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Supply Chain Management: Strategy, Planning, and Operation

Seventh Edition

Chapter 3

Supply Chain Drivers and Metrics

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Learning Objectives (1 of 3)

3.1 Describe key financial measures of firm performance.

3.2 Identify the major drivers of supply chain performance.

3.3 Define the key performance metrics for facilities and discuss their role in creating strategic fit between the supply chain strategy and the competitive strategy.

Learning Objectives (2 of 3)

3.4 Define the key performance metrics for inventory and discuss its role in creating strategic fit between the supply chain strategy and the competitive strategy.

3.5 Define the key performance metrics for transportation and discuss its role in creating strategic fit between the supply chain strategy and the competitive strategy.

Learning Objectives (3 of 3)

3.6 Define the key performance metrics for information and discuss its role in creating strategic fit between the supply chain strategy and the competitive strategy.

3.7 Define the key performance metrics for sourcing and discuss its role in creating strategic fit between the supply chain strategy and the competitive strategy.

3.8 Define the key performance metrics for pricing and discuss its role in creating strategic fit between the supply chain strategy and the competitive strategy.

Financial Measures of Performance (1 of 7)

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

Financial Measures of Performance (2 of 7)

Return on assets (R O A) measures the return earned on each dollar invested by the firm in assets

Financial Data for Amazon and Nordstrom (1 of 6)

Table 3-1 Selected Financial Data for Amazon.com and Nordstrom Inc.

Blank	Amazon.com	Nordstrom Inc.
Period Ending	31-Dec-13	2-Feb-13
Total Revenue	74,452,000	12,148,000
Cost of Goods Sold	54,181,000	7,432,000
Gross Profit	20,271,000	4,716,000
Selling, General, and Administrative	19,526,000	3,371,000
Operating Income or Loss	745,000	1,345,000
Total Other Income/Expenses Net	–98,000	–
Earnings Before Interest and Taxes	647,000	1,345,000
Interest Expense	141,000	160,000

Financial Data for Amazon and Nordstrom (2 of 6)

Table 3-1 [Continued]

Blank	Amazon.com	Nordstrom Inc.
Period Ending	31-Dec-13	2-Feb-13
Income Before Tax	506,000	1,185,000
Income Tax Expense	161,000	450,000
Minority Interest	–	–
Net Income	274,000	613,000
Assets	Blank	Blank
Cash and Cash Equivalents	8,658,000	1,285,000
Short-Term Investments	3,789,000	–
Net Receivables	4,767,000	2,356,000
Inventory	7,411,000	1,360,000

Financial Data for Amazon and Nordstrom (3 of 6)

Table 3-1 [Continued]

Blank	Amazon.com	Nordstrom Inc.
Period Ending	31-Dec-13	2-Feb-13
Other Current Assets	–	80,000
Total Current Assets	24,625,000	5,081,000
Property, Plant, and Equipment (P P & E)	10,949,000	2,579,000
Goodwill	2,655,000	175,000
Other Assets	1,930,000	254,000
Total Assets	40,159,000	8,089,000
Liabilities and Stockholder Equity	Blank	Blank
Accounts Payable	21,821,000	1,415,000

Financial Data for Amazon and Nordstrom (4 of 6)

Table 3-1 [Continued]

Blank	Amazon.com	Nordstrom Inc.
Period Ending	31-Dec-13	2-Feb-13
Short-/Current Long-Term Debt	–	7,000
Other Current Liabilities	1,159,000	804,000
Long-Term Debt	3,191,000	3,124,000
Other Liabilities	4,242,000	341,000
Deferred Long-Term Liability Charges	–	485,000
Total Liabilities	30,413,000	6,176,000
Total Stockholder Equity	9,746,000	1,913,000

Financial Data for Amazon and Nordstrom (5 of 6)

Table 3-2 A Comparison of Financial Metrics for Amazon.com and Nordstrom Inc.

Metric	Amazon.com	Nordstrom Inc.
R O E	start fraction 274 over 9,746 end fraction = 2.81%	start fraction 735 over 1,913 end fraction = 38.42%
R O A	start fraction 274 + 141 times left parenthesis 1 minus 0.35 right parenthesis over 40,159 end fraction = 0.91%	start fraction 735 + 160 times left parenthesis 1 minus 0.35 over 8,089 = 10.37%
R O F L	1.90%	28.05%
Profit Margin	start fraction 274 + 141 times left parenthesis 1 minus 0.35 right parenthesis over 74,452 end fraction = 0.49%	start fraction 735 + 160 times left parenthesis 1 minus 0.35 over 12,148 = 6.91%
Asset Turnover	start fraction 74,452 over 40,159 end fraction = 1.85	start fraction 12,148 over 8,089 end fraction = 1.50

Financial Data for Amazon and Nordstrom (6 of 6)

Table 3-2 [Continued]

Metric	Amazon.com	Nordstrom Inc.
A P T	start fraction 54,181 over 21,821 end fraction = 2.48	start fraction 7,432 over 1,011 end fraction = 7.35
A R T	start fraction 74,452 over 4,767 end fraction = 15.62	start fraction 12,148 over 2,129 end fraction = 5.71
I N V T	start fraction 54,181 over 7,411 end fraction = 7.31	start fraction 7,432 over 1,360 end fraction = 5.46
P P E T	start fraction 74,452 over 10,949 end fraction = 6.80	start fraction 12,148 over 2,579 end fraction = 4.71
C 2 C	start fraction negative 1 over 2.48 end fraction + start fraction 1 over 15.62 end fraction + start fraction 1 over 7.31 end fraction = negative 0.20 years = negative 10.53 weeks	start fraction negative 1 over 7.35 end fraction + start fraction 1 over 15.71 end fraction + start fraction 1 over 5.46 end fraction = 0.22 years = 11.56 weeks
S G & A / Revenue	start fraction 19,526 over 74,452 end fraction = 26.23%	start fraction 3,371 over 12,148 end fraction = 27.75%

Financial Measures of Performance (3 of 7)

An important ratio that defines financial leverage is accounts payable turnover (A P T)

Financial Measures of Performance (4 of 7)

R O A can be written as the product of two ratios – profit margin and asset turnover

Financial Measures of Performance (5 of 7)

Key components of asset turnover are accounts receivable turnover (A R T); inventory turnover (I N V T); and property, plant, and equipment turnover (P P E T)

Financial Measures of Performance (6 of 7)

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

Selected Financial Metrics

Table 3-3 Selected Financial Metrics Across Industries, 2000–2012

Industry	Average Operating Margin	Average C 2 C Cycle	Average Inventory Turns	Average S G & A Cost/ Revenue
Pharmaceutical	0.25	190.3	2.0	0.31
Medical device manufacturers	0.18	211.6	2.2	0.36
Consumer packaged goods	0.17	28.3	5.6	0.31
Food	0.16	37.4	6.2	0.23
Consumer electronics	0.12	9.3	43.8	0.14
Apparel	0.10	127.7	3.2	0.35
Chemical	0.09	78.1	5.3	0.09
Automotive	0.04	75.9	9.9	0.13

Financial Measures of Performance (7 of 7)

To measures not part of financial statements

Markdowns: discounts required to convince customers to buy excess inventory

Lost sales: represent customer sales that did not materialize because of the absence of products the customer wanted to buy

Summary of Learning Objective 1

The key financial metrics of firm performance include return on equity; return on assets; accounts payable turnover; profit margin; asset turnover; accounts receivable turnover; inventory turns; property, plant, and equipment turns; cash-to-cash cycle; and S G & A / revenue. Markdowns and lost sales are two important financial measures of supply chain performance that are not recorded in financial statements.

Framework for Supply Chain Decisions (1 of 2)

Figure 3-1 Supply Chain Decision-Making Frame work

Framework for Supply Chain Decisions (2 of 2)

Logistical Drivers

Facilities

Inventory

Transportation

Cross-Functional Drivers

Information

Sourcing

Pricing

Interactions determine overall supply chain performance

Summary of Learning Objective 2

The major drivers of supply chain performance are facilities, inventory, transportation, information, sourcing, and pricing. Each driver affects the balance between responsiveness and efficiency and the resulting strategic fit. Thus, it is important for supply chain designers to structure the six drivers appropriately to achieve strategic fit.

Drivers of Supply Chain Performance (1 of 2)

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

Drivers of Supply Chain Performance (2 of 2)

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

Facilities (1 of 6)

Role in the supply chain

Production sites and storage sites

Increase responsiveness by increasing the number of facilities, making them more flexible, or increasing capacity

Facilities (2 of 6)

Tradeoffs between facility, inventory, and transportation costs

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 but decreases inventory costs and response time

Facilities (3 of 6)

Components of facilities decisions

Capability

Flexible, dedicated, or a combination of the two

Product focus or a functional focus

Location

Where a company will locate its facilities

Centralize for economies of scale, decentralize for responsiveness

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

Facilities (4 of 6)

Capacity

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

Excess capacity – responsive, costly

Little excess capacity – more efficient, less responsive

Demand Allocation

Markets each facility will serve

Revisited as conditions change

Facilities (5 of 6)

Facility-Related Metrics

Capacity

Utilization

Processing/setup/down/idle time

Quality losses

Production cost per unit

Theoretical flow/cycle time of production

Actual average flow/cycle time

Facilities (6 of 6)

Product variety

Volume contribution of top 20 percent S K U ' s and customers

Average production batch size

Production service level

Summary of Learning Objective 3

The major facility related decisions include identifying the number of facilities, the extent of flexibility, the level of capacity, and the markets served by each facility. Increasing the number of facilities, their flexibility, or their excess capacity increases responsiveness but hurts efficiency. Key facility-related metrics are capacity, utilization, processing/setup/down/idle time, quality, theoretical flow/cycle time of production, actual flow/cycle time, product variety, volume contribution of top 20 percent S K U s/customers, average production batch size, and service level.

Inventory (1 of 3)

Role in the Supply Chain

Mismatch between supply and demand

Exploit economies of scale

Reduce costs

Improve product availability

Affects assets, costs, responsiveness, material flow time

Inventory (2 of 3)

Overall Trade-Off

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

Inventory (3 of 3)

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 = D T

where

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

Components of Inventory Decisions (1 of 4)

Cycle Inventory

Average amount of inventory used to satisfy demand between supplier 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

Components of Inventory Decisions (2 of 4)

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

Components of Inventory Decisions (3 of 4)

Inventory-Related Metrics

C 2 C cycle time

Average inventory

Inventory turns

Products with more than a specified number of days of inventory

Average replenishment batch size

Components of Inventory Decisions (4 of 4)

Average safety inventory

Seasonal inventory

Fill rate

Fraction of time out of stock

Obsolete inventory

Summary of Learning Objective 4

The major inventory related decisions include identifying the batch size, the safety inventory, the seasonal inventory, and the level of product availability. Increasing the safety inventory and level of product availability increases responsiveness but hurts efficiency. Increasing the batch size and seasonal inventory increases holding costs but may decrease production, transportation, and purchasing costs. Key inventory-related metrics are average inventory, turns, products with more than a specified number of days of inventory, average replenishment batch size, average safety inventory, seasonal inventory, fill rate, and fraction of time out of stock.

Transportation (1 of 5)

Role in the Supply Chain

Moves inventory between stages in the supply chain

Affects responsiveness and efficiency

Faster transportation allows greater responsiveness but lower efficiency

Also affects inventory and facilities

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

Transportation (2 of 5)

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

Transportation (3 of 5)

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

Transportation (4 of 5)

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

Transportation (5 of 5)

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

Summary of Learning Objective 5

The major transportation related decisions include designing the transportation network and selecting the transportation mode. Faster modes of transport are more expensive but can improve responsiveness while helping decrease inventory and facility costs. Key transportation-related metrics are average inbound transportation cost, average incoming shipment size, average inbound transportation cost per shipment, average outbound transportation cost, average outbound shipment size, average outbound transportation cost per shipment, and fraction transported by mode.

Information (1 of 2)

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

Information (2 of 2)

Role in the Competitive Strategy

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

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

More information increases complexity and cost of both infrastructure and analysis exponentially while marginal value diminishes

Share the minimum amount of information required to achieve coordination

Components of Information Decisions (1 of 3)

Demand Planning

Best estimate of future demand

Include estimation of forecast error

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

Critical for success

Components of Information Decisions (2 of 3)

Sales and Operations Planning (S & O P)

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

Can be used to plan supply chain needs and project revenues and profits

Components of Information Decisions (3 of 3)

Information-Related Metrics

Forecast horizon

Frequency of update

Forecast error

Variance from plan

Ratio of demand variability to order variability

Summary of Learning Objective 6

The major information related decisions include coming up with a demand plan as well as a sales & operations plan that optimally matches supply and demand. It is important that information is shared across the supply chain to ensure that plans at different stages are coordinated. Key information-related metrics are forecast horizon, forecast error, variance from plan, and ratio of demand variability to order variability.

Sourcing (1 of 2)

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

Should increase the size of the total surplus to be shared across the supply chain

Sourcing (2 of 2)

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

Components of Sourcing Decisions (1 of 3)

In-House or Outsource

Perform a task in-house or outsource it to a third party

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

Components of Sourcing Decisions (2 of 3)

Supplier Selection

Number of suppliers, criteria for evaluation and selection

Procurement

Obtain goods and service within a supply chain

Goal is to decrease total cost of ownership and increase supply chain surplus

Components of Sourcing Decisions (3 of 3)

Sourcing-Related Metrics

Days payable outstanding

Average purchase price

Range of purchase price

Average purchase quantity

Supply quality

Supply lead time

Percentage of on-time deliveries

Supplier reliability

Summary of Learning Objective 7

The major sourcing related decisions include deciding whether an activity will be insourced or outsourced, identifying key factors in supplier selection, and selecting the supplier port- folio. Key sourcing-related metrics are days payable outstanding, average purchase price, range of purchase price, average purchase quantity, percentage on-time deliveries, supply quality, and supply lead time.

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

Objective should be to increase firm profit

Components of Pricing Decisions (1 of 3)

Pricing and Economies of Scale

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

Everyday Low Pricing Versus High-Low Pricing

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

Components of Pricing Decisions (2 of 3)

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

Components of Pricing Decisions (3 of 3)

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

Summary of Learning Objective 8

The major pricing related decisions include deciding whether the firm will offer quantity discounts, whether it will offer everyday low pricing or prices that vary over time, and whether it will offer a fixed price or a menu of prices that vary along some dimension such as response time. Pricing-related metrics are 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, and range of periodic sales.

Net Income

ROE

Average Shareholder Equity

[

]

+´-

Earningsbeforeinterest

ROA

AverageTotalAssets

Net Income Interest Expense ( Tax Rat

Average Total Assets

274

2.81%

9,746

735

38.42%

1913

(

)

+´-

27414110.35

0.91%

40,159

(

)

+´-

73516010.35

10.37%

8,089

(

)

+´-

27414110.35

0.49%

74,452

(

)

+´-

73516010.35

6.91%

12,148

74,452

1.85

40,159

12,148

1.50

8,089

54,181

2.48

21,821

-++

111

7.355.715.46

0.22 years11.56weeks

19,526

26.23%

74,452

3,371

27.75%

12,148

7,432

7.35

1,011

74,452

15.62

4,767

12,148

5.71

2,129

54,181

7.31

7,411

7,432

5.46

1,360

74,452

6.80

10,949

12,148

4.71

2,579

-++

=-=-

111

2.4815.627.31

0.20 years10.53weeks

Cost of Goods Sold

APT

Accounts Payable

=´

Earnings before interestSalesRevenue

ROA

Sales RevenueTotal Assets

Profit Margin Asset Turnover

Sales RevenueCostof Goods sold

ART; INVT;

Accounts ReceivableInventories

Sales Revenue

PPET

PP&E

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C2CWeeks Payable

APT

Weeks in Inventory

INVT

Weeks Receivable

ART

Chapter 3 ◆ Supply Chain Drivers and Metrics 45

A FRAMEWORK FOR SUPPLY CHAIN DECISIONS

The strategic fit discussed in Chapter 2 requires that a company’s supply chain achieve the bal- ance between responsiveness and efficiency that best supports the company’s competitive strat- egy. This requires a supply chain structure that suitably deals with the uncertainty implied by the strategy. Related to the five levers to deal with uncertainty that were discussed in Chapter 2, we identify six supply chain drivers whose interaction defines the performance of a supply chain as shown in Figure 3-1. Facilities, inventory, and transportation together form the logistical drivers responsible for the effective production, storage, and movement of goods. Information, sourcing, and pricing form the set of cross-functional drivers that play a role in every supply chain activity. Observe that the five drivers – facilities, inventory, transportation, information, and pricing – cor- respond directly to the five levers – capacity, inventory, time, information, and price – for dealing with uncertainty. Sourcing is added as a sixth driver because this is a decision that must be made for each supply chain activity. It is important to realize that these drivers do not act independently but interact to determine the overall supply chain performance. Good supply chain design and operation recognize this interaction and structure the drivers to achieve the desired level of responsiveness at the lowest possible cost, thus improving the supply chain surplus and the firm’s financial performance.

Having more facilities generally makes a chain more responsive but increases the amount of inventory required, whereas having fewer, central facilities creates higher efficiency. Holding higher levels of inventory increases the responsiveness of a supply chain, whereas keeping inven- tory low increases the chain’s efficiency. Using faster modes of transportation increases a chain’s responsiveness and may lower the inventory required, whereas using slower modes generally increases efficiency but may require more inventory. Investing in information can vastly improve

3.2 Identify the major drivers of supply chain performance.

SUMMARY OF LEARNING OBJECTIVE 1

The key financial metrics of firm performance include return on equity; return on assets; accounts payable turnover; profit margin; asset turnover; accounts receivable turnover; inventory turns; property, plant, and equipment turns; cash-to-cash cycle; and SG&A / revenue. Markdowns and lost sales are two important financial measures of supply chain perfor- mance that are not recorded in financial statements.

Facilities Inventory Transportation

Logistical Drivers

Information Sourcing Pricing Cross-Functional Drivers

Supply Chain Structure

Efficiency Responsiveness

Competitive Strategy

Supply Chain Strategy

Figure 3-1 Supply Chain Decision-Making Frame work

M03_CHOP1889_07_SE_C03.indd 45 8/23/17 7:49 PM