Operational, Financial, and Performance Measurement: Mcgraw-Hill/Irwin

Operational, Financial, and Performance Measurement
McGraw-Hill/Irwin
Copyright 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
Overview of operational and financial performance measurement

Measurement system objectives Operational assessment Financial assessment
If you dont measure it, you cant manage it.

16-2
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
16-3
The Balanced Scorecard is a comprehensive system of performance assessment
Figure 16.1 The Balanced Scorecard
16-4
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
16-5
Operational assessment
Functional perspectives Measuring customer accommodation Determining appropriate metrics Supply chain comprehensive metrics Benchmarking
16-6
Functional perspective on logistics measures includes these major categories

Cost Customer service Quality Productivity Asset management
16-7
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
16-8
Customer service requires specific measures for each element of the basic service platform
Availability
Organizations 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
16-9
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
16-10
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
16-11
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
16-12
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

16-13
Example of common metrics by category

Table 16.1 Typical Performance Metrics
16-14
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 firms 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
16-15
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
16-16
Illustration of framework use showing metric 2 is closer to measurement need
Figure 16.2 Illustration of Measurement Framework
16-17
Supply chain comprehensive metrics

Cash-to-cash conversion time
Time required to convert a dollar spent on inventory into a dollar of sales revenue
On-shelf in-stock percentage

Percentage of time a product is available on the shelf in a store
Inventory days of supply

Calendar days of sales available based on recent sales activity
Total supply chain cost

Sum of costs across all firms in the supply chain
Dwell time
Ratio of days inventory sits idle to the days it is productively used or positioned
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
16-18
Illustration of supply chain total cost extending beyond an individual firm
Figure 16.3 Total Supply Chain Cost
16-19
Benchmarking makes management aware of stateof-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
16-20
High-achieving firms are more involved in benchmarking than average-achieving firms

Table 16.2 Performance Benchmarking Differential
16-21
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
16-22
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
16-23
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
16-24
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

16-25
Example of contribution analysis

Table 16.3 Contribution Margin Income Statement for Two Customers
16-26
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
16-27
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
16-28
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
16-29
Illustration of strategic profit model with example data
Figure 16.4 Strategic Profit Model
16-30
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
16-31
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
16-32
Product B contributes a higher return even though its gross margin is lower
Table 16.4 CMROI for Two Products
16-33
Example showing ROA improvement if inventory cost is reduced to $300
Figure 16.5 Strategic Profit Model (Inventory Reduction)
16-34
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
16-35
Example metrics to validate financial elements in columns 3 and 4

Adapted from Table 16.5
16-36
Example metrics to validate financial elements in columns 3 and 4 (continued)

Adapted from Table 16.5 (continued)
16-37
Example metrics to validate financial elements in columns 3 and 4 (continued)

Adapted from Table 16.5 (continued)
16-38

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Operational, Financial, and Performance Measurement

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

Overview of operational and financial performance measurement

If you dont measure it, you cant manage it.

Measurement system objectives related to logistical operations

The Balanced Scorecard is a comprehensive system of performance assessment

Figure 16.1 The Balanced Scorecard

Measurement focus using a balance scorecard approach

Internal operations perspective

Innovation and learning perspective

Functional perspective on logistics measures includes these major categories

Cost is the most direct reflection of logistics performance

Common to report cost as a

Cost per unit of volume

Quality measures often include service reliability performance

Productivity is measured in terms of output of goods compared with quantities of inputs

Downtime is the percentage of hours that equipment is not utilized

Return on assets and return on investment

Inventory turnover rate is measured differently by different types of firms

Critical that average inventory use as many data points as possible

Example of common metrics by category

Measuring customer accommodation requires an additional set of metrics

Determining appropriate metrics using the framework in Figure 16.2

Illustration of framework use showing metric 2 is closer to measurement need

Figure 16.2 Illustration of Measurement Framework

Supply chain comprehensive metrics

On-shelf in-stock percentage

Inventory days of supply

Total supply chain cost

Supply chain response time

Illustration of supply chain total cost extending beyond an individual firm

Figure 16.3 Total Supply Chain Cost

Benchmarking makes management aware of stateof-the-art business practice

Which organizations should we benchmark against?

High-achieving firms are more involved in benchmarking than average-achieving firms

Financial assessment is needed to link supply chain performance to financial results

Cost-revenue analysis Strategic profit model

Cost-revenue analysis is needed to provide a financial view of integrated logistics

Accounting practices to prepare financial statements create some deficiencies

Failure to specify and assign inventory cost

Contribution analysis requires all costs be identified as fixed or variable

Indirect costs exist because of more than one segment of business

Example of contribution analysis

Disagreements arise in determining how to allocate indirect costs

Activity-based costing is a partial solution to arbitrary allocations

Illustration of strategic profit model with example data

Figure 16.4 Strategic Profit Model

Two fundamental ways to improve return on assets

Manage asset turnover improvements

Applications of the strategic profit model (SPM)

Example showing ROA improvement if inventory cost is reduced to $300

Figure 16.5 Strategic Profit Model (Inventory Reduction)

Example metrics to validate financial elements in columns 3 and 4

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

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

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