SCHOOL OF MECHANICAL AND INDUSTRIAL

ENGINEERING

Supply Chain Management & Logistics

02 – Supply Chain Drivers and Metrics

Yared Lemma
Yared.lemma@aait.edu.et

A.Y. 2019-2020
Topics For Discussion

• Drivers of supply chain performance

• A framework for structuring drivers

• Obstacles to achieving fit

Drivers of supply chain performance

• To understand how a company can improve supply chain

performance in terms of responsiveness and efficiency, we must

examine the logistical and cross-functional drivers of supply

chain performance: facilities, inventory, transportation,

information, sourcing and pricing.

 CONT’D

• These drivers interact with each other to determine the supply

chain's performance in terms of responsiveness and efficiency.

• As a result, the structure of these drivers determines if and how

strategic fit is achieved across the supply chain.
 CONT’D
Facilities

• The actual physical locations in the supply chain network where

product is stored, assembled, or fabricated.

• The major types of facilities are production sites and storages sites.
• Decision regarding the role, location, capacity, and flexibility or

facilities have a significant impact on the supply chain’s performance.

 CONT’D
Inventory
• Raw materials, WIP, finished goods within a supply chain

• Changing inventory policies can dramatically alter the supply chain’s

efficiency and responsiveness.

• For example, a clothing retailer can make itself more responsive by

stocking large amounts of inventory and satisfying customer demand
from stock. A large inventory increases the retailer’s cost, thereby
making it less efficient. Reducing inventory makes the retailer more
efficient but hurts its responsiveness.
 CONT’D
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.
 CONT’D
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.
 CONT’D
Sourcing
• Sourcing is the choice of who will perform a particular supply chain activity
such as a production, storage, transportation, or the 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.
 CONT’D

Pricing
• Pricing determines how much a firm will charge for 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 supply chain performance.
 CONT’D
• Our definition of these drivers attempts to delineate logistics and
supply chain management.

• Supply chain management includes the use of logistical and cross-

functional drivers to increase the supply chain surplus.

• Cross-functional drivers have become increasingly important in

raising the supply chain surplus in recent years.

• While logistics remains a major part, supply chain management is

increasingly becoming focused on the three cross-functional drivers
Framework for Structuring Drivers
• The goal of a supply chain strategy is to strike
the balance between responsiveness and
efficiency that fits with the competitive
strategy.

• To reach this goal, a company must structure

the right combination of the three logistical
and three cross-functional drivers discussed
earlier.
 CONT’D
Corporate Strategy

Competitive Strategy

Supply Chain Strategy

Responsiveness Efficiency

Facilities Inventory Transportation Information Sourcing Pricing

Logistical drivers Cross functional drivers

 CONT’D
• For each of the individual drivers, supply chain managers must make
a trade-off between efficiency and responsiveness based on
interaction with the other drivers.

• The combined impact of these drivers then determines the

responsiveness and the profits of the entire supply chain.

• Most companies begin with a competitive strategy and then decide

what their supply chain strategy ought to be.
 CONT’D
• The supply chain strategy determines how the supply chain should
perform with respect to efficiency and responsiveness.

• The supply chain must then use the three logistical and three cross-
functional drivers to reach the performance level the supply chain
strategy dictates and maximize the supply chain profits.

• Although this framework is generally viewed from the top down, in

many instances, a study of the six drivers may indicate the need to
change the supply chain and potentially even the competitive strategy.
Facilities - role
• Role in the supply chain
• the “where” of the supply chain
• manufacturing or storage (warehouses)

• Role in the competitive strategy

• economies of scale (efficiency priority)
• larger number of smaller facilities (responsiveness
priority)
 CONT’D
• For production facilities, firms must decide whether they will be
flexible, dedicated, or a combination of the two.
– Flexible capacity can be used for many types of products but is often less efficient,
whereas dedicated capacity can be used for only a limited number of products but is
more efficient.

• Firms must also decide whether to design a facility with a product

focus or a functional focus.
– A product-focused facility performs many different functions (e.g. fabrication and
assembly) in producing a single type of product.
– A functional-focused facility performs few functions (e.g., only fabrication or only
assembly) on many types of products.
 CONT’D
Components of Facilities Decisions
• Location
• centralization (efficiency) vs. decentralization (responsiveness)
• other factors to consider (e.g., proximity to customers)

• Capacity (flexibility versus efficiency)

• Manufacturing methodology (product focused versus process focused)

• Warehousing methodology (SKU storage, job lot storage, cross-

docking)

• Overall trade-off: Responsiveness versus efficiency

 CONT’D
Facility-Related Metrics
• Capacity: measure the maximum amount a facility can process

• Utilization: measures the fraction of capacity that is currently being

used in the facility. Utilization affects both the unit cost of processing
and the associated delays. Unit costs tend to decline and delays
increase with increasing utilization.

• Theoretical flow/cycle time of production: measures the time

required to process a unit if there are absolutely no delays at any
stages.
 CONT’D
• Actual average flow/cycle time: measures the average actual time
taken for all units processed over a specified duration such as a week
or month. The actual flow/cycle time includes the theoretical time and
any delays.

• Flow time efficiency: is the ratio of the theoretical flow rate to the
actual average flow time

• Product variety: measures the number of products/products families

processed in a facility. Processing costs and flow times are likely to
increase with product variety.
 CONT’D
• 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.

• Average production batch size: measures the average amount

produced in each production batch. Large batch sizes will decrease
production cost but increase inventories in the supply chain.

• Production service level: measures the fraction of production orders

completed on time and in full
 CONT’D
Overall Trade-Off: Responsiveness versus Efficiency
• The fundamental trade-off that managers face when making facilities
decisions is between the cost of the number, location, and type of
facilities (efficiency) and the level of responsiveness that these
facilities provide the company’s customers.

• Increasing the number of facilities increases facility and inventory costs

but decreases transportation costs and reduce response time.

• Increasing the flexibility of a facility increases facility costs but

decreases inventory costs and response time.
Worldwide operations

Source: http://www.toyota.co.jp/en/facilities/manufacturing/worldwide.html
Inventory - role
• Inventory exists because of a mismatch between supply and demand
• Source of cost and influence on responsiveness
• Impact on
• material flow time: time elapsed between when material enters
the supply chain to when it exits the supply chain
• Throughput: rate at which sales to end consumers occur
• I = RT (Little’s Law)
• I = inventory; R = throughput; T = flow time

• Inventory and throughput are “synonymous” in a supply chain

 CONT’D

• If responsiveness is a strategic competitive priority, a firm can locate

larger amounts of inventory closer to customers

• If cost is more important, inventory can be reduced to make the firm

more efficient
Components of Inventory Decisions CONT’D
• Cycle inventory
– Average amount of inventory used to satisfy demand between
shipments
– Depends on lot size

• Safety inventory
– inventory held in case demand exceeds expectations
– costs of carrying too much inventory versus cost of losing sales

• Seasonal inventory
– inventory built up to counter predictable variability in demand
– cost of carrying additional inventory versus cost of flexible
production
 CONT’D
• Overall trade-off: Responsiveness versus efficiency
• more inventory: greater responsiveness but greater cost
• less inventory: lower cost but lower responsiveness

• Level of product availability

• Level of product availability is the fraction of demand that is
served on time from product held in inventory.
• A high level of product availability provides a high level of
responsiveness but increases cost because a lot of inventory is held
but rarely used.
 CONT’D
Inventory-related metrics
• Average inventory: measure the average amount of inventory
carried. Average inventory should be measured in units, days of
demand, and financial value.

• Product with more than a specified number of days of

inventory: identifies the products for which the firm is carrying a
high level of inventory. This metric can be used to identify
products that are in oversupply or identify reasons that justify the
high inventory, such as price discounts, or being a very slow mover.
 CONT’D

• Average replenishment batch size: measures the average amount

in each replenishment order. The batch size should be measured by

SKU in terms of both units and days of demand. It can be estimated

by averaging over time the difference between the maximum and

the minimum inventory (measured in each replenishment cycle) on

hand.
 CONT’D
• Average safety inventory: measures the average amount of
inventory on hand when a replenishment order arrives. Average
safety inventory should be measured by SKU in both units and days
of demand. It can be estimated by averaging over time the minimum
inventory on hand in each replenishment cycle.

• Seasonal inventory: measures the amount of both cycle and safety

inventory that is purchased solely due to seasonal changes in
demand.
 CONT’D
• Fill rate: measures the fraction of orders/demand that were met on
time from inventory. Fill rate should not be averaged over time but
over a specified number of units of demand (say, every thousand,
million, etc).

• Fraction of time out of stock: measures the fraction of time that a

particular SKU had zero inventory. This fraction can be used to
estimate the demand during the stock out period.
 CONT’D
Overall trade-off: Responsiveness vs Efficiency

• The fundamental trade-off that managers face when making

inventory decisions is between responsiveness and efficiency.

• Increasing inventory generally makes the supply chain more

responsive to the customer.

• A higher level of inventory also facilitates a reduction in production

and transportation costs because of improved economies of scale in
both functions. This choice increase inventory holding cost
Transportation: role

• Moves the product between stages in the supply chain

• Impact on responsiveness and efficiency
• Faster transportation allows greater responsiveness but lower
efficiency

• Also affects inventory and facilities

 CONT’D
• If responsiveness is a strategic competitive priority, then faster
transportation modes can provide greater responsiveness to
customers who are willing to pay for it

• Can also use slower transportation modes for customers whose

priority is price (cost)

• Can also consider both inventory and transportation to find the

right balance
Components of Transportation Decisions
CONT’D

• Mode of transportation
– air, truck, rail, ship, pipeline, electronic transportation
– vary in cost, speed, size of shipment, flexibility
• Route and network selection
– route: path along which a product is shipped
– network: collection of locations and routes
• In-house or outsource
• Overall trade-off: Responsiveness versus efficiency
Transportation-related metrics CONT’D
• Average inbound transportation cost: typically measures the cost of
bringing product into a facility as a percentage of sales or cost of goods sold
(COGS)

• Average incoming shipment size: measures the average number of units or

dollars in each incoming shipment at a facility

• 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.
 CONT’D
• 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.

• Average outbound shipment size: measures the average number of units or

dollars on each outbound shipment at a facility.

• Average outbound transportation cost per shipment: measures the average

transportation cost of each outgoing delivery.

• 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
if certain modes are overused or underutilized.
 CONT’D
Overall trade-off: responsiveness vs efficiency

• The fundamental trade-off for transportation is between 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.
Information: role

• The connection between the various stages in the supply chain –

allows coordination between stages

• Crucial to daily operation of each stage in a supply chain – e.g.,

production scheduling, inventory levels

• Allows supply chain to become more efficient and more responsive at

the same time (reduces the need for a trade-off)
 CONT’D
Components of Information Decisions
• Push (MRP) versus pull (demand information transmitted quickly
throughout the supply chain)

• Coordination and information sharing

• Forecasting and aggregate planning
• Enabling technologies (EDI, Internet, ERP systems, Supply Chain
Management software, etc.)

• Overall trade-off: Responsiveness versus efficiency

 CONT’D
Information-related metrics

• Forecast horizon: identifies how far in advance of the actual event

a forecast is made. The forecast horizon must equal the lead time of
the decision that is driven .

• Frequency of update: identifies how frequently each forecast is

updated.

• Forecast error: measures the difference between the forecast and

actual demand.
 CONT’D

• Seasonal factors: measures the extent to which the average

demand in a season is above or below the average in the year.

• Variance from plan: identifies the difference between the planned

production/inventories and the actual values.

• Ratio of demand variability to order variability: measures the

standard deviation of incoming demand and supply orders placed.
 CONT’D
Overall trade-off: Responsiveness vs efficiency

• Good information can help a firm improve both its responsiveness and
efficiency. The information driver is used to improve the performance of
other drivers, and the use of information is based on the strategic
position the other drivers support.

• Accurate information can help a firm improve efficiency by decreasing

inventory and transportation costs.

• Accurate information can improve responsiveness by helping a supply

chain better match supply and demand.
Sourcing: role

• Set of business processes required to purchase goods and services in

a supply chain

• Supplier selection, single vs. multiple suppliers, contract negotiation

• Sourcing decisions are crucial because they affect the level of
efficiency and responsiveness in a supply chain

• In-house vs. outsource decisions- improving efficiency and

responsiveness
 CONT’D
Components of Sourcing Decisions

• In-house versus outsource decisions

• Supplier evaluation and selection
• Procurement process
• Overall trade-off: Increase the supply chain profits
 CONT’D
Sourcing-related metrics

• Days payable outstanding: measures the number of days between when a

supplier performed a supply chain task and when it was paid.

• Average purchase price: measures the average price at which a good or

service was purchased during the year. The average price should be weighted
by the quantity purchased at each price.

• Range of purchase price: measures the fluctuation in purchase price during a

specific period. The goal is to identify if the quantity purchased correlated
with the price.
 CONT’D
• 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.

• Fraction on-time deliveries: measures the fraction of deliveries from

the supplier that were on time

• Supply quality: measures the quality of product supplied

• Supply lead time: measures the average time between when an order is
placed and the product arrives
 CONT’D
Overall trade-off: increases the supply chain profits
• Sourcing decisions should be made to increase the size of the total profit to be
shared across the supply chain.

• The total profits are affected by the impact of sourcing on sales, service,
production costs, inventory costs, transportation costs, and information cost.

• Outsourcing to a third party is meaningful if the third party raises the supply chain
profits more than the firm can by its own.

• In contrast, a firm should keep a supply chain function in-house if third party
cannot increase the supply chain profits or if the risk associated with outsourcing is
significant.
Pricing: role
• Pricing determines the amount to charge customers in a supply
chain

• Pricing strategies can be used to match demand and supply

• Firms can utilize optimal pricing strategies to improve efficiency
and responsiveness

• Low price and low product availability; vary prices by response

times
 CONT’D
Components of Pricing Decisions

• Pricing and economies of scale

• Everyday low pricing versus high-low pricing
• Fixed price versus menu pricing
• Overall trade-off: Increase the firm profits
 CONT’D
Pricing-related metrics
• Profit margin: measures profit as a percentage of revenue. A firm
needs to examine a wide variety of profit margin metrics to optimize
its pricing, including dimensions such as type of margin (gross, net,
etc), scope (SKU, product line, division, firm), customer type, and
others.

• Days sales outstanding: measures the average time between when a

sale is made and when the cash is collected.
 CONT’D
• Incremental fixed cost per order: measures the incremental costs
that are independent of the size of the order. These include
changeover costs at a manufacturing plant or order processing or
transportation costs that are incurred independent of shipment size at
a mail-order firm.

• Incremental variable cost per unit: measures the incremental costs

that vary with the size of the order. These include picking costs at a
mail-order firm or variable production costs at a manufacturing plant.
 CONT’D
• Average sale price: measures the average price at which a supply chain
activity was performed in a given period. The average should be obtained
by weighting the price with the quantity sold at that price.

• Average order size: measures the average quantity per order. The average
sale price, order size, incremental fixed cost per order, and incremental
variable cost per unit help estimate the contribution from performing the
supply chain activity.

• Range of sale price: measures the maximum and the minimum of sale
price per unit over a specified time horizon.
 CONT’D

• Range of periodic sales: measures the maximum and minimum of the

quantity sold per period (day/week/month) during a specified time

horizon. The goal is to understand and correlation between sales and

price and any potential opportunity to shift sales by changing price

over time.
 CONT’D
Overall trade-off: Increase firm profits

• All pricing decisions should be made with the objective of increasing

firm profits.

• This requires an understanding of the cost structure of performing a

supply chain activity and the value this activity brings to supply chain.

• Strategies such as everyday low pricing may foster stable demand that
allows for efficiency in the supply chain.
 CONT’D

• Other pricing strategies may lower supply chain costs, defend market
share, or even steal market share.

• Differential pricing may be used to attract customers with varying

needs, as long as this strategy helps either increase revenues or shrink

costs, preferably both.

Obstacles to Achieving Strategic Fit
Increasing variety of products

• Product proliferation is rampant today.

• With customer demanding ever more customized products,

manufacturers have responded with mass customization and even

segments-of-one (companies view each customer as an independent

market segment) views of the market.

 CONT’D

• Products that were formerly quite generic are now custom-made for
a specific consumer. The increase in product variety complicates

the supply chain by making forecasting much more difficult.

• Increased variety tends to raise uncertainty, and increased

uncertainty hurts both efficiency and responsiveness within the

supply chain.
 CONT’D
Decreasing product life cycles

• In addition to the increasing variety of product types, the life cycle of products has
been shrinking.

• Today there are products whose life cycles can be measured in months, compared to
the old standard of years.

• This decrease in product life cycle makes the job of achieving strategic fit more

difficult, as the supply chain must constantly adapt to manufacture and deliver new

products, in addition to coping with these products’ demand uncertainty.

 CONT’D

• Shorter life cycle increase uncertainty while reducing the window of

opportunity within which the supply chain can achieve fit.

• Increased uncertainty combined with a smaller window of opportunity

has put additional pressure on supply chains to coordinate and create

a good match between supply and demand.

 CONT’D
Increasingly demanding customers

• Customers are constantly demanding improvements in delivery lead times,

cost, and product performance. If they do not receive these improvements,

they move on to new suppliers.

• Many companies had periodic, standard price increases-not due to a rise in

demand or any other factor, but simply because raising prices was the way

business was done.

 CONT’D
• Now, one repeatedly sees companies that cannot force through any

price increases without losing market share.

• Today’s customers are demanding faster fulfillment, better quality, and

better-performing products for the same price they paid years ago.

• This tremendous growth in customer demands means that the supply

chain must provide more just to maintain its business.

 CONT’D
Fragmentation of supply chain ownership
• Over the past several decades, most firms have become less vertically integrated.
As companies have shed noncore functions, they have been able to take
advantage of supplier and customer competencies that they themselves did not
have.
• This new ownership structure, has also made managing the SC more difficult.
With the chain broken into many owners, each with its own policies and interest,
the chain is more difficult to coordinate.
• Potentially, this problem could cause each stage of a SC to work only toward its
own objective rather than the whole chain’s, resulting in the reduction of overall
SC profitability.
 CONT’D
Globalization

• Supply chains today are more likely than ever to be global.

• Establishing a global supply chain creates many benefits, such as the

ability to source from a global base of suppliers who may offer better or

cheaper goods than were available in a company’s home nation.

• Globalization adds stress to the chain, because facilities within the chain

are farther apart, making coordination much more difficult.

 CONT’D
Difficulty executing new strategies

• Creating a successful supply chain strategy is not easy.

• Once a good strategy is formulated, the execution of the strategy can
be even more difficult. For instance, Toyota’s production system,

which is a supply chain strategy, has been widely known and

understood. Yet this strategy has been a sustained competitive

advantage for Toyota for more than two decades.

 CONT’D
• Does Toyota have a brilliant strategy that no one else can figure out?
Their strategy is brilliant, but many others have figured it out.

• The difficulty other firms have had in in executing that strategy. Many
highly talented employees at all levels of the organizations are

necessary to make a supply chain strategy successful.

• Skillful execution of a strategy can be as important as the strategy

 CONT’D

• Key point: Many obstacles, such as rising product variety and shorter
life cycle, have made it increasingly difficult for supply chains to

achieve strategic fit. Overcoming these obstacle offers a tremendous

opportunity for firms to use supply chain management to gain

competitive advantage.
• How could a grocery retailer use inventory to increase the
responsiveness of the company's supply chain?

• How could an industrial supplies distributor use information to

increase its responsiveness?

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