UNIT 1:

FUNDAMENTALS OF LOGISTICS
AND SUPPLY CHAIN MANAGEMENT
Chapter-4 : Supply Chain Drivers and Metrics
POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 1
Learning
Outcomes
≡ linking key financial measures
of firm performance to supply
chain performance
≡ List and describe the Six
drivers of supply chain
management
≡ Explain supply chain
management strategies
focused on efficiency
≡ Explain supply chain
management strategies
focused on responsiveness

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 2

 Financial Measures Of Performance

− From a shareholder perspective, return on equity (ROE) is the main

summary measure of a firm’s performance
ROE = Net Income /Average Shareholder Equity
− Return on assets (ROA) measures the return earned on each dollar
invested by the firm in assets
ROA= Earnings before interest /Average Total Assets
*** Earnings before interest = Net Income + Interest Expense X (1 – Tax Rate)
*** Average Total Assets= (Opening Assets + Closing Assets)/2

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 3

 Financial Measures Of Performance

− An important ratio that defines financial leverage is accounts payable

turnover (APT)
APT = Cost of Goods Sold / Accounts Payable
− ROA can be written as the product of two ratios – profit margin and asset
turnover
ROA= (Earnings before interest /Sales Revenue) X (Sales Revenue X Total Asset)
ROA= Profit Margin X Asset Turnover

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 4

 Financial Measures Of Performance

− Key components of asset turnover are Accounts Receivable Turnover (ART); Inventory Turnover (INVT); and Property, Plant, and Equipment
turnover (PPET)
o ART = Sales Revenue / Accounts Receivable
o INVT = Cost of Goods Sold / Inventories
o PPET = Sales Revenue / PP & E

− 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 = (minus) Weeks Payable + Weeks in Inventory +Weeks Receivable
→ Weeks Payable = (1/APT)
→ Weeks in Inventory = (1/INVT)
→ Weeks Receivable = (1/ART)

− To measures not part of financial statements

o Markdowns: discounts required to convince customers to buy excess inventory
o Lost sales: represent customer sales that did not materialize because of the absence of products the customer wanted to buy

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 5

 Assume a tax rate of 0.35

Consider the financial performance shown in Table 3-1 for Amazon.com and Nordstrom Inc. In
2013,
o Amazon achieved ROE = (274/9,746) = 2.81 percent
o Nordstrom achieved ROE = (613/1,913) =32.04 percent and
o Amazon achieved ROA = [(274 + 141) X (1 – 0.35)]/40,159 = 0.91 percent
o Nordstrom achieved ROA = [(613 + 160) X(1 - 0.35)]/8,089 = 8.86 percent
→ The difference between ROE and ROA is referred to as return on financial leverage (ROFL).
In 2013,
▪ Amazon had ROFL = 2.81 − 0.91 = 1.90 percent
▪ Nordstrom had ROFL= 32.04 - 8.86 = 23.18 percent
In Amazon’s case, a significant portion of the financial leverage in 2013 came from accounts
payable rather than debt. Thus, an important ratio that defines financial leverage is accounts
payable turnover (APT).

o In Amazon’s case, in 2013 APT = (54,181/21,821)= 2.48

o In Nordstrom’s case = (7,432/1,415) = 5.25.
▪ The small APT indicates that Amazon was able to use the money it owed suppliers to
finance a considerable fraction of its operations.
▪ In 2013, Amazon effectively financed its own operations for about 52/2.48 = 20.97
weeks with its suppliers’ money.

A firm can increase ROA by growing the profit margin and/or increasing the asset turnover. In
2013,
o Amazon achieved a profit margin of (647/74,452) = 0.87 percent
o Nordstrom achieved a profit margin (1,345/12,148) = 11.07 percent
and an asset turnover
o Amazon : (74,452/40,159) = 1.85
o Nordstrom: (12,148/8,089) = 1.50
→ Despite a lower asset turnover than Amazon, Nordstrom had a better ROA because it achieved
much higher profit margins.
→ Profit margin can be improved by receiving better prices or by reducing the various expenses
incurred.
The key components of asset turnover are accounts receivable turnover (ART); inventory
turnover (INVT); and property, plant, and equipment turnover (PPET).
In 2013
o Amazon achieved accounts receivable turnover of (74,452/4,767) = 15.62
o Nordstrom achieved accounts receivable turnover of (12,148/2,356) = 5.16
In 2013
→ Amazon collected its money from sales relatively quickly (in about 52/15.62 = 3.33 weeks on
average in 2013) after it made a sale.
→ Whereas Nordstrom took longer (about 10 weeks).
In 2013
o Amazon turned its inventory about (54,181/7,411) = 7.31 times
o Nordstrom turned its inventory (7,432/1,360) = 5.46 times

o Amazon turned its inventory about (54,181/7,411) = 7.31 times

o Nordstrom turned its inventory (7,432/1,360) = 5.46 times
In 2013
o Amazon had PPET = (74,452/10,949) = 6.80
o Nordstrom had PPET=(12,148/2,579) = 4.71

→ Thus, inventory sat with Amazon in 2013 for about (52/7.31) = 7.11 weeks on average
→ Thus, inventory sat with Nordstrom in 2013 for about(52/5.46) = 9.52 weeks on average

Each dollar invested in PP&E supported about

o Amazon $6.80 of sales
o Nordstrom $4.71 of sales

→ Amazon achieved a higher asset turnover than Nordstrom by turning its inventory faster and
generating higher revenue per dollar invested in PP&E.
→ Nordstrom, however, achieved a much higher ROA compared with Amazon because it had a
much higher profit margin.
→ A company can improve its asset turnover by turning its inventory more quickly or using its
existing warehousing and technology infrastructure to support a higher level of sales (or
decreasing the warehousing and technology infrastructure needed to support the existing level
of sales).
→ A company can improve its profit margin by increasing a customer’s willingness to pay or
decreasing operating expense.
Cash-to-cash (C2C) cycle

Another useful metric is the cash-to-cash (C2C) cycle, which roughly measures the aver-
age amount of time from when cash enters the process as cost to when it returns as collected
revenue.
C2C = -Weeks Payable + Weeks in Inventory +Weeks Receivable
o Weeks Payable = (1/APT)
o Weeks in Inventory = (1/INVT)
o Weeks Receivable = (1/ART)

o In Amazon’s case, we obtain C2C = -20.97 + 7.11 + 3.33 = -10.53 in 2013.

o In Nordstrom’s case what is C2C ???
→ In 2013, Amazon collected its money from the sale of products more than 10 weeks before it had to pay
its suppliers.

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 8

 (1) Facilities
• Facilities are the actual physical locations in the supply
chain network where product is stored, assembled, or
fabricated. The two major types of facilities are
production sites and storage sites.

(2) Inventory
Drivers of • Inventory encompasses all raw materials, work in process,
Supply Chain and finished goods within a supply chain. Changing
inventory policies can dramatically alter the supply chain’s
Performance efficiency and responsiveness.

(3) Transportation
• Transportation entails moving inventory from point to point
in the supply chain. Transportation can take the form of
many combinations of modes and routes, each with its own
performance characteristics. Transportation choices have
a large impact on supply chain responsiveness and
efficiency.

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 9

 (4) Information
• Information consists of data and analysis concerning facilities,
inventory, transportation, costs, prices, and customers throughout
the supply chain. Information is potentially the biggest driver of
performance in the supply chain because it directly affects each of
the other drivers. Information presents management with the
opportunity to make supply chains more responsive and more
efficient.
Drivers of (5) Sourcing
Supply Chain • Sourcing is the choice of who will perform a particular supply
chain activity, such as production, storage, transportation, or the
Performance management of information. At the strategic level, these decisions
determine what functions a firm performs and what functions the
firm outsources. Sourcing decisions affect both the
responsiveness and efficiency of a supply chain.

(6) Pricing
• Pricing determines how much a firm will charge for the goods and
services that it makes available in the supply chain. Pricing affects
the behavior of the buyer of the good or service, thus affecting
demand and supply chain performance.

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 10

Framework for
Structuring Drivers

o A supply chain’s performance in terms of

responsiveness and efficiency is based on the
interaction between the following logistical and
cross-functional drivers of supply chain
performance: facilities, inventory, transportation,
information, sourcing, and pricing.
o The goal is to 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.
o SCM strategies focusing on efficiency are most
concerned with using the supply chain to drive
down costs.
o SCM strategies focusing on responsiveness are
most concerned with using the supply chain to
increase customer satisfaction

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 11

 Facilities

▪ Role in the supply chain

- Increase responsiveness by increasing the number of facilities,
making them more flexible, or increasing capacity
- Tradeoffs between facility, inventory, and transportation costs
o Increasing number of facilities increases facility and inventory costs,
decreases transportation costs and reduces response time
o Increasing the flexibility or capacity of a facility increases facility costs
but decreases inventory costs and response time

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 12

 Facilities

▪ Components of facilities decisions

- Role
o Flexible, dedicated, or a combination of the two
o Product focus or a functional focus
- Location
o Where a company will locate its facilities
o Centralize for economies of scale, decentralize for responsiveness
o Consider macroeconomic factors, quality of workers, cost of workers and facility, availability of infrastructure,
proximity to customers, location of other facilities, tax effects
- Capacity
o A facility’s capacity to perform its intended function or functions
o Excess capacity – responsive, costly
o Little excess capacity – more efficient, less responsive

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 13

 Facilities

- Facility-related metrics
o Capacity - measures the maximum amount a facility can process.
o Utilization - measures the fraction of capacity that is currently being used in the facility.
o Processing/setup/down/idle time -measures the fraction of time that the facility was processing units, being set up to process units, unavailable
because it was down, or idle because it had no units to process.
o Production cost per unit- measures the average cost to produce a unit of output. These costs may be measured per unit, per case, or per pound,
depending on the product.
o Quality losses - measure the fraction of production lost as a result of defects.
o Theoretical flow/cycle time of production - measures the time required to process a unit if there are absolutely no delays at any stage.
o Actual average flow/cycle time -measures the average actual time taken for all units processed over a specified duration, such as a week or a
month.
o Flow time efficiency - is the ratio of the theoretical flow time to the actual average flow time.
o Product variety - measures the number of products or product families processed in a facility.
o Volume contribution of top 20 percent SKU's and customers - measures the fraction of total volume processed by a facility that comes from the
top 20 percent of SKUs or customers.
o Average production batch size - measures the average amount produced in each production batch.
o Production service level - measures the fraction of production orders completed on time and in full.
POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 14
 Inventory

▪ Role in the Supply Chain

- Inventory – offsets discrepancies between supply and demand

- Exploit economies of scale
- inventory is held to reduce cost or increase the level of product availability
- Affects the assets held, the costs incurred, and responsiveness (material flow time)
- Overall trade-off
o Increasing inventory generally makes the supply chain more responsive
o A higher level of inventory facilitates a reduction in production and transportation costs because of improved economies of scale
o Inventory holding costs increase

- 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
o Little’s law : I = DT (where I = flow time, T = throughput, D = demand)

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 15

 Inventory

▪ Components of Inventory Decisions

- Cycle inventory
o Average amount of inventory used to satisfy demand between supplier shipments
o Function of lot size decisions
- Safety inventory
o Inventory held in case demand exceeds expectations
o Costs of carrying too much inventory versus cost of losing sales
- Seasonal inventory
o Inventory built up to counter predictable variability in demand
o Cost of carrying additional inventory versus cost of flexible production
- Level of product availability
o The fraction of demand that is served on time from product held in inventory
o Trade off between customer service and cost

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 16

 Inventory

- Inventory-related Metrics
o C2C cycle time - is a high-level metric that includes inventories, accounts payable, and receivables.
o Average inventory- measures the average amount of inventory carried. Average inventory should be measured in
units, days of demand, and financial value.
o Inventory turns- measure the number of times inventory turns over in a year. It is the ratio of average inventory to
either the cost of goods sold or sales.
o Products with more than a specified number of days of inventory- identifies the products for which the firm is
carrying a high level of inventory.
o Average replenishment batch size - measures the average amount in each replenishment order.
o Average safety inventory- measures the average amount of inventory on hand when a replenishment order arrives.
o Seasonal inventory - measures the amount by which the inflow of product exceeds its sales (beyond cycle and
safety inventory).
o Fill rate (order/case) measures the fraction of orders/demand that were met on time from inventory.
o Fraction of time out of stock measures the fraction of time that a particular SKU had zero inventory.
o Obsolete inventory- measures the fraction of inventory older than a specified obsolescence date.

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 17

 Transportation

▪ Role in the supply chain

− Moves the product 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

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 18

 Transportation

▪ Components of Transportation Decisions

− Design of transportation network
o Modes, locations, and routes
o Direct or with intermediate consolidation points
o One or multiple supply or demand points in a single run

− Choice of transportation mode

o Air, truck, rail, sea, and pipeline as modes of transport
o Information goods can also be sent via the Internet
o Different speed, size of shipments, cost of shipping, and flexibility

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 19

 Transportation
− Transportation-related metrics
o Average inbound transportation cost- typically measures the cost of bringing product into a facility. Ideally, this cost should
be measured per unit brought in, but it is often measured as a percentage of sales or cost of goods sold (COGS). The inbound
transportation cost is generally included in COGS. It is useful to measure this cost separately for each supplier.
o Average incoming shipment size- measures the average number of units or dollars in each incoming shipment at a facility.
o Average inbound transportation cost per shipment- measures the average transportation cost of each incoming delivery.
Along with the incoming shipment size, this metric identifies opportunities for greater economies of scale in inbound
transportation.
o Average outbound transportation cost- measures the cost of sending product out of a facility to the customer. Ideally, this
cost should be measured per unit shipped, but it is often measured as a percentage of sales. It is useful to separate this metric
by customer.
o Average outbound shipment size- measures the average number of units or dollars on each outbound shipment at a facility.
o Average outbound transportation cost per shipment- measures the average transportation cost of each outgoing delivery.
Along with the outgoing shipment size, this metric identifies opportunities for greater economies of scale in outbound
transportation.
o Fraction transported by mode - measures the fraction of transportation (in units or dollars) using each mode of
transportation. This metric can be used to estimate whether certain modes are overused or underused.
POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 20
 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
▪ 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

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 21

 Information

▪ Components of Information Decisions

− Push versus Pull
o Different information requirements and uses

− Coordination and information sharing

o 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)

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

− Enabling technologies
1) Electronic data interchange (EDI)

2) The Internet

3) Enterprise resource planning (ERP) systems

4) Supply chain management (SCM) software

5) Radio frequency identification (RFID)

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 22

 Information

− Information-related metrics
o Forecast horizon - identifies how far in advance of the actual event a forecast is made.
o Frequency of update - identifies how frequently each forecast is updated.
o Forecast error- measures the difference between the forecast and actual demand.
o Seasonal factors- measure the extent to which the average demand in a season is above or
below the average in the year.
o Variance from plan- identifies the difference between the planned production/inventories and
the actual values.
o Ratio of demand variability to order variability- measures the standard deviation of incoming
demand and supply orders placed.

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 23

 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
− Increase the size of the total surplus to be shared across the supply chain
▪ 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

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 24

 Sourcing

▪ Components of Sourcing Decisions

− In-house or outsource
o Perform a task in-house or outsource it to a third party
o Outsource if it raises the supply chain surplus more than the firm can on its own
o Keep function in-house if the third party cannot increase the supply chain surplus or if the outsourcing
risk is significant
− Supplier selection
o Number of suppliers, criteria for evaluation and selection
− Procurement
o Obtain goods and service within a supply chain
o Goal is to increase supply chain surplus

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 25

 Sourcing

− Sourcing-related Metrics
o Days payable outstanding- measures the number of days between when a supplier performed a supply chain task
and when it was paid for.
o Average purchase price- measures the average price at which a good or service was purchased during the year. The
average should be obtained by weighting each price by the quantity purchased at that price.
o Range of purchase price- measures the fluctuation in purchase price during a specified period. The goal is to identify
if the quantity purchased correlated with the price.
o Average purchase quantity- measures the average amount purchased per order. The goal is to identify whether a
sufficient level of aggregation is occurring across locations when placing an order.
o Supply quality- measures the quality of product supplied.
o Supply lead time- measures the average time between when an order is placed and when the product arrives. Long
lead times reduce responsiveness and add to the inventory the supply chain must carry.
o Percentage of on-time deliveries- measures the fraction of deliveries from the supplier that were on time.
o Supplier reliability- measures the variability of the supplier’s lead time as well as the delivered quantity relative to
plan. Poor supplier reliability hurts responsiveness and adds to the amount of inventory the supply chain must carry.

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 26

 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

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 27

 Pricing

▪ Components of Pricing Decisions

− Pricing and economies of scale
o The provider of the activity must decide how to price it appropriately to reflect economies of
scale
− Everyday low pricing versus high-low pricing
o Different pricing strategies lead to different demand profiles that the supply chain must serve
▪ Fixed price versus menu pricing
o 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
o Can lead to customer behavior that has a negative impact on profits

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 28

 Pricing

− Pricing-related Metrics
o Profit margin- measures profit as a percentage of revenue.
o Days sales outstanding- measures the average time between when a sale is made and when the cash is collected.
o Incremental fixed cost per order- measures the incremental costs that are independent of the size of the order.
o Incremental variable cost per unit- measures the incremental costs that vary with the size of the order.
o Average sale price- measures the average price at which a supply chain activity was performed in each period.
o Average order size- measures the average quantity per order.
o Range of sale price- measures the maximum and the minimum of sale price per unit over a specified time horizon.
o Range of periodic sales- measures the maximum and minimum of the quantity sold per period (day/week/month)
during a specified time horizon.

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 29

Comparison
of Efficient and
Responsive
Supply Chain

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 30

 Driver Efficiency Responsiveness

1. Inventory Cost of holding Availability

2. Transportation Consolidation Speed

Considerations 3. Facilities Consolidation / Proximity /

for Supply Chain 4. Information

Dedicated
Low cost/slow/no
Flexibility
High cost/

Drivers 5. Sourcing
duplication
Low cost sources
streamlined/reliable
Responsive sources

6. Pricing Constant price Low-high price

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 31

 ▪ Achieving strategic fit is a company’s ability to find a balance between
responsiveness and efficiency that matches the needs of its target
customers.
o Increasing variety of products : Customers demanding ever more
customized products.
o Decreasing product life cycles : Today there are products whose life
cycles can be measured in months ,compared to the old standard of
years.

Obstacles to o Increasingly demanding customers: Customers are constantly

demanding improvements in delivery lead times, cost and product
performance.

achieving o Fragmentation of supply chain ownership : Most firms have

become less vertically integrated. As companies have shed noncore

strategic fit
functions, they have been able to take advantage of suppliers &
customer competencies that they themselves did not have.
o Globalization: Adds stress to the chain, because facilities within the
chain are farther apart, making coordination much more difficult.
o Difficulty in executing new strategies: Once the good strategy is
formulated , the execution of the strategy can be more difficult
▪ TO CONCLUDE…..
o Overcoming these obstacles offers a tremendous opportunity in
terms of untapped improvement within supply chain. the increasing
impact of obstacles has led to supply chain management becoming a
major factor in the success or failure of firms.

POSTGRADUATE DIPLOMA IN LOGISTICS AND SUPPLY CHAIN MANAGEMENT 32

Thank you for
your Attention!
Any Questions?