1. Operational, Financial, and Performance Measurement
We have mentioned performance measures a few time in this class… not you will get the joy of a whole chapter on the topic.
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Overview of operational and financial performance measurement
Measurement system objectives
Operational assessment
Financial assessment
As you can see in quotes “if you don’t measure it… you can’t manage it”
It is like trying to get fast at a 5k, but not timing yourself. You can try different things, but you really don’t know if they are working.
We are going to look at operational and financial measurements.
“If you don’t measure it, you can’t manage it.”

3. 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
When you create a measurement system… you are probably trying to achieve one of the following objectives.
Monitoring: the metric and reporting the ability to track
Controlling: setting performance standards on the metric
Directing: setting performance levels that people need to meet.
Improved value: process improvement through logistic efforts.

4. Figure 16.1 The Balanced Scorecard
The Balanced Scorecard is a comprehensive system of performance assessment
The balanced scorecard is a common metric. It looks at the companies performance from a number of angles: financial, customer, internal operations, and learning
Figure 16.1 The Balanced Scorecard

5. 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
Financial: are you making money
Internal operations: looks at your quality and productivity
Customer perspective: customer satisfaction, service levels
Innovation and learning: process improvement, benchmarking.

6. Operational assessment
Functional perspectives
Measuring customer accommodation
Determining appropriate metrics
Supply chain comprehensive metrics
Benchmarking
We are going to five categories of the operational assessment….
Starting with functional perspective.

7. Functional perspective on logistics measures includes these major categories
Cost
Customer service
Quality
Productivity
Asset management
This functional perspective is also broken down into a number of components… we will focus on cost first.

8. 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
Cost is an important metric for logistic performance… it is normally viewed in total cost.
The total logistics cost is calculated by adding:
Order processing, inventory, transportation, warehousing and handling, and facility network.
Most companies can not measure total logistics cost.. We are not able to measure it effectively.
Two of the most common measurements is the cost as a percentage of volume or cost per unit.

9. 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
The next section is customer service…
We are familiar with availability measurements such as fill rate. This is a common customer service measurement.
You can look at it form a item, line, or order.
The other common metrics are operational:
Order cycle time. Days between order and delivery
And on-time delivery percentage.

10. 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
Quality is the next measurement tool…
This is the measurement of reliability.
Some common measurements: percentage of damaged goods.
Percentage of defective goods

11. 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
Productivity… this is a measurement output vs input.
It can be units shipped per employee
Equipment downtime.
Productivity is not always the best think… productivity just form productivity sake is actually a form of waste.

12. 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
Assess management is the last of the 5 functional perspectives….
Regarding the buildings… warehouse utilization or equipment downtime
Inventory… turnover rate (the number of times the parts are replaced in a year), days of supply
ROI

13. Critical that average inventory use as many data points as possible
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
There are a number of different measurements for inventory turnover…
The top one uses unit value, middle is sales information, and last is units sold.
Critical that average inventory use as many data points as possible

14. Example of common metrics by category
Table 16.1 Typical Performance Metrics
I mentioned a few of the metrics in each of the categories… but here is a list of more.

15. 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
If you want to measure customer accommodation… there are some different measurements.
We have mentioned the perfect order before… that is the perfect orders divided by all orders.
Absolute performance… quantities number of the number of missed orders. The percentage can give misinformation.
Customer satisfaction… result of surveys or complaints.

16. Figure 16.2 Illustration of Measurement Framework
Illustration of framework use showing metric 2 is closer to measurement need
Determining the proper measurement is a process. You really don’t get value is measuring everything, so you need to focus on the important stuff.
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
The box has a star in it which represents the desired measurement for the company. They want an efficiency/ monitoring/ operational measurement.
#1 Is too strategic and too diagnostic. #2 is much closer to the desired measurement.
Figure 16.2 Illustration of Measurement Framework

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
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
If you are looking for some comprehensive metrics… ones that encompass most supply chain performance and effectiveness information. You should look at the 6 metrics. (we have talked about most before)
Cash-to-cash conversion: dollar spent on inventory to a dollar in sales revenue.
Day of supply: how many day of inventory on hand.
Dwell time: idle inventory compared to productive use of inventory.
In stock percentage (we call availability in the Coast Guard)
Total supply chain costs (need to sum form all firms)
Response time (how fast the company can adjust output to changing demand)

18. Figure 16.3 Total Supply Chain Cost
Illustration of supply chain total cost extending beyond an individual firm
We talked about the total supply cost… need to take into account all components.
Figure 16.3 Total Supply Chain Cost

19. 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
Does anyone know what benchmarking is?
It is a critical aspect of performance measurement. It is looking at the best in the field and seeing how they perform. You measure your level against the best.
If you are part of a big company (like Johnson and Johnson it is easier to get comparative information)
It may be required to look for something outside your area for comparative benchmarking.
We found that the world of ATM machine availability is similar to aviation availability. You want to find someone with outstanding performance to measure against.

20. High-achieving firms are more involved in benchmarking than average-achieving firms
Table 16.2 Performance Benchmarking Differential
Benchmarking is an important measurement tool for high performing companies. You can see by the table that high performing companies are more likely involved in benchmarking. Almost 2x the average index.

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
We talked about operational assessments… now we are going to move on to financial assessments.
First we are going to talk about cost-revenue analysis

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
Doing a proper logistical cost-revenue analysis is often difficult because accounting principles sometimes mask metrics. At ALC, we make logistical measurements (items) separately from our accounting measurements (aggregate into odd groupings). The next slide will show some other minor problems with the accounting system.
We will then look at the approaches to identifying and controlling logistical expenses: contribution, net profit, and activity based costing.

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
Here are the problems with accounting practices.
I already mentioned the accounting aggregation.
There are also freight expenses… inbound is taken out of gross sales and outbound is an operating expense.

24. Fixed costs are those that do not directly change with volume
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
If you are going to do a contribution analysis… you must divide all costs into one of two categories: fixed or variable.
We talked about these costs a few weeks ago.
Fixed costs do not change with and increase in volume. The rent at 7-11 is the same regardless of how many slurpees they sell. So rent is a fixed cost.
Variable costs do change… the monthly spending for cherry slurpee syrup is directly related to how many slurpees the store sells. So Syrup would be a variable cost.
There is another aspect that you also need to understand… direct vs indirect costs.
Direct costs san be related to a particular item. For example, we will look at the 7-11 again. Lets look at the soda fountain machine… it has many flavors in it. If you wanted to examine the drinking patterns of diet drinkers… you could see the direct impact on diet syrup purchases. If diet drinkers stoped visiting your 7-11… you would no longer need any new syrup. Direct cost can be tied to a particular product or customer.
Indirect costs can not be tied directly. In the case of the fountain machine… ice is an indirect cost. You do not know what percent of the ice is used by diet drinkers or those dreaded suger drinkers. Since is is not directly tied… it is an indirect cost.

25. Example of contribution analysis
Table 16.3 Contribution Margin Income Statement for Two Customers
This slide is now combining the 4 elements we just learned.
You can have variable direct and fixed direct. Can someone give an example of a variable direct cost in a hospital. Blue paper robes… they are variable because you use more if you have more patients… and direct because they can be directly tied to patient volume.
For the retail can someone think of a fixed direct example. This is a little tougher. The children’s department managers salary. It is fixed (because she is a manager and her salary is not dependent on sales, but her efforts can be directly related to children’s clothing customers).

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
The next analysis method is the net profit approach…
If we look back at the previous slide you will see that there was $41,000 in indirect fixed costs. This would be the cost of the lights in a department store… it is fixed and it effects all departments, not just the children’s department.
This $41,000 needs to be equally spilt up between all departments.
But how to divide it… equally (5 departments each pays 1/5). Based on sales (the highest sales department pays a higher share. Based on square footage (more sqft = more light shining on the floor). The situation turns into a congress/ senate debate.

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
Activity based costing looks at tracing the costs to the actual activity performed.
For example say that order processing is a fixed indirect cost amounting to $5000 a year.
You have two customers whose sales volume is 40% (hospital) and 60% (retailer). If you split the money is would be $2000 and $3000.
The problem is that the 60% customer (retailer) actually makes just a few orders a year (big orders) while the 40% customer (hospital) makes many orders a year. The orders are 80 per year for the hospital and 20 for the retailer. So based on ABC the split would be hospital $4000 and retailer $1000/
Of course identifying the driver of the expense to an activity is sometimes a challenge.

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
The return on investment is something that has been very popular for the last 10 + years. When a company spends money on a product… they want to know what they get for that money. I had to complete a return on investment calculation for click parts… I will show you a little from that analysis.
Latter will calculate Return on asset… which is different than return on investment. The ROA looks at how much you are making based on you operational assets.

29. Illustration of strategic profit model with example data
This is probably a little challenging to read… it is from page 398 if you are interested….
Figure 16.4 Strategic Profit Model

30. Illustration of strategic profit model with example data
It will be important that you understand the concept behind this… because you are going to get a model filled in like this. The good thing is that I’m going to give you the steps to fill it out right now.
Figure 16.4 Strategic Profit Model

31. Illustration of strategic profit model with example data
We are starting in the upper right corner…
Sales minus the cost of goods = the gross margin.
Figure 16.4 Strategic Profit Model

32. Illustration of strategic profit model with example data
Below that is the information required to calculate total expenses…
Variable + fixed = total.
Figure 16.4 Strategic Profit Model

33. Illustration of strategic profit model with example data
We just calculated gross margin and total expenses…
If you subtract them you get net profit.
Figure 16.4 Strategic Profit Model

34. Illustration of strategic profit model with example data
With sales information you can figure out the net profit margin…
Net profit / sales = net profit margin….
Now we move to the bottom section.
Figure 16.4 Strategic Profit Model

35. Illustration of strategic profit model with example data
We are now on the bottom section…
Inventory + accounts receivable+ other current assets = current assets.
Figure 16.4 Strategic Profit Model

36. Illustration of strategic profit model with example data
With fixed asset information… you can add current assets which equals total assets.
Figure 16.4 Strategic Profit Model

37. Illustration of strategic profit model with example data
With sales information we can figure out asset turnover.
Sale / total asset = asset turn over.
Figure 16.4 Strategic Profit Model

38. Illustration of strategic profit model with example data
Now we are connecting the top and the bottom to determine return on asset
Net profit margin * asset turnover = ROA.
Now it is your turn….
Figure 16.4 Strategic Profit Model

39. What is the Return on Asset for this problem?

40. The problem works itself if you closely follow the hints on the page.

41. 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
Well say you want to improve your return on asset… there are a couple things you can do…
Increase your net profit margin or increase your asset turnover. These are the last two numbers that are multiplied to create the ROA
Net profit margin is the portion of each sale the company keeps as profit.
Asset turnover is the measurement of efficiency of asset usage.

42. 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
If you think about the required profit when you are bringing on new products you can positively effect you ROA…

43. Product A vs Product B Table 16.4 CMROI for Two Products
When you look at the two products which appears to be the best choice to produce.
Should answer A

44. Product A vs Product B Table 16.4 CMROI for Two Products
Now lets add some additional information. Which do you think is the best now?
Should answer A

45. Product B contributes a higher return even though its gross margin is lower
Table 16.4 CMROI for Two Products
Now we add the last piece of the puzzle, the average inventory.
With this piece, we can see the lower required inventory level required by Product B makes it a better Contribution Margin Return on Investment.

46. Example showing ROA improvement if inventory cost is reduced to $300
The problem you completed in class was just the same problem I worked… but with a lower inventory level. The lower inventory level also gave you a lower variable cost (because you are not producing as much).
My example gave a ROA of 10, while your lower inventory level gave a ROA of 13.3%
Figure 16.5 Strategic Profit Model (Inventory Reduction)

47. 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
The negative accounting procedure used by Enron and Worldcom were part of the reason the SOX act was created in 2002.
It gives a greater degree of visibility of supply chain operations then were previously required.