than in companies with longer payment terms.  I need to state that reducing inventory levels is always a good idea.  I am only trying to illustrate that cash-to-cash is a very good measure of the overall efficiency of the supply chain.

Next on my list, at the Diagnose level, would be a number of margin calculations, starting with gross margin, though I would also include what I call SG&A margin and R&D margin, both of which are of course values included in the calculation of operating margin.  These are calculated in the same way as gross margin.  That is I calculate SG&A margin as (revenue – SG&A)/ revenue, and R&D margin as (revenue – R&D)/revenue.  As with cash-to-cash, many of the influences of these margin KPI’s are outside of the direct control of the supply chain organization, but they do give a lot of insight into the relative importance of building the products versus selling the products and developing the products.  This comparison also allows a company to understand where they can get “the biggest bang for their bucks” by implementing change.  Given that this blog is focussed on supply chain management, I would also bring in inventory measures as this level, such as inventory turns and days of raw material, work in progress and finished goods.  These give you some indication of where the problem lies.  For example, I know of one company whose WIP inventory exceeds their RM and FG inventories combined by a 5:1 ratio.  No prizes for guessing where I would start.

Lastly these metrics only have relevance when compared and over time.   In other words, it is very important to benchmark your supply chain against your competitors to get a good understanding where your company is competitive.  Understanding how you are comparing over time is a good way of understanding if your company is losing or gaining on your competition.  A snapshot cannot provide this insight.  And why not also benchmark your customers and suppliers?  Imagine the value of discovering that your company is a about to enter into a long term supply agreement with a customer whose gross margin has been steadily decreasing over the past 3 years.

Without a doubt detailed operational metrics are important, but only in the context of where your company wants to compete and how your company compares over time to your competition.  As AMR promotes, first assess your supply chain, then diagnose what are the biggest issues, before drilling to the details.

As always, let me know what you think.

A new article in IndustryWeek entitled “Customer demand seen as main financial obstacle in 2009 for industrial manufacturers” cites research from Prime Advantage that found a whopping “93% of CFOs say an inability to measure customer demand is among their top three external concerns.”  Interestingly, while the credit crunch is getting most of the headlines, it is only indirectly a primary threat for these companies.  It’s the impact of unpredictable demand patterns that is a much bigger direct issue.  In fact, 76% of the respondents cited demand uncertainty as their top concern.

The article mainly focuses on what the CFO’s perspective is and what actions they will be taking given these uncertainties.  But, what does this mean for supply chain management professionals?  Clearly, there is a linkage in that the CFO often defines the macro-conditions and key performance indicators (KPIs) for the entire company, including operations performance metrics managed by supply chain management.

As a result, most supply chain management professionals today are very focused on cost reductions, and these most directly tie to inventory reductions throughout the supply chain (by the way, if you’re interested, we just released a white paper on this topic entitled “Inventory rationalization and right sizing strategies“).  Fundamentally the challenge is one of regaining alignment between supply and demand in an environment where demand is very unpredictable and supply may be disrupted.

There  are some key things companies are doing to try to address these challenges, to name a few:

• Ensuring supply chain visibility into multi-enterprise, multi-tier supply chains since inventory control and responding to unplanned events is very much a function of knowing what is where and what state your supply chain is in at any moment (and making sure everyone has that same set of facts)
• Becoming exception-driven by ensuring that front line decision makers can define alerts and thresholds to proactively notify them of exceptions that could negatively impact the business.  Shortening the time to know about a problem drives faster response and reduces the magnitude of impact.
  
• Enhancing collaboration with both customers and suppliers to reduce latency of information and decision-making.  Co-planning and response management at both ends of the supply chain help to mitigate the ripple effect of unplanned events that are increasingly common.
• Knocking down silos internally to ensure that demand and supply are looked at together – by everyone.  For years organizations have been created with separate demand planning and supply chain planning teams with tools designed for each of their needs.  The new need is to integrate these efforts more closely together to ensure that everyone sees the immediate impact of demand on supply and vice versa.
• Aligning supply chain management decisions with the financial metrics of the company.  In the midst of constant change, decisions must be made “in the trenches” quickly throughout the day with insight into their impact on key performance indicators.
  

The CFO has an excellent overall view into the business.  They also inherently know what the impact of demand uncertainty will have on the business.  Where many companies struggle is to tie financial planning metrics down to the operational level, where day-to-day decisions are often made that impact these metrics but also must take into account a host of other issues (such as customer satisfaction, which finance doesn’t focus on).  The key challenge for organizations is to translate these financial metrics into their day-to-day supply chain management decision-making.

I was pleased to see an article in IndustryWeek titled “Cash and the supply chain”.  The subtitle, “Money management is the life blood of the supply chain ”, is even more evocative, though I would have reversed the order to “The supply chain is the life blood of money management”.  True, the authors focused quite a lot of the space on the process of managing collections as a way of reducing the Accounts Receivables in order to reduce the Cash-to-Cash cycle. Undoubtedly this is an important topic and poor collections can ruin great improvements made in the speed, manner, and cost of satisfying orders, which are the heartbeat of a supply chain.  I would like to focus on what we can do as supply chain management practitioners to understand how the decisions we make affect the financial performance of a company.

For a long time there has been a focus on the “perfect” order in the supply chain.  In the current economic climate the instinct is to capture all demand at any cost.   Amongst other things this article highlights the need to focus on a “profitable” order.  This can only be done by having all the data at hand and being able to compare and contrast different alternatives methods of satisfying the demand in a fast an effective manner.  In today’s multi-tier supply chains, this means having operational data – routings, bills of material, inventories, lead times, … – and costs – purchase price, transportations costs, inventory holding costs, … – available in a single system so that the full consequences of decisions made somewhere in the supply chain can be evaluated throughout the supply chain in a fast and effective manner.  The consequences need to be measured in the form of both operational and financial key performance indicators (KPI’s).  Operational KPI’s such as inventory turns, capacity utilization, customer service.  Financial KPI’s such as revenue, gross margin, cash-to-cash cycle.  Of these gross margin is the most reliable measure of profit, whereas cash-to-cash cycle is the most reliable measure of cash flow.  There are many other financial factors, which are out of the control of supply chain practitioners, that determine whether these two KPI’s indeed lead to profit and effective cash management.

Cash-to-Cash (C2C) is a key performance indicator that is usually ignored in supply chain management applications largely because two of the variables used to calculate C2C, days of sales outstanding (DSO) and days of payables outstanding (DPO), are typically the responsibility of Finance and out of the control of the supply chain.  The focus in the supply chain is usually on inventory, the 3rd variable in the C2C calculation.  This is a pity because the payment history or payment terms with certain customers can have a great effect on the C2C cycle.  In my experience the customers that provide the most revenue often do so at the lowest margins and with the longest payment periods.  By importing the payments terms or payment history for each customer and supplier, we could evaluate the effect on C2C of satisfying one demand stream/order over another.  This allows us to project DSO and DPO (admittedly assuming that payment history or payment terms will not change) based upon to whom we sell, and from whom we buy..  Of course we also need to evaluate the effect of decisions on gross margin and other financial KPI’s so that we are able to balance C2C with gross margin, and, for that matter, with revenue

Having the ability to compare and contrast revenue, gross margin, and C2C (along with operational KPI’s) would allow supply chain practitioners to reach the compromises necessary in day-to-day operations to meet corporate goals in a rational and effective manner.  As importantly, it doing so would also provide a mechanism for communicating the compromises to senior management in terms used by senior management.

Came across this good post entitled “Companies don’t compete; supply chains compete” which attributes this quote to the CIO of Nortel.  I’m not sure you’d get everyone to fully agree with this given how many other pieces there are to the puzzle, but I think it’s more true than not.  Worse yet, I think there are way too many important people that wouldn’t believe this at all.

I think in many companies supply chain management is that essential component of the machinery that makes a company function that is frequently overlooked.  A case in point is Apple.  Apple is justifiably renowned for it’s product innovation/design and marketing prowess.  But, Apple wouldn’t be Apple without excelling at supply chain management.  Yet, nobody talks about that…unless something goes wrong.  In a rare behind-the-scenes look, there was just recently an article published talking about the “operations wonk” that is second in command at Apple and responsible for their supply chain excellence (see Supply chain excellence at Apple).  I’m sure nobody outside of Apple and his direct family knows that Tim Cook is that person.

As more and more companies compete on a global basis and have supply chains that span the globe, your competitive position in the market increasingly does depend on your supply chain management prowess.  Excellence in supply chain management dictates significant aspect of customer satisfaction, operating performance (margin, inventory, etc.) and many other key performance indicators (KPIs) that determine the health of your company.  And these are critically important because they determine the amount of available cash and investments you can make in launching new products, opening new markets, etc.

It’s unfortunate that supply chain management too frequently gets viewed in a tactical way at the most senior levels of many companies.  I think the key to raising the awareness level of the contribution that excellence in supply chain management can deliver is to tie the impact directly to the key performance indicators that the top executives monitor and care about the most.  This is actually a part of the methodology AMR Research uses in determining their annual Supply Chain Top 25 list and they’ve been able to demonstrate the direct correlation between supply chain excellence and these KPIs in both good times and bad.