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Optimum Performance

By John McPhee | 24 | 2 | March 01, 2014
Racing toward the perfect order



In the world of supply chain management, three overarching metrics drive business performance: inventory, cost, and service. These concepts are in a state of perpetual pressure as functional teams vie for limited resources, pursuing targets that often are at odds with one another. This strain is a function of the conflicting nature of the metrics themselves, as well as the business goals they propel–and it is this “triangle of tension” that enables the supply chain to be driven, or to drive itself, to near faultless operation.

Metric 1. Days sales of inventory receives the greatest attention historically and is far and away the chief supply chain metric. In general terms, 70 is the foundation of days sales of inventory analysis in consumer products companies. This number is considered to be better than most, but not as good as it could be. Specifically, say a company has $14.5 billion in sales, meaning $40 million in sales each day. If it has an inventory position of $2.8 billion, then some quick division tells us its days sales of inventory is 70.

Metric 2. Logistics costs as percentage of revenue is the second calculation that defines supply chain performance. In the “triangle of tension” between our three essential metrics, this is the financial measure that complements inventory and service focus elsewhere in the organization. In the simplest terms, logistics costs as percentage of revenue is a gauge of how much of the company’s profits are invested in logistics expenses. Of course, businesses will define their logistics costs in a variety of ways. Take our hypothetical company with $14.5 billion in annual revenue: If it were to spend $1.2 billion annually on logistics costs, then its logistics costs as percentage of revenue would be approximately 8 percent.

Metric 3. Delivery precision assesses the speed and completeness with which an organization delivers product to customers. The company-specific variable in this case is the goal date for product delivery. To get that elusive perfect order, the optimum focus—and therefore the service delivery target—is the customer request date. Quite simply, this is the time that the customer expects a product to be delivered at an agreed-upon location. It also is the standard against which the “on time” half of the “on time in full” measure is weighed, a foundation of the concept of the perfect order. Order completeness is likewise evaluated by the latter half of on time in full. Keep in mind that there is no one right way to measure the “in full-ness” of a shipment. Three common alternatives include individual units, units in a line on an order, and units in all lines on an order.  In the case of our make-believe company, the standard performance metric that drives so much of the fundamental annual target setting and delivery planning is 90 percent.

In summary, when assessing supply chain performance and the “triangle of tension” among days sales of inventory, logistics costs as percentage of revenue, and delivery precision, the three numerical goals are 70, 8 percent, and 90 percent, respectively.

The traditional perfect order

A traditional perfect order can be summarized as delivering 100 percent of products to the right place at the right time, or 100 percent on time in full. What’s intriging is the inherent contradiction between the concept of a traditional perfect order and the business reality that the ultimate goal for each function in an organization is not simply to optimize performance, but to optimize that function’s performance in order to maximize long-term shareholder value. This discussion may fall outside the purview of this article—however, to summarize, long-term shareholder value is the one metric that most closely synthesizes all the varied efforts, focus, and impact that a business has on the community and in the marketplace.

Take, for instance, a company that adopts a singular focus on the traditional perfect order. Two of the most fundamental levers for increasing delivery precision are, in simple terms, having more product available for final delivery to the customer and investing more resources in expediting the delivery of product to customers. In order to have more product available for final delivery to customers, the company has many options. One alternative is managing to higher inventory target levels with buffer stock in various forms and locations throughout the supply chain. This has the significant service advantage of enabling the organization to be more responsive and flexible as “stuff happens” in the long period between customers placing orders and their final receipt of the product—or, as often occurs, a variation to the original order placed.

Ah, yes: “There’s been a change to the order”—seven small words that strike fear into the heart of every supply chain professional. The order may increase in size, require earlier delivery, need a different delivery destination, or have extra services added. Many of these modifications are positive for shareholder value and, therefore, in a holistic sense, are good for the supply chain professional. They also are examples of situations in which a higher inventory level (having a higher days sales of inventory goal) will enable the supply chain team to react more effectively. 

The second opportunity to more closely attain the traditional perfect order is to increase the investment made in delivering product. Primarily, this will drive up the “on time” half of on time in full. The most impactful (and expensive) way to do this is through changing the mode of transporting product from surface to air. For instance, the cost to deliver a single product unit from a port in Asia across the Pacific Ocean; through ports on the West Coast of the United States; and then across the United States to, say, Memphis, Tennessee (historically the US demographic center) is between $0.50 and $1. The cost to deliver product directly to a customer’s distribution center without going through Memphis is approximately the same. The cost to affect that same delivery by flying product from Asia to a distribution center in Memphis is almost 10 times that amount.

To come to the main point, the easy route to the traditional perfect order is to make changes that will negatively affect days sales of inventory and logistics costs as percentage of revenue metrics. This is an unacceptable solution for most companies. And so the triangle of tension lives and breathes on, as we work to approach the traditional perfect order while having only positive impacts on key metrics. Of course, the great truth is that the best way to approach the traditional perfect order is to improve the fundamentals that drive delivery precision. This means heightening resource efficiency and streamlining and optimizing processes—and that is the work that most of us industry professionals do every day in supply chains around the world.

The truly perfect order

The truly perfect order has the greatest positive impact. In the simplest terms, it is the on time in full measure of delivery precision that exists when the triangle of tension maximizes shareholder value. How do we attain this magical number? Many businesses have relentlessly driven the three supply chain metrics toward aggressive goals. In these competitive environments that define so many of the leading corporations, there is a strong sense that current long-term attained performance levels do approximate the optimum performance for each of these metrics.

The checks and balances that these three competing metrics provide are integral to ensuring that the company continues to drive toward a consistent superior level of supply chain performance. And with these checks and balances in place, it is the relentless pursuit of the truly perfect order that must drive the work that defines the supply chains of tomorrow.

The unpolished diamond opportunity for today’s supply chain lies in making step changes to the underlying fundamentals that guide these three metrics. There is widespread recognition of this truth throughout many organizations today. More than that, in 2014, there are multiple projects that speak to this. It is these endeavors, these innovations, and this commitment to supply chain excellence that enable the high performance levels where the triangle of tension resonates and propels great companies forward.

John McPhee is director of North America supply chain delivery at Nike. Prior to his current position, he worked in supply chain roles in the mining and investment banking industries. McPhee may be contacted at john.mcphee@nike.com.

4 Comments

  1. 1 Andy C 29 Apr
    Great article. One of the methods I use to help management visualize and understand metric interactions is through use of DOE. Though it has some drawbacks, it does help to quantify the interactions, so to speak.
  2. 2 Mark Hardison 29 Apr
    Excellent article and summary, John.  You were able to synthesize the dynamics that so many of us are faced with into a practical and applicable approach to supply chain improvement.

    Thanks for the benchmarking data as well!
  3. 3 Nilesh 28 Apr
    Good article. Infact I feel that there are plethora of metric (eg SCOR model) which still confuses a professional as to which metrics serves best their industry. So I believe the very first step for an organization would be to agree upon the metrics itself and whether the metric serve the vision and mission of the organization (shareholder profit). This article clearly also enunciates the counter balance between various metrics and to strike the right note on them. Well Operations might be the punching bag always but with these figures in hand and understanding the levers greatly enables a Supply chain professional (term used loosely).
  4. 4 Steve Ruger 07 Apr
    This is a good piece of work and I appreciate the target inventory levels (70 days).  Is ther any additional analysis on how sensitive that number actually is?  Meaning for companies meeting the definition of “effective management”, is the standard deviation 5?  10?  15?

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