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Supply Chain Drivers and Metrics

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PowerPoint presentation to accompany

Chopra and Meindl Supply Chain Management, 5e

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https://www.youtube.com/watch?v=R4HPYYR5iLw&list=PLCD3E338A3E58E906&index=10

https://www.youtube.com/watch?v=VNK2X4Y1fss

https://www.youtube.com/watch?v=jx7zUXb0l78- My Video

Learning Objectives

Describe key financial measures of firm performance.

Identify the major drivers of supply chain performance.

Discuss the role of each driver in creating strategic fit between the supply chain strategy and the competitive strategy.

Define the key metrics that track the performance of the supply chain in terms of each driver.

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Chapter discuss how these drivers are used in the design, planning, and operation of the supply chain.

We define several metrics and its impact on strategic fit and financial performance.

Financial Measures Of Performance

From a shareholder perspective, return on equity (ROE) is the main summary measure of a firm’s performance

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ROE measures the return on investment : Important to shareholders

E.g. Amazon ROE of 2.81 % and Apple has a ROE of 32%

On each dollar invested in Amazon earns 2.81 %

Financial Measures Of Performance

Return on assets (ROA) measures the return earned on each dollar invested by the firm in assets

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ROA- measures each dollar invested in assets how much returns are retained

Financial Data for Amazon

Table 3-1

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Financial Measures Of Performance

An important ratio that defines financial leverage is accounts payable turnover (APT)

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Want this to be lower so if

APT for Publix is 2.48 and Windixie is 5.25

We can say that

Publix does better at using the money they owe suppliers to finance a considerable part of their operations.

52 weeks/ 2.48=20.97 weeks Publix was able to finance its operations for about 20.97 weeks using supplier's money.

Financial Measures Of Performance

ROA can be written as the product of two ratios – profit margin and asset turnover

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Profit Margin : Higher the better. Get higher margins by increasing prices or reducing expenses usually through Supply chain activities.

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 = – days payable (1/APT) + days in inventory (1/INVT) + days receivable (1/ART)

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How fast you turn your sold product to getting paid. Cash.

Drivers of Supply Chain Performance

Facilities

The physical locations in the supply chain network where product is stored, assembled, or fabricated

Inventory

All raw materials, work in process, and finished goods within a supply chain

Transportation

Moving inventory from point to point in the supply chain

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https://www.youtube.com/watch?v=Lyf5qwUY2sI

Logistical Drivers Are the three shown here.

Facilities: if doing well they may increase the number of facilities to increase responsiveness. If they are doing bad they may close stores

Inventory: Levels are based on there product demand: ex: Ikea hold more inventory as based on their design and their product line usually doesn’t change much so it makes sense for them to keep large inventories to meet demand

Zara: high fashion changes constantly so you will not hold on to inventory.

Transportation: transport types and designs

Drivers of Supply Chain Performance

Information

Data and analysis concerning facilities, inventory, transportation, costs, prices, and customers throughout the supply chain

Sourcing

Who will perform a particular supply chain activity

Pricing

How much a firm will charge for the goods and services that it makes available in the supply chain

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Cross Functional Drivers

Information: Data and Analysis helps drivers in supply chain in different areas.

Sourcing: Choosing who is going to perform a supply chain activity. Ex. Production In-house, Outsourced, Inventory out source etc

Pricing: What company will charge and the supply chain performance that they can invest in to gain a return on investment.

A Framework for Structuring Drivers

Figure 3-1

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Company starts with a Competitive strategy then develop Supply Chain strategy

second balance efficiency and responsiveness. You may also go bottom up in this diagram

Look at all these drivers to maximize your supply chain profits.

E.g. Walmart : Reliable and low cost retailer.

Emphasize efficiency but also needs to be responsiveness.

Manufacturer >>> Distribution center (inventory stays for a short time) >>> Then goes to Stores

Transportation: Cost is higher as they manage there own fleet. But contributes to lower inventories and more efficient operations

Only put stores in locations where demand is high.

RFID chips in inventory management – Share information with suppliers to have inventory replenished just in time.

Sourcing : Efficient sources

Pricing: Low prices- strong customer demand.

Good Balance to achieve their supply chain goals > Efficiency and responsiveness

Facilities

Role in the supply chain

The “where” of the supply chain

Manufacturing or storage (warehouses)

Role in the competitive strategy

Economies of scale (efficiency priority)

Larger number of smaller facilities (responsiveness priority)

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IKEA: few stores but large stores

Wal-greens- Many locations but smaller stores

Facilities

Components of facilities decisions

Role

Flexible, dedicated, or a combination of the two

Product focus or a functional focus

Location

Where a company will locate its facilities

Centralize/decentralize, macroeconomic factors, quality of workers, cost of workers and facility, availability of infrastructure, proximity to customers, location of other facilities, tax effects

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Facilities

Components of facilities decisions

Capacity

A facility’s capacity to perform its intended function or functions

Excess capacity – responsive, costly

Little excess capacity – more efficient, less responsive

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Facilities

Components of facilities decisions

Facility-related metrics

Capacity

Utilization

Processing/setup/down/idle time

Production cost per unit

Quality losses

Theoretical flow/cycle time of production

Actual average flow/cycle time

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Facilities

Overall trade-off: Responsiveness versus efficiency

Cost of the number, location, capacity, and type of facilities (efficiency) and the level of responsiveness

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 but decreases inventory costs and response time

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Overall Trade-Off

Responsiveness versus efficiency

Cost of the number, location, capacity, and type of facilities (efficiency)

Level of responsiveness

Increasing number of facilities increases facility and inventory costs, decreases transportation costs and reduces response time

Increasing the flexibility or capacity of a facility increases facility costs, decreases inventory costs and response time

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Inventory

Role in the Supply Chain

Mismatch between supply and demand

Satisfy demand

Exploit economies of scale

Impacts assets, costs, responsiveness, material flow time

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Inventory

Material flow time, the time that elapses between the point at which material enters the supply chain to the point at which it exits

Throughput, the rate at which sales occur

Little’s law

I = DT

where

I = flow time, T = throughput, D = demand

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Amazon Carries inventory of Books of 100,000 items

Sell 1000 items everyday

I= D *T

100,000

T= I/D=

100,000/ 1000 = 100days

Item spends 100 days in inventory

Decision : How much to re-order. Based in uncertainty of product.

Inventory

Role in Competitive Strategy

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

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Components of Inventory Decisions

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

Costs of carrying too much inventory versus cost of losing sales

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Components of Inventory Decisions

Seasonal inventory

Inventory built up to counter predictable variability in demand

Cost of carrying additional inventory versus cost of flexible production

Level of product availability

The fraction of demand that is served on time from product held in inventory

Trade off between customer service and cost

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Components of Inventory Decisions

Inventory-related metrics

Cash-to-cash cycle time

Average inventory

Inventory turns

Products with more than a specified number of days of inventory

Average replenishment batch size

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What products are selling fast and which are not.

Components of Inventory Decisions

Inventory-related metrics

Average safety inventory

Seasonal inventory

Fill rate

Fraction of time out of stock

Obsolete inventory

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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

Inventory holding costs increase

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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

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E.g. Blue Nile.

Transportation

Role in the Competitive Strategy

Allows a firm to adjust the location of its facilities and inventory to find the right balance between responsiveness and efficiency

Components of Transportation Decisions

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

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

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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 (efficiency) and the speed with which that product is transported (responsiveness)

Using fast modes of transport raises responsiveness and transportation cost but lowers the inventory holding cost

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Information

Role in the Supply Chain

Improve the utilization of supply chain assets and the coordination of supply chain flows to increase responsiveness and reduce cost

Information is a key driver that can be used to provide higher responsiveness while simultaneously improving efficiency

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Information

Role in the Competitive Strategy

Right information can help a supply chain better meet customer needs at lower cost

Improves visibility of transactions and coordination of decisions across the supply chain

Share the minimum amount of information required to achieve coordination

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Components of Information Decisions

Push versus Pull

Different information requirements and uses

Coordination and information sharing

Supply chain coordination, all stages of a supply chain work toward the objective of maximizing total supply chain profitability based on shared information

Sales and operations planning (S&OP)

The process of creating an overall supply plan (production and inventories) to meet the anticipated level of demand (sales)

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Components of Information Decisions

Enabling technologies

Electronic data interchange (EDI)

The Internet

Enterprise resource planning (ERP) systems

Supply chain management (SCM) software

Radio frequency identification (RFID)

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EDI- Paperless and more efficient

ERP=

SCM=

RFID= tags no more manual counting.

Components of Information Decisions

Information-related metrics

Forecast horizon

Frequency update

Forecast error

Seasonal factors

Variance from plan

Ratio of demand variability to order variability

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Forecast horizon= How far in the future demand forecast is made

Information

Overall trade-off: Complexity versus value

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

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Sourcing

Role in the Supply Chain

Set of business processes required to purchase goods and services

Will tasks be performed by a source internal to the company or a third party

Globalization creates many more sourcing options with both considerable opportunity and potential risk

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Sourcing

Role in the Competitive Strategy

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

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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

Procurement

The supplier sends product in response to customer orders

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Components of Sourcing Decisions

Sourcing-related metrics

Days payable outstanding

Average purchase price

Range of purchase price

Average purchase quantity

Supply quality

Supply lead time

Fraction of on-time deliveries

Supplier reliability

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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

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Pricing

Role in the Supply Chain

Pricing determines the amount to charge customers for goods and services

Affects the supply chain level of responsiveness required and the demand profile the supply chain attempts to serve

Pricing strategies can be used to match demand and supply

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Pricing

Role in the Competitive Strategy

Firms can utilize optimal pricing strategies to improve efficiency and responsiveness

Pricing strategies vary to meet different customer responsiveness requirements

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Components of Pricing Decisions

Pricing and economies of scale

The provider of the activity must decide how to price it appropriately to reflect these economies of scale

Everyday low pricing versus high-low pricing

Different pricing strategies lead to different demand profiles that the supply chain must serve

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Components of Pricing Decisions

Fixed price versus menu pricing

If marginal supply chain costs or the value to the customer vary significantly along some attribute, it is often effective to have a pricing menu

Can lead to customer behavior that has a negative impact on profits

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Components of Pricing Decisions

Pricing-related metrics

Profit margin

Days sales outstanding

Incremental fixed cost per order

Incremental variable cost per unit

Average sale price

Average order size

Range of sale price

Range of periodic sales

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Pricing

Overall trade-off: Increase firm profits

Understand of the cost structure of performing a supply chain activity and the value this activity brings to the supply chain

Strategy may support efficiency in the supply chain, lower supply chain costs, defend market share, or steal market share

Differential pricing may be used to attract customers with varying needs

Strategy should help either increase revenues or shrink costs or preferably both

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Summary of Learning Objectives

Describe key financial measures of firm performance

Identify the major drivers of supply chain performance

Discuss the role of each driver in creating strategic fit between the supply chain strategy and the competitive strategy

Define the key metrics that track the performance of the supply chain in terms of each driver

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All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher.

Printed in the United States of America.

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ROE = Net Income

Average Shareholder Equity

ROE=

Net Income

Average Shareholder Equity

ROA= Earnings before interest

Average Total Assets

ROA=

Earnings before interest

Average Total Assets

= Net Income + Interest expense × (1– tax rate)⎡⎣ ⎤⎦

Average Total Assets

Net Income+Interest expense´(1–tax rate)

Average Total Assets

Whereas ROE measures the return on investment made by a firm’s shareholders, return on assets (ROA) measures the return earned on each dollar invested by the firm in assets.

Consider Amazon.com’s financial performance shown in Table 3-1. In 2009{2010}, Amazon achieved ROE = 17.2 percent (902/5,257) {1,152/6,864 = 16.8 percent in 2010} and ROA = 6.7 percent ((902 + 34*(1 – .35))/13,813) {(1,152 + 39*(1 – .35))/18,797 = 6.3 percent in 2010}. The difference between ROE and ROA is referred to as return on financial leverage (ROFL). In 2009 {2010}, Amazon had ROFL = 10.5 percent {10.5 percent}. ROFL captures the amount of ROE that can be attributed to financial leverage (accounts payable, debt, etc.). In Amazon’s case, a significant portion of the financial leverage in 2009 and 2010 came from accounts payable rather than debt. Thus, an important ratio that defines financial leverage is accounts payable turnover (APT).

APT = Cost of goods sold Accounts payable

ROA = Earnings before interest

Average Total Assets =

Net Income + [Interest expense * (1 - tax rate)] Average Total Assets

Chapter 3 • Supply Chain Drivers and Metrics 39

Table 3-1 Selected Financial Data for Amazon.com Inc. Year ended December 31 ($ millions) 2010 2009 2008

Net operating revenues 34,204 24,509 19,166 Cost of goods sold 26,561 18,978 14,896 Gross profit 7,643 5,531 4,270 Selling, general, and administrative expense 6,237 4,402 3,428 Operating income 1,406 1,129 842 Interest expense 39 34 71 Other income (loss) – net 130 66 130 Income before income taxes 1,497 1,161 901 Income taxes 352 253 247 Net income 1,152 902 645

Assets

Cash and cash equivalents 3,777 3,444 2,769 Short-term investments 4,985 2,922 958 Net receivables 1,783 1,260 1,031 Inventories 3,202 2,171 1,399 Total current assets 13,747 9,797 6,157 Property, plant and equipment 2,414 1,290 854 Goodwill 1,349 1,234 438 Other assets 1,265 1,492 705 Total assets 18,797 13,813 8,314

Liabilities and Stockholder Equity

Accounts payable 10,372 7,364 4,687 Short-term debt 59 Total current liability 10,372 7,364 4,746 Long-term debt 109 533 Other liabilities 1,561 1,083 363 Total liabilities 11,933 8,556 5,642 Stockholder equity 6,864 5,257 2,672

M03_CHOP3952_05_SE_C03.QXD 10/15/11 9:19 PM Page 39

http://Amazon.com

APT = Cost of goods sold Accounts Payable

APT=

Cost of goods sold

Accounts Payable

ROA= Earnings before interest

Sales Revenue (Profit Margin)

ROA=

Earnings before interest

Sales Revenue

(Profit Margin)

× Sales Revenue

Total Assets (Asset Turnover)

Sales Revenue

Total Assets

(Asset Turnover)