CHAPTER TWELVE
Measurements for the Logistics Department
THE LOGISTICS FUNCTION IS composed of production scheduling, purchasing, materials handling, and distribution. These areas are all central to the smooth functioning of a company's production processes. A failure in any of these areas can severely affect or even halt production, so this is a prime area in which to set up and maintain a rigorous system of measurement tracking. The 28 measurements described in this chapter are intended to address the key operational aspects of logistics and should be measured on a trend line to ensure that management can spot operational difficulties as soon as they arise. The measurements discussed are:
| Production Schedule Accuracy
Economic Order Quantity Number of Orders to Place in a Period Economic Production Run Size Raw Material Inventory Turns Raw Material Content Finished Goods Inventory Turns Obsolete Inventory Percentage Percentage of Inventory > XX Days Old Percentage of Returnable Inventory Excess Inventory Index Inventory Accuracy Percentage of Certified Suppliers Electronic Data Interchange Supplier Percentage Distribution Turnover Supplier Fill Rate On-Time Parts Delivery Percentage |
Purchased Component Defect Rate
Incoming Components Correct Quantity Percentage Percentage of Actual Payments Varying from Purchase Order Price Percentage of Purchase Orders Issued below Minimum Dollar Level Proportion of Corporate Credit Card Usage Percentage of Receipts Authorized by Purchase Orders Freight Audit Recovery Ratio Picking Accuracy for Assembled Products Order Fill Rate Average Time to Ship On-Time Delivery Percentage Dock-to-Dock Time Percentage of Products Damaged in Transit Percentage of Sales through Distributors |
PRODUCTION SCHEDULE ACCURACY
Description: Without a production schedule that is carefully followed, the production department will find itself in a state of bedlam, with material shortages, irate customers, and projects being rushed through the production facility. To avoid this, the logistics staff must ensure that the jobs listed on the production schedule are completed in an orderly manner and in the scheduled sequence and quantities. The production schedule accuracy measurement is a useful tool for tracking this.
Formula: Divide the number of scheduled jobs completed during the measurement period by the total number of jobs scheduled for completion. However, if there are large jobs that cross over multiple periods, they will fall outside of this measurement, which tracks only completed jobs. In such cases, it may be more accurate to divide the number of completed production tasks within each scheduled job by the total number of scheduled tasks for all jobs. The basic formula is:
Example: The Wilkerson Supercomputer Company produces the largest computers in the world, which are used by many physics and weather-reporting laboratories. Each computer takes roughly three months to build when its production schedule is precisely followed. However, each one tends to take much longer, because the product manager for each job interferes in the production process to leapfrog the job ahead in the work queue. The logistics manager has recently put a stop to this behavior by denying all nonproduction personnel access to the manufacturing facility, and now needs to prove the point by showing the before-and-after monthly production schedule accuracy. The manager prepares the information found in Table 12.1.
| Before | After | |
| Total scheduled production tasks completed | 29 | 43 |
| Total production tasks scheduled | 67 | 59 |
| Production schedule accuracy | 43% | 73% |
The table shows a decisive improvement in schedule accuracy, which the logistics manager uses to permanently block the product managers from interfering with the production process.
Cautions: Despite the obvious production efficiencies associated with creating a production plan and then precisely following that plan, there are times when last-minute changes are required by customers, which can throw some portion of the schedule into disarray. Though some provision can be made for such changes within the schedule, these intrusions will occur, and they will affect the schedule's accuracy.
ECONOMIC ORDER QUANTITY
Description: If a company does not use a material requirements planning system or just-in-time system to control its inflow of raw materials, then a reasonable alternative is the economic order quantity. Under this calculation, the point at which the carrying cost of inventory equals its ordering cost can be derived. Theoretically, this is the ideal quantity that should be ordered. Note the problems with this approach in the Cautions section.
Formula: Multiply the total usage of a component by two, and then multiply the result by the cost per order. Then divide this result by the carrying cost per unit, and calculate the root of the result. Of particular importance is the variety of costs that can be included in the carrying cost per unit, which includes incremental materials handling costs, the cost of extra warehouse space and storage racks to contain it, damage caused by storage, insurance fees, and property taxes. The formula is:
A flaw in the EOQ formula is that at least half of the denominator consists of warehousing costs, which are driven by the physical size of the inventory. To ensure that the appropriate carrying costs are charged to an excessively large or small inventory item, consider the following variation on the EOQ formula:
The value-based carrying cost per unit includes the cost of funds, obsolescence, scrap, shrinkage, insurance, and inventory taxes, and is expressed as a percentage of the dollar cost of inventory. The cost per cubic foot includes the cost of warehouse space, utilities, maintenance, and property taxes, and is expressed as a dollar cost per cubic foot of storage.
Example: The Billings Pool Table Company buys a variety of slate table tops for its various models. The slate is quite expensive and is subject to breakage during materials handling, so the logistics staff tries to keep as little of it in stock as possible. The economic order quantity (EOQ) calculation for the slate top for the top-of-the-line Grande model is based on the following information:
| Annual usage in units | 125 |
| Ordering cost per order | $25 |
| Insurance cost per unit | $35 |
| Storage cost per unit | $80 |
| Interest cost per unit | $85 |
The EOQ formula is:
Cautions: It is important to calculate all of the incremental carrying costs associated with an inventory item because they can be so large that the resulting economic order quantity ends up being small. Also, actual order quantities allowed by suppliers may be so different from the calculated EOQ that the logistics staff has no choice but to diverge from the calculated best purchase quantity. For example, the EOQ may indicate that a purchase of 38 units is best, but the supplier sells only in quantities of 50. Also, a material requirements planning system may reveal that a component has no required use in the production schedule, in which case no additional order is required, no matter how low the existing inventory levels may drop—an issue that is not included in the basic EOQ formula at all. For these reasons, EOQ should be treated as a general guideline for purchasing quantities, rather than a strictly followed calculation.
NUMBER OF ORDERS TO PLACE IN A PERIOD
Description: The purchasing manager needs to have a general idea of the number of orders that the purchasing staff will be placing within a given time so that the departmental headcount can be adjusted to match purchasing needs. The EOQ formula can be modified slightly to derive this information.
Formula: Divide the total usage in units for a selected time by the economic order quantity, as shown in the preceding section. The formula is:
Example: The ViewBright Company, maker of rearview mirrors for the auto industry, has one major component: glass. Its purchasing manager is reviewing vacation requests from the staff and wants to know when the largest number of purchase orders are expected to be placed in the coming year. The manager assembles the information in Table 12.2 by quarter.
Based on the information in the table, the purchasing manager can see that the six months in the middle of the year will require the most purchasing effort. Consequently, the manager decides to limit the number of vacation hours that will be allowed through that period.
Cautions: This measurement assumes that the effort required to place any order is the same. In reality, the cost of order placement varies widely, depending on the number of purchasing steps required for items of different costs (more steps for high-dollar orders), the uniqueness of the items ordered, and the need for documentation for international orders. It is consequently better to run this calculation for different types of orders to gain a more accurate understanding of the total projected amount of time required to place them.
ECONOMIC PRODUCTION RUN SIZE
Description: The economic production run size is similar to the economic order quantity that was described in the Economic Order Quantity section, except that it applies to the scheduling of production run quantities rather than purchasing quantities. This is a useful tool for the production scheduling staff, which needs to know the most cost-effective size for which production runs should be scheduled. Please review the issues related to this measurement in the Cautions section.
Formula: Multiply the total unit demand of a product by two, and then multiply the result by the run setup cost. Then divide the result by the carrying cost per unit and calculate the root of the result. Of particular importance is the variety of costs that can be included in the carrying cost per unit, which includes incremental materials handling costs, the cost of extra warehouse space and storage racks to contain it, damage caused by storage, insurance fees, and property taxes. The formula is:
Example: The Hi-Tech Washing Machine Company makes very large quantities of its revolutionary microwave washing machine for the consumer market. Its production scheduling manager wants to determine the optimal production run size for this product. The microwave model has total annual demand of 150,000 units, a setup cost of $425,000, and a carrying cost per unit of $32. Its economic production run size is as follows:
Cautions: This measurement applies only to situations in which production runs are being made to stock, rather than to fill, orders. If specific orders are being filled, then production runs must match the size of the orders so that specific customer delivery dates are met.
Also, the theory of the economic production run size has been challenged by the just-in-time (JIT) manufacturing concept, which holds that the ideal run size is a single unit, which can be achieved by lowering the setup time to a minimal amount.
RAW MATERIAL INVENTORY TURNS
Description: One of the key performance measures of a logistics manager is the ability to keep a company's investment in raw materials to a minimum, which requires excellent inventory tracking systems, carefully maintained production planning systems, and good relations with high-quality suppliers. The end result of these systems is a very high number of raw material inventory turns.
Formula: Divide the dollar volume of raw materials consumed during the measurement period by the total dollar value of inventory on hand at the end of the period, and multiply the result by 12. The inventory value at the end of the period can be arbitrarily high in relation to average inventory levels throughout the measurement period, so an average value can be used instead. The formula is:
Example: The Cod Fishnet Company assembles its high-end amateur fishing nets from the finest spun cotton and teak handles. Since its sales tend to be highly variable in size and timing, it is very important for the logistics manager to keep low volumes on hand to avoid large investments in raw materials. As an incentive, the manager is paid a bonus in every month in which raw material turns of at least 12 are achieved. For the most recent month, the amount of raw material dollars consumed was $138,500, whereas the beginning inventory balance was $159,900 and the ending balance was $123,425. Based on this information, the company's raw material inventory turns for the period were:
The measurement indicates that the logistics manager has not achieved inventory turnover of at least 12 and therefore will not be paid a bonus. However, if the ending inventory value had been used in the measurement instead of the average value, the calculation would have yielded a turnover rate of 13.5, which would have earned the logistics manager a bonus. Because of this difference, the Cod Fishnet Company's president should codify the exact nature of the calculation used to determine whether the bonus is paid.
Cautions: This is a good measurement for tracking logistics performance. The use of high-cost air freight services to bring in inventory at the last minute, however, can lead a logistics manager to increase freight costs in order to achieve a high level of raw material turnover, even though the total cost to the company is increased by doing so. This problem can be avoided by measuring changes in freight costs alongside the turnover measurement.
RAW MATERIAL CONTENT
Description: It is useful to determine the proportion of raw material costs included in a typical sale so that management can determine whether the company is adding a sufficient amount of value to the product to yield a required level of profit. Otherwise, a company is essentially a reseller. Also, the measurement can be tracked on a trend line to determine whether the proportion of raw material to sales is rising, which indicates that raw material costs are increasing without a corresponding increase in sales.
Formula: Summarize the total amount of raw material dollars sold and divide it by sales. The amount of raw materials can be collected from the bills of materials associated with each product sold, though this only summarizes the standard amount of raw materials used (which may not reflect actual scrap levels or the most current raw material costs). An alternative is to obtain the information by adding the most recent period's raw material costs to the beginning raw material inventory balance, and then subtracting the ending raw material balance. The measurement can also be subdivided and tracked for individual products so that the purchasing staff can see which product margins are suffering from raw material cost increases. The formula is:
Example: The Underhill Plastics Company has a standard policy of passing along to its customers the amount of any increases in the price of its resin raw materials. This is the responsibility of the logistics manager; however, the president has noticed that this task tends to be delayed by several months, resulting in a higher proportion of raw material costs to sales in the meantime as well as reduced profits. Consequently, the president asks the accounting staff for a monthly calculation of raw material content, which will indicate any increases in raw material costs for which pass-through price increases have not yet occurred. The president obtains information for the past five months, which can be seen in Table 12.3.
The raw material content calculation in the table reveals that the content percentage jumped in April and stayed high, indicating that there has been a jump in resin prices that the logistics manager has not yet passed through to the company's customers. The president heads for the logistics department for a loud discussion with its manager.
Cautions: A change in the level of raw material content can also be caused by a change in the price of a product by the marketing staff or by giving away free product samples, because both actions will reduce the sales figure in the denominator, resulting in a higher ratio even if the amount of raw material dollars does not change. These types of activities are beyond the control of the logistics staff, although this department is generally considered to be responsible for the calculation's results.
The ratio can also change if the mix of products differs from period to period and if the raw material content percentage is different for each of the products sold.
FINISHED GOODS INVENTORY TURNS
Description: A company may have an excellent overall inventory turnover rate but a poor finished goods turnover rate. This may be caused by the continuation of production into a slow part of the sales cycle, which will use up the remaining raw materials and convert them over to finished goods, which in turn will then sit until the sales cycle picks up again. This manufacturing strategy is used by companies that level-load their workforces year-round and by companies that are attempting to increase their loan borrowing bases by pumping up the value of their inventories by converting them to higher-value finished goods. Given the latter reason, a lender may be interested in reviewing this measurement on a trend line to determine whether it increases in concert with the company's borrowing base.
Formula: Divide the amount of finished goods dollars sold during the measurement period by the finished goods dollar amount on hand and multiply the result by 12. In cases where there are highly seasonal sales, it is better to use an average annualized sales figure than the annualized sales for the month in which the measurement is made. The formula is:
Example: The Barstow Canoe Company sells most of its fiberglass canoes in the spring and summer. Rather than lay off its experienced production team for the rest of the year, it continues to employ them through the fall and winter seasons, building finished goods inventories for the next selling season. A prominent business school is developing a case study on Barstow's production system and wants to include in their report the amount of the finished goods inventory turns at the end of each quarter. They compile the information shown in Table 12.4.
The measurement clearly shows the wide variability in inventory turnover that is caused by a combination of the company's seasonal sales and its steady rate of production through all parts of the year.
Cautions: The amount of finished goods turnover can change if the amount of direct labor or overhead charged to a product is altered, which can be done through modifications to a labor routing document or the overhead allocation methodology. Thus, the measurement can yield different results even when there is no change in the number of finished goods units on hand.
OBSOLETE INVENTORY PERCENTAGE
Description: A company needs to know the proportion of its inventory that is obsolete for several reasons. First, external auditors will require that an obsolescence reserve be set up against these items, which will lower the inventory value and create a charge against current earnings. Second, constantly monitoring the level of obsolescence allows a company to work on eliminating the inventory through such means as returns to suppliers, taxable donations, and reduced-price sales to customers. Finally, obsolete inventory takes up valuable warehouse space that could be put to other uses. Monitoring it with the obsolete inventory percentage allows management to eliminate these items to reduce space requirements.
Formula: Summarize the cost of all inventory items having no recent use, and divide by the total inventory valuation. The amount used in the numerator is subject to some interpretation, since there may be an occasional use that will eventually consume the amount left in stock, despite the fact that it has not been used for some time. An alternative summarization method for the numerator that prevents this problem is to include only those inventory items that do not appear on any bill of materials for a currently produced item. The formula is:
Example: The logistics manager of the Terrific Truck Supply Company is new to the job and wants to know whether the inventory has an obsolescence problem. Truck replacement parts have a long shelf life, so the manager calls up a parts usage report and decides that any item that has not sold more than 10% of the on-hand volume in the past year will be defined as obsolete. A query command in the company's online inventory reporting system shows that the value of the inventory in the specified range is $248,000. The total inventory value is $2,090,000, which therefore yields an obsolete inventory percentage of 11.9%. The manager contacts several suppliers and earns the company $50,000 in credits by returning many of these obsolete items.
Cautions: A large amount of obsolete inventory does not reflect well on the logistics manager, who is responsible for maintaining a high level of inventory turnover. It is possible that the logistics manager will attempt to alter the amount listed in the numerator, either by defining recent usage as anything within a very long time, or by ensuring that all inventory items are included on some sort of bill of materials, which is generally considered evidence that they may eventually be used. To prevent this problem, the calculation should be given to someone outside of the logistics department.
PERCENTAGE OF INVENTORY > XX DAYS OLD
Description: A company may not have any obsolete inventory, but it may have enough older inventory that it raises concern about the possibility of obsolescence at some point in the future. By determining the amount of inventory that is older than a certain fixed date, the logistics staff can determine which items should be returned to suppliers (see the next measurement) or which items should be sold off at a reduced price.
Formula: Settle on a number of days after which inventory is considered to be old enough to require liquidation action. Then determine the dollar value of all items whose age exceeds this number of days. Divide that total by the total dollar value of inventory. The measurement should be accompanied by a report that lists the detailed amounts and locations of each inventory item in the numerator so that the logistics staff can review them in detail. The formula is:
Example: The Medieval Illumination Company makes candles that are specially tailored to each major holiday. Its Christmas candles use a red wax that degrades after 120 days and must be melted down after that time for reuse as new candles. The marketing manager requests a report that itemizes the dollar value of candles that have been in stock more than 60 days, which still leaves up to 60 more days in which to sell them off. The results of the report show $12,500 of candles that are at least 60 days old, out of a total candle inventory of $320,000. The percentage of inventory over 60 days old is therefore 3.9% ($12,500 divided by $320,000).
Cautions: The measurement can give some idea of the total amount of inventory that may require liquidation, but it does not show the raw material usage requirements of the production schedule, which may be scheduled to use these items during an upcoming production run. This can only be found by comparing the old inventory list to the production requirements report.
Using this report to determine the proportion of old finished goods yields a better idea of what products may need to be sold off. However, knowledge is needed of the timing of the sales season for each product on the list. For example, an article of clothing may appear to be old, but if its prime selling season is just starting, then it would make sense to leave it alone through much of the season, to see whether it can be sold at its full retail price before considering any type of price discounting.
PERCENTAGE OF RETURNABLE INVENTORY
Description: Over time, a company will tend to accumulate either more inventory than it can use or inventory that is no longer used at all. These excess accumulations may be caused by an excessively large purchase, scaling back of production needs below original expectations, or perhaps a change in a product design that leaves some components completely unnecessary. Whatever the reason, it is useful to review the inventory occasionally to determine what proportion of it can be returned to suppliers for cash or credit.
Formula: Summarize all inventory items for which suppliers have indicated that they will accept a return in exchange for cash or credit. For these items, use in the numerator either the listed book value of returnable items or the net amount of cash that can be realized by returning them (which will usually include a restocking fee charged by suppliers). The first variation is used when a company is more interested in the amount of total inventory that it can eliminate from its accounting records, whereas the second approach is used when a company is more interested in the amount of cash that can be realized through the transaction. The denominator is the book value of the entire inventory. The formula is:
Example: The Holystone System, Inc., producer of a teeth-whitening system for dental patients, is rolling out a new system that does not use several of the components stored in its warehouse. Accordingly, it contacts it suppliers and finds that they will accept returns for inventory items that have a book value of $230,000, but for which they will charge a restocking fee of 20%. The total inventory valuation is $1,475,000. Holystone is in cash flow difficulties, and so is most interested in measuring the amount of cash it can realize by returning inventory to suppliers. The percentage of returnable inventory is:
Cautions: Even though a large proportion of the inventory may initially appear to be returnable, consider that near-term production needs may entail the repurchase of some of those items, resulting in additional freight charges to bring them back to the warehouse. The underlying details of the measurement should consequently be reviewed in order to ascertain not only which items can be returned, but more specifically which ones can be returned that will not be needed in the near term. This involves the judgment of the logistics staff, perhaps aided by a reorder quantity calculation (see Economic Order Quantity section), to determine whether it is cost justifiable to return goods to a supplier that will eventually be needed again. A reduced version of the measurement that prevents this problem is to include in the numerator only those inventory items for which there is no production need whatsoever, irrespective of the timeline involved.
EXCESS INVENTORY INDEX
Description: When a company discovers that it has obsolete inventory on hand, there is a temptation to ignore the problem, not write down the inventory, and let it continue to sit in the warehouse. The same issue arises when there is simply too much inventory; it is not necessarily obsolete, but the company will not be able to dispose of it in the near term. A good approach is to use the excess inventory index to calculate the cost of doing nothing rather than properly disposing of the inventory. The metric compiles the amount of inventory that should be disposed of, multiplies it by a price erosion factor (which estimates the amount by which the resale price of the inventory will drop during the measurement period), and then adds the incremental costs of holding the inventory during the measurement period. The result can be a surprisingly large amount and may trigger action to dispose of the inventory now.
Formula: Add together the amount of inventory to be disposed of, both on-site and elsewhere, and multiply it by the amount by which the disposal price of the inventory is likely to decline during the measurement period. Then add to it the cost of holding the inventory. Holding costs can include insurance, storage fees, utilities, interest expense, and so forth. The formula is:
Example: Galactic Devices has just discovered that it has far too many laptop computers, both in its warehouse and at its retail locations. The excess laptops have a recorded cost of $10,000,000. The sales department estimates that the laptops will lose 5% of their value per month. Galactic incurs an incremental cost of 1% per month to carry the inventory. Based on this information, the excess inventory index is:
The prospect of losing $600,000 per month by retaining the laptops jolts the management team into action, which conducts a fire sale to unload the excess inventory.
Cautions: None. This metric is an excellent way to get the attention of management when it is not acting swiftly enough to eliminate excess stock.
INVENTORY ACCURACY
Description: If a company's inventory records are inaccurate, timely production of its products becomes a near-impossibility. For example, if a key part is not located at the spot in the warehouse where its record indicates it should be, or its indicated quantity is incorrect, then the materials-handling staff must frantically search for it and probably issue a rush order to a supplier for more of it, while the production line remains idle, waiting for the key raw materials. To avoid this problem, the company must ensure not only that the quantity and location of a raw material is correct, but also that its units of measure and part number are accurate. If any of these four items are wrong, there is a strong chance that the production process will be negatively affected. Thus, inventory accuracy is one of the most important materials-handling measurements.
Formula: Divide the number of accurate test items sampled by the total number of items sampled. The definition of an accurate test item is one whose actual quantity, unit of measure, description, and location match those indicated in the warehouse records. If any one of these items is incorrect, then the test item should be considered inaccurate. The formula is:
Example: An internal auditor for the Meridian and Baseline Company, maker of surveying instruments, is conducting an inventory accuracy review in the company's warehouse. The auditor records the incorrect information for a sample count of eight items (see Table 12.5).
The warehouse manager has spent a great deal of time ensuring that the inventory record accuracy in the warehouse is perfect. The manager is astounded when the auditor's measurement reveals an accuracy level of zero, despite perfect quantity accuracy; the manager has completely ignored the record accuracy of part descriptions, locations, and units of measure, and as a result has had multiple incorrect components of the measurement for some inventory items. The manager informs the staff that they will be correcting records over the weekend.
Cautions: It is extremely important to conduct this measurement using all four of the criteria noted in the formula derivation. The quantity, unit of measure, description, and location must match the inventory record. If this is not the case, then the reason for using it—ensuring that the correct amount of inventory is on hand for production needs—will be invalidated. For example, even if the inventory is available in the correct quantity, if its location code is wrong, then no one will be able to find it to use it in the production process. Similarly, the quantity recorded may exactly match the amount located in the warehouse, but will still lead to an incorrect quantity if the unit of measure in the inventory record is something different, such as dozens instead of each.
PERCENTAGE OF CERTIFIED SUPPLIERS
Description: The logistics department certifies a supplier when the supplier's internal production systems are considered to be sufficient to ensure that any shipments sent to the company will contain the correct quantities of the correct components and will have a quality level that meets the company's minimum standards. By issuing this certification, the logistics staff has essentially shifted its receiving review function into the supplier's factory, so there is no need to review its goods when they arrive at the receiving dock. In its most advanced form, this means that certified suppliers can deliver their components directly into the company's production line without being reviewed by any company personnel. This represents a considerable time savings, as well as a major reduction of the materials-processing flow. Consequently, logistics department members who wish to achieve a highly efficient materials flow should track the percentage of certified suppliers.
Formula: Divide the number of certified production suppliers by the total number of production suppliers. Since certification is a very time-consuming and expensive process, it is likely that not all suppliers will ever go through the certification process, resulting in a performance measurement that is always less than 100%. An alternative approach that will allow for 100% results is to create a list of suppliers who should eventually be certified and only use them in the denominator. The formula is:
Example: The American Defense Company produces a complex sonar system for Navy submarines. This requires the assembly of extremely delicate electronic components that are produced by 20 component suppliers. The company has had an ongoing problem with damage to these circuits during delivery to the company's production facility, which is caused both by inadequately robust design of the product and inadequate use of shipping materials. American's logistics staff decides to create a certification program for all 20 suppliers that focuses on their ability to design and produce more robust components as well as better packaging designs. After six months of effort, it certifies 11 of the 20 suppliers, which is a 55% certification level. The process has been so arduous at the remaining suppliers that the company elects to shift its business away from them and to the 11 certified suppliers.
Cautions: Achieving a high level of certification completion is not a one-time measurement result. On the contrary, supplier performance must be constantly reevaluated, either because its capabilities may decline over time, or because the company's certification standards have risen. Consequently, the measurement should really determine the percentage of suppliers who have been recertified within the past year (or some other appropriate measurement period).
ELECTRONIC DATA INTERCHANGE SUPPLIER PERCENTAGE
Description: It is much easier to manage the incoming flow of materials from suppliers, as well as pay them in a more orderly manner, if there is an electronic data interchange (EDI) linkage between the company and its suppliers. In its most advanced form, this system allows suppliers to receive listings of scheduled production needs directly from the buying company's manufacturing planning system, as well as automated purchase orders, while the buying company can receive immediate feedback from suppliers regarding delivery amounts and dates. The system can also be used to reconcile invoices and pay suppliers in concert with automated clearing house (ACH) banking transactions.
Formula: Summarize the number of suppliers with EDI linkages to the company by the total number of suppliers being regularly used by the company. Only those suppliers who are conducting all available transactions through EDI should be included in the numerator, which will place increased emphasis on suppliers who have installed the system but are not using it to its maximum effect. Also, the number of suppliers listed in the denominator should not include all incidental suppliers having minimal business with the company (since this can be a formidably large number), but rather the group of ongoing suppliers who regularly transact business with it. The formula is:
Example: The Musical Heritage Company, restorer of damaged antique musical instruments, conducts a great deal of business with a set of auction houses around the world that feed its restoration craftsmen an unending stream of old instruments. It needs to control the incoming flow of instruments, since its inventory damage insurance policy will cover the company only for those instruments currently in the restoration process; all other instruments, many of them quite expensive, are at risk while being stored. The answer is an EDI notification system for the suppliers, who are electronically told when to ship the next set of instruments, and who can automatically confirm with Musical Heritage that the instruments have been shipped. The company has the eight auction houses as clients, all of whom send it sufficient volume to warrant EDI installations. Of this group, three are using both the shipment authorization and confirmation EDI features, one house is not using it at all, and the remaining four are only using the shipment authorization function.
If Musical Heritage is most concerned about limiting its liability under the insurance policy, then the measurement should be targeted at the shipment authorization function, which has achieved an 87.5% success rate (seven of eight auction houses are using it). If Musical Heritage is also concerned about the shipment confirmation EDI feature, which is useful for scheduling the workflow of its artisans, then the success rate is only 37.5% (three of eight auction houses are using it).
Cautions: Achieving an EDI supplier percentage of well below 100% is quite acceptable. The reason is that installing an EDI system at each supplier is a time-consuming process, because of the travel between locations for setup meetings and the cost of software and related equipment. There will consequently be some suppliers whose transaction volumes are so low that installing an EDI system will never make sense. This problem can be avoided by carefully pruning the number of suppliers listed in the numerator so only those suppliers are included that are most likely to install EDI. If this approach is used, then a 100% EDI supplier percentage is possible.
DISTRIBUTION TURNOVER
Description: One of the techniques of a just-in-time production system is to have parts delivered to the company's production facility very frequently and in very small batches. By doing so, a company's inventory investment is reduced, while it also needs minimal storage space for the inventory. The distribution turnover measure is a good way to determine whether a company is making progress in achieving just-in-time delivery.
Formula: Summarize the dollar value of all goods currently on order for immediate delivery (this does not include the dollar value of master purchase orders, which may cover prospective purchases for an entire year), and divide it into the dollar value of all manufacturing-related purchases made during the preceding 12 months. The formula is:
A high distribution turnover ratio is indicative of a just-in-time delivery system.
Example: The Franklin Trimmer Company manufactures low-polluting gas-powered lawn trimmers with four-stroke engines. It has embarked on a just-in-time manufacturing plan that includes the use of just-in-time deliveries. It formerly purchased its engines from a supplier in Portugal who shipped deliveries once a month, but has now shifted to a supplier in nearby Canton, Ohio, that is willing to ship in much smaller unit quantities on a daily basis. Engines comprise 50% of all manufacturing purchases. The before-and-after results of this change are shown in Table 12.6.
The distribution turnover measure reveals a remarkable reduction in the level of incoming inventory. However, this improvement must also be compared to any changes in the unit cost and freight associated with shifting from the Portugal supplier to the Ohio supplier.
Cautions: It may be necessary to accumulate purchased manufacturing dollars in a separate general ledger account, since this information is not always clustered together for easy access. However, the dollar value of incoming inventory is even more difficult to determine, since most organizations track inventory only once, when it arrives at the receiving dock—not when it is still in transit to the company.
SUPPLIER FILL RATE
Description: A supplier should be able to fill all line items on a purchase order by the delivery date specified on the purchase order. If not, the ordering company will be forced to maintain additional inventory on hand as safety stock, which increases its investment in working capital. Consequently, you should track the supplier fill rate on an ongoing basis to determine whether some suppliers are routinely unable to fill some items in a timely manner. This may call for a change in supplier, or at least sourcing those items being backordered with other suppliers more capable of reliably fulfilling the company's needs.
Formula: Divide the number of purchase order line items filled as of the required due date by the total number of line items ordered. This formula works best when aggregated across all purchase orders issued throughout the measurement period, rather than for a single purchase order. The formula is:
Example: The Templeton Church Supplies Company sells a large array of religious products to thousands of churches. It buys its supplies from a variety of distributors, for which it places purchase orders that routinely contain more than 100 line items. It has had a problem with backordered line items in the past, which has caused it to maintain more safety stock in its warehouse than it would like. Templeton's procurement manager decides to track the supplier fill rate for its top three suppliers, with the following results:
The table reveals that Chalice Distributors is quite a reliable supplier, while Holy Ghost Distributors is having significant fulfillment problems. Templeton may want to consider shifting some or all of its business away from Holy Ghost.
Cautions: This is a generally reliable metric, but it can be skewed if the company sets a required delivery date on its purchase orders that is so soon that suppliers are bound to have difficulty fulfilling orders. Also, a supplier may be the sole source of a particular item, which renders this measurement ineffective if you simply cannot obtain it anywhere else.
ON-TIME PARTS DELIVERY PERCENTAGE
Description: One of the key performance measures for rating a supplier is its ability to deliver ordered parts on time, since a late delivery can shut down a production line. Furthermore, a long-standing ability to always deliver on time gives a company the ability to reduce the level of safety stock kept on hand to cover potential parts shortages, which represents a clear reduction in working capital requirements. Consequently, the on-time parts delivery percentage is crucial to the logistics function.
Formula: Subtract the requested arrival date from the actual arrival date. If the intent is to develop a measurement that covers multiple deliveries, then an average can be created by summarizing this comparison for all the deliveries and then dividing by the total number of deliveries. Also, if an order arrives before the requested arrival date, the resulting negative number should be converted to a zero for measurement purposes; otherwise, it will offset any late deliveries when there is no benefit to the company of having an early delivery. Because a company must pay for these early deliveries sooner than expected, they can even be treated as positive variances by stripping away the minus sign. Any of these variations are possible, depending on a company's perception of the importance of not having early deliveries. The basic formula is:
Example: The Rawlins Power Boat Company is measuring the on-time parts delivery percentage of its teak parts manufacturer. Teak fittings are extremely expensive, so the company does not like to have much safety stock on hand. This means, however, that Rawlins must rely on the supplier's ability to deliver on time, which has not been a strong point of late. Its delivery performance for the last five deliveries is shown in Table 12.7.
By simply summarizing the days variance for all five deliveries, the on-time parts delivery percentage becomes 1.8 days. However, this includes the negative variances caused by two deliveries being received too early. There is no benefit to Rawlins from having early deliveries because it must store the parts somewhere as well as pay for them sooner than expected. Consequently, by resetting these negative variances to zero, the calculation is:
Also, the accounts payable staff does not like having to pay the teak supplier early for the deliveries that arrive before their due dates. Since this viewpoint gives a negative connotation to early deliveries, the logistics manager elects not to reset them to zero for the calculation, but rather to strip away their negative sign, turning them into positive variances. Under this approach, the formula is:
Thus, the treatment of variances caused by early deliveries can have a considerable impact on the reported amount of a supplier's on-time parts delivery percentage. The type of measurement used in this example caused the result to vary from a low of 1.8 days to a high of 3.8 days, which represents more than a doubling of the high value over the low value.
Cautions: This is an excellent measurement, but it does not address other key aspects of supplier performance, such as the quality of the goods delivered (see the next measurement) or its cost. These additional features can be measured alongside the on-time delivery percentage or melded into an overall rating score for each supplier.
PURCHASED COMPONENT DEFECT RATE
Description: The purchasing staff should be interested in the proportion of components purchased from outside suppliers that are defective. Any defect requires expensive time to document and return and may even interfere with the timely completion of the production schedule. This is consequently one of the most important measures of supplier performance. It should be measured both by supplier and by each component provided by each supplier, in case there are problems with only some portion of a supplier's total deliveries to a company. Also, it should be measured on a trend line so that gradual increases can be easily spotted and dealt with.
Formula: Summarize all rejected components and divide them by the total number of components received. As just noted, this measurement should at least be summarized by supplier, if not by specific component types delivered by individual suppliers. The formula is:
Example: The Tango Mural Company, manufacturer of flame-retardant Spanish tiles, has been having trouble with the receipt of chemicals from a key supplier. The company operates a lean inventory system that does not allow it to go for more than two days without inventory replenishment. The rejection of chemicals from its orders has consequently thrown it into an expedited ordering mode in recent months to keep its tile-baking facility operational. The purchasing staff accumulates the information in Table 12.8 to present to its chemical supplier.
The reject rate in month three has jumped drastically over that of the preceding two months, denoting some type of quality problems at the supplier. The purchasing manager decides to take this table into a meeting with the supplier, with the intention of demanding immediate improvement in the rejection rate.
Cautions: If a company's computerized receiving system allows one to itemize different types of reasons for a rejected component, it is possible to include more than one rejection reason when a part is rejected. If so, the compilation of the information needed for the numerator of this measurement may result in some double counting. This will result in an apparent number of rejected components that is higher than the actual amount. To prevent this problem, the summarization should be by number of units rejected, rather than the total number of rejection reasons.
An increased rejection rate can be caused by a change in the receiving procedures at the company or by a change in the specifications that the company is imposing on its purchased components. In either case, a change in the resulting measurement will have little to do with altered performance by suppliers, since the changes are internal to the company.
Also, rejected components may be only one of several key values that a company places on a supplier—other reasons are low pricing and on-time deliveries. If this is the case, the purchased component defect rate can be combined with measurements for these other factors to arrive at a supplier report-card rating system.
INCOMING COMPONENTS CORRECT QUANTITY PERCENTAGE
Description: Another key item that the receiving staff is concerned about is the quantity of items received in comparison to the amount ordered. If the amount is too low, the company may be faced with a parts shortage in its production operation. If the quantity is too high, then it may find itself with more inventory than it can use. Also, if an odd lot size is received, it may be difficult for the receiving staff to find a location in the warehouse in which to store it. For these reasons, the incoming components correct quantity percentage is very commonly used.
Formula: Divide the number of orders to suppliers for which the correct quantity is delivered by the total quantity of orders delivered. This measurement is commonly applied to each supplier, so that the performance of each one can be measured. A variation on the formula is to include in the numerator only those orders received for which the entire order amount is shipped; this approach is used by companies that do not want to deal with multiple partial orders from their suppliers, because of the increased cost of receiving and related paperwork. The basic formula is:
Example: The internal auditing staff of the Wilco Aircraft Radio Company has brought a potential fraud situation to the notice of its logistics manager. Staff members are concerned that the quantities of amplifiers received from a key supplier are always slightly lower than the ordered amount, but always within the 5% counting tolerance established by the warehouse staff. This results in full payment by Wilco for the ordered amount, even though the actual amount received is always less. The auditors' evidence is listed in Table 12.9.
The table indicates that virtually all orders received from the supplier are considered accurate if the measurement allows for a variation of 5% in the quantity received, while none of the orders would qualify if the tolerance were reduced by just 1%. The logistics manager concludes that the supplier must have learned about the company's counting tolerance and is deliberately sending deliveries that barely achieve the minimum count threshold. Further investigation reveals that the supplier is splitting its profits with the company's warehouse manager, who is responsible for setting the counting tolerance level.
Cautions: The formula can result in a very low correct quantity percentage if the quantity received is off by even just one unit. This may seem harsh if, for example, an order of 10,000 units is incorrect by a single unit. Consequently, it is common for companies to consider an order quantity to be accurate if the quantity received is within a few percentage points of the ordered amount. The exact percentage used will vary based on the need for precision and the cost of the components received, although 5% is generally considered to be the maximum allowable variance.
PERCENTAGE OF ACTUAL PAYMENTS VARYING FROM PURCHASE ORDER PRICE
Description: When a company issues a purchase order to a supplier, the company has no obligation to pay the supplier anything but the price per unit that is listed on the purchase order, no matter what amount may appear on the resulting invoice issued by the supplier. Nonetheless, an accounts payable staffperson is usually required to reconcile any pricing differences between the two documents, which can take a great deal of accounting staff time. There may also be times when an inattentive accounting staff does not compare the purchase order to the invoice, and instead just pays the invoice amount, possibly costing the company money. For this reason, it is useful to determine which suppliers are in the habit of ignoring the prices at which they are supposed to be billing the company.
Formula: Divide the total dollars of excess billings over the amount listed on purchase orders by the total amount listed on all purchase orders for which payments have been made to suppliers. This measurement reveals the most information if it is organized by individual supplier and accompanied by a detailed listing of exactly which invoices were overbilled. The measurement is:
Example: The Loafer Lounge Company, maker of exceedingly plush living room chairs for the discriminating television viewer, may have a problem with excessively high materials costs. Its accounting staff pays for supplier invoices only after confirming that the related quantities have been received and approved by the warehouse staff—there is no matching of invoice prices to purchase order prices. The logistics manager wants to prove that this extra matching step can save a great deal of money. To prove this point, the manager collects the information in Table 12.10 for the month of February.
The table reveals that suppliers are consistently taking advantage of the company by overcharging on their invoices. The net overpayment made in just one month is $24,500, which would nearly pay the annual salary of an accounts payable clerk who could match invoices to purchase orders and eliminate this problem.
Cautions: An overbilling can be legitimate if there is a valid reason for charging an extra fee, such as a rush service or delivery charge that is caused by an exceedingly short delivery date, as required by the company, or a change in the order specifications that occurred after the related purchase order was issued. These special variances should be noted in the accounts payable computer records so they can be printed out when the measurement is calculated.
PERCENTAGE OF PURCHASE ORDERS ISSUED BELOW MINIMUM DOLLAR LEVEL
Description: Issuing purchase orders can be expensive, because the buyer must investigate pricing, possibly issue bid notifications, review bids, and make a selection before issuing the purchase order. This can cost anywhere from $100 to several thousand dollars to complete. To make the purchasing process cost-effective, most organizations prohibit the use of purchase orders for small orders, preferring instead to use corporate purchasing cards or petty cash. By tracking the percentage of purchase orders issued below a minimum dollar level, the logistics manager can determine whether this is a problem area.
Formula: Determine a minimum dollar level below which purchase orders should not be used; this amount will vary by company and will be based on both the volume of orders at different dollar levels and the cost of creating each purchase order. Then count all purchase orders issued during the measurement period for amounts less than the threshold level and divide it by the total number of purchase orders issued during the same period. The formula is:
Example: The Windy Electric Utility, which specializes in wind turbine electricity generation, has a large purchasing staff that is required to issue purchase orders for virtually all purchases made by the company. The logistics manager thinks that this level of control has been taken too far and wants to prove the point by itemizing the cost of small orders. The logistics manager compiles Table 12.11, which shows the volume of purchase orders placed at various dollar levels.
The table shows that the company's purchasing policies are increasingly strict as the size of an order increases, going from $65 for the smallest order to $1,350 for the largest one. Given the large volume of small orders, it is apparent that the company is using a large amount of resources to process orders in areas where there is a minimal risk of significant loss. Since the average buyer is paid $45,000 per year, the logistics manager believes that more than five positions can be eliminated simply by stopping the purchase order requirement for orders below $100, and a total of 13 positions can be eliminated if the prohibition is increased to cover all orders below $500.
Cautions: A fraud-minded employee who can influence the point below which purchase orders are not allowed can set it so that a large quantity of unauthorized purchases (for example, at high prices or from unapproved suppliers) can be made with impunity. This problem can be avoided by occasionally auditing the orders placed below the purchase order threshold, looking for appropriate pricing, quantity, and quality levels.
PROPORTION OF CORPORATE CREDIT CARD USAGE
Description: A logical adjunct calculation to the preceding measure is to measure the proportion of total purchase transactions that are being accomplished through the use of corporate purchasing cards. Using credit cards reduces the amount of paperwork required of the purchasing staff, though the control over the types, quantities, and costs of purchases will decline. A typical goal is nearly 100% card usage for all purchasing transactions under $100, with some companies using a much higher cutoff, such as $2,500.
Formula: Divide the number of credit card purchasing transactions by the total number of purchasing transactions. This measurement is usually restricted to all purchasing transactions below a corporate-mandated level, such as $100. It may also be measured for each department or credit card holder, to see where credit card usage is minimal. The formula is:
Example: The Anderson Boat Company is forcing its employees to use company-issued credit cards to purchase all items costing $500 or less, thereby reducing the work load of its accounting staff. Acceptance of the new policy has been spotty. The logistics manager has decided to highlight departments in which credit cards are not being used. The relevant information is in Table 12.12.
Predictably, the materials management group, which is supervised by the logistics manager, has a near-perfect 95% credit card usage level. However, the engineers in the boat design and testing groups appear to be somewhat less enamored with the concept. Therefore, the logistics manager schedules meetings with the managers of both departments to see what steps can be taken to increase the usage level.
Cautions: Though 100% usage of purchasing cards for all transactions below a specific dollar limit is a laudable goal for reducing purchasing labor costs, it is subject to abuse. For example, an employee can make multiple credit card purchases at a level just below the maximum limit to buy something that is much more expensive, which would normally have been subject to a great deal of purchasing scrutiny. Furthermore, purchasing cards can be used to make personal acquisitions or to buy inappropriate items or services. All of these problems can be mitigated through internal audit reviews, limitations on the types of purchases allowed through corporate credit cards, and periodic maximum purchasing limits. All of these controls should be put in place, however, before a company can determine whether a high proportion of corporate credit card use has actually reduced its total purchasing costs.
PERCENTAGE OF RECEIPTS AUTHORIZED BY PURCHASE ORDERS
Description: One of the most difficult tasks for the receiving staff is to decide what to do with orders that are received with no accompanying purchase order. Since the orders are not authorized, the staff could simply reject them. They run the risk, however, of rejecting some item that may have been bought on a priority basis, which will cause undue trouble for the logistics manager when projects in other parts of the company are held up. Accordingly, these orders are frequently set to one side for a few hours or days, while the receiving staff tries to find out who ordered them. This can be a significant waste of receiving time, and it is worth measuring on a trend line to determine whether the problem is worsening.
Formula: The receiving department should maintain a receiving log, on each line of which is recorded the receipt of a single product within an order. Using the line items in the receiving log that correspond to the dates within the measurement period, summarize the number of receipt line items authorized by open purchase orders by the total number of receipt line items in the log. The formula is:
Example: Hoboken Highlanders, makers of Scottish clothing for New Jersey residents (an admittedly small niche), has eliminated several of its purchasing controls to increase its level of purchasing efficiency. To counteract this deliberate weakening of controls, the logistics manager has insisted upon the use of purchase orders for 100% of all purchases made by the company. The primary method for measuring the success of this initiative is to track the percentage of receipts authorized by purchase orders. The measurement was less than 20% at the beginning of the campaign to use this control and has gradually trended upward since then. The logistics manager has authorized an assistant to track the measurement every month and report when the measure stops improving. The trend line for the past three months is shown in Table 12.13.
The assistant sees that the rate of improvement is declining, with only a 3% month-to-month increase since May. Although only 11% of all receipts are no longer being authorized in advance by purchase orders, the measurement does not reveal the dollar amount of these unauthorized purchases, which may be considerable. Accordingly, the assistant decides to review further the dollar volume of these transactions before bringing them to the attention of the logistics manager.
Cautions: This is an excellent measurement, since the use of purchase orders is one of the best controls over unauthorized buying, and the measurement clearly shows the extent of control problems in this area. However, it does not include other types of purchases that never run through the receiving area, such as services, subscriptions, or recurring lease payments. These other types of costs can constitute the majority of all nonpayroll costs in services industries; consequently, the measurement is most useful in businesses dealing in tangible goods.
FREIGHT AUDIT RECOVERY RATIO
Description: Many auditing firms specialize in comparing the freight bills paid by a company to the standard rate schedules published by their shippers in order to find overbilling situations. If they find any, the auditors earn a percentage of the total amount recovered. Given the amount of funds that can be collected by using freight auditors, it behooves the logistics manager to track their achieved recovery ratio to determine whether they are effective in earning money for the company.
Formula: Divide the total refund received from a company's freight carriers by the total amount of freight billings for the period for which the freight billing audit was conducted. If more than one auditing firm is being used at the same time, then this measure should be calculated separately for each one. Also, the percentage fee received by the freight auditing firm can be deducted from the total refund, to derive the net recovery rate experienced by the company as a result of the auditors' efforts. The basic formula is:
Example: The Redfern Ski Company ships its super-lightweight plastic skis to a variety of military and rescue organizations throughout the world, which depot them in remote locations for emergency rescue operations. Its per-unit freight bills sometimes exceed the cost of the skis being shipped, so the company regularly brings in freight auditors to ensure that the lowest possible freight charges are being paid. This year, the Robertson Auditing Company is reviewing billings for Redfern. It charges 35% for all refunds collected, which is higher than the 30% charged by last year's auditors, who achieved a 5% freight audit recovery rate, net of their fee. Of the $1,250,000 of freight billings that Robertson reviews, it finds that 8.5% should be refunded to the company. The calculation of its freight audit recovery ratio is:
Since Robertson achieved a higher recovery rate, net of their fee, than the previous year's auditors, Redfern may consider retaining this higher-performing audit firm for the following year.
Cautions: Most organizations do not have a sufficient volume of freight bills to warrant using freight-auditing firms on a year-round basis (if they did, they would be justified in bringing the work in-house). If freight auditors are brought in too frequently, they may end up reviewing freight invoices that were already reviewed during the last audit. Picking over the same invoices in this manner will inevitably result in a decline in the freight audit recovery ratio, which is not the fault of the freight auditors, but rather of the company that scheduled them to begin work too soon.
PICKING ACCURACY FOR ASSEMBLED PRODUCTS
Description: When a company ships disassembled products to customers, it is important that the kits shipped out have exactly the correct number of the right parts. If the number is too high, then the company will be increasing its materials costs more than necessary. If the number is too low, then the company faces a significant customer relations problem, as well as added costs to locate and ship missing parts to customers. For these reasons, the picking accuracy of assembled products is important for companies that ship kits.
Formula: Conduct an audit of a sample of completed kits, counting as an error every kit in which the quantity of parts is incorrect, as well as every kit in which the quantity is correct but the types of parts included are incorrect. Once a kit is considered incorrect for either reason, it cannot be counted as an error again (thereby avoiding double counting). Then divide the total number of errors by the total number of product kits sampled. Finally, subtract the resulting percentage from 100%. The formula is:
Example: The Swiss Furniture Company ships disassembled kits of Swiss furniture to customers throughout the world. It has recently received a rash of complaints about missing parts in its stereo cabinet product. To determine the extent of the problem, the company's internal audit team pulls 20 completed cabinet kits from the finished goods storage area and discovers that three units have incorrect parts and five units have too few parts. One of the kits with an incorrect part is also one of the kits with a parts shortfall.
Based on this information, the picking accuracy for the stereo cabinet is derived as:
Cautions: If the company managers think that the key issue is avoiding customer complaints, then they may be justified in not bothering to count a part overage as an error. This is especially common when counting fittings and fasteners, which are usually the least expensive parts of a product kit.
ORDER FILL RATE
Description: Customers are most satisfied when every item they order is completely filled and shipped to them on time. If even one line item is missing from an order, customer satisfaction levels will drop considerably. For this reason, one of the more popular logistics measures is the order fill rate, which is the percentage of orders that are completely filled by the promised ship date.
Formula: Summarize all customer orders for which all line items are completed and shipped as of the promised ship date, and divide by the total number of orders whose promised ship dates fall within the measurement period. The formula is:
Example: World Audio Distributors sells complete sound systems to recording studios (its most profitable segment), as well as individual components to home-based recording artists. Shipments to recording studios usually contain several dozen line items while shipments to home users average about two line items. World Audio's order fill rate is generally in the vicinity of 90%, but it has begun receiving complaints from several major recording studios that their orders have been delayed. To track down the problem, World Audio's president separates the order fill rate measurement into deliveries to major studios and to home users, obtaining the results in Table 12.14.
The information in the table reveals that the order fulfillment staff has been paying more attention to filling the simpler orders for home users.
Cautions: As noted in the example, the main problem with the order fill rate is that its results are highly dependent on the number of line items listed on an order. For example, if the picking staff receives nine 1-line orders and one 10-line order, they will very likely turn their attention first to the nine single-line orders, since they are easiest to fill, and will result in a 90% order fill rate before they even begin work on the single multiline order. If the picking staff is heavily compensated on the basis of this measure, such behavior can quite possibly result in the intentional delay of multiline orders in favor of single-line orders. The solution is to use a line fill rate measure instead of the order fill rate, so that performance is based on individual line items within customer orders.
The results of the order fill rate measure can be artificially enhanced if someone were to access the order entry system and enter delayed promised ship dates for orders. To prevent this type of falsification, lock out changes to the promised ship date field or at least implement change tracking (if the software has this feature) so that all changes to the date field will be recorded.
AVERAGE TIME TO SHIP
Description: After a product has been manufactured, it may be assumed that it will be shipped a few moments later. Although this may be the case for shipping departments having minor backlogs or products with simple packaging requirements, it is not at all true for companies with the reverse problems. In particular, it is quite common for large custom-made products to require one or more days of work before a properly configured shipping container can be built for it. Measuring the average delivery time can determine whether this constitutes a significant portion of the time period required to make a product and deliver it to the customer.
Formula: For each shipment in a sample group being reviewed, subtract the actual delivery date from the date when the order was sent to the shipping area. The delivery date can be taken from the shipping log or the bill of lading, while the date of movement to the shipping area can be taken either from production records (if products have just been produced) or from materials-handling records (if they have been taken from finished goods inventory). The formula is:
Example: The Magellanic Company, maker of custom seagoing rowboats for the fishing industry, typically spends several days constructing shipping containers for each of its rowboats. The logistics manager wants to determine whether the standard time of two days is adhered to in all cases; otherwise, a larger handling fee should be charged on certain types of boats. The manager derives the information in Table 12.15 from deliveries made in the past month.
| Order Number | Boat Dimensions (inches) | Average Delivery Time |
| 307 | 5 × 12 | 2 |
| 318 | 6 × 15 | 3 |
| 312 | 6.5 × 15 | 3 |
| 310 | 5.5 × 14 | 2 |
| 315 | 6 × 13.5 | 2 |
The logistics manager notes that boats longer than 13.5 inches take an extra day to construct; further investigation reveals that this is caused by the standard wooden box frame of 13.5 inches being exceeded, requiring considerable extra time to lengthen. Accordingly, the manager recommends a price increase for all boats over 13.5 inches to account for this packaging problem.
Function: It may not be the fault of the shipping department if the average delivery time is extended because of a credit-related stoppage in shipping. This happens when the collections staff decides that a customer is not paying for existing invoices in a timely manner and requires the shipping staff to stop shipping products to the customer until overdue payments are received. If products related to these customers have already arrived in the shipping department, then they may sit there for weeks before payment is received, thereby increasing the size of the measurement. The problem can be avoided by having the shipping department immediately return these items to the warehouse for storage.
ON-TIME DELIVERY PERCENTAGE
Description: Many customers need to integrate a company's products into their own products, which are scheduled for production on a specific date. This means that a company must ensure that its products arrive at the customer site by a specific date to avoid serious inconvenience to the customer (which may even involve penalties or the outright rejection of the order if the arrival date is missed). In these situations, one of the top performance measures is the on-time delivery percentage.
Formula: For a selected sample of deliveries, subtract the actual order delivery date from the required delivery date, resulting in an average variance for the group. The required delivery date is easily obtained from the customer order, and the actual delivery date can be obtained from either the third-party shipper or the company's own in-house delivery service. The formula is:
Example: The Tic-Tac-Dough Company's marketing staff wants to reposition its premier bagel product lines as the freshest in the marketplace by ensuring that only bagels cooked within the past four hours are delivered to its numerous supermarket outlets. Because of this strategy, the on-time delivery percentage becomes its most crucial performance measure. On the previous day, it achieved the delivery results shown in Table 12.16.
Of the five deliveries made, only batch number 146 arrived later than the designated time. This resulted in an on-time delivery percentage of 80%, which is derived by dividing the four on-time deliveries by the five deliveries sent out.
Cautions: This is an excellent measurement. However, a company can achieve high rankings by simply delivering all products early, which the customer may not want, since these deliveries must be stored in valuable customer warehouse space until needed. Consequently, the measurement can be modified to count a delivery as being on time only if it arrives within a certain number of days (or hours) of the customer-specified time. A high measurement result can also be achieved by using rush delivery services, which are quite expensive. This problem can be spotted by tracking freight costs alongside this measurement.
DOCK-TO-DOCK TIME
Description: A company that is concentrating on lean operations wants to have inventory on hand for the minimum amount of time. This means that goods should arrive at the receiving dock, be moved into the production area, be converted into finished goods, and be shipped to the customer in the minimum amount of time. Reducing the amount of time taken for these activities reduces the investment in on-hand inventory, as well as the costs associated with holding inventory. We can approximate the time taken for this flow of materials with the dock-to-dock time metric.
Formula: The general concept of dock-to-dock time is to measure the interval from when raw materials arrive at the receiving dock to when finished goods are shipped to the customer. This is difficult to achieve at the level of an individual product, since most production environments involve a large variety of units. You can calculate the metric at an aggregate level with the following three-stage calculation:
1. Divide the units shipped during the measurement period by the number of production hours in the measurement period.
2. Add together the units in raw materials, work-in-process, and finished goods.
3. Divide the result of step 2 by the result of step 1.
The formula is:
Example: Harbor Products manufactures military-grade widgets. During the most recent week of operations, there were 50 widget units in raw materials, 35 units in work-in-process, and 80 units in finished goods inventory, for a total of 165 units. Harbor shipped 90 units during the week, and there were 40 production hours during the week. This resulted in the following amount of dock-to-dock time:
Cautions: The fallacy in this metric is the determination of units in production. The amount in finished goods is easily determinable, and since materials are typically added to the beginning of the work-in-process function, it is not especially difficult to calculate units in that area, as well. However, it is extremely difficult to extract production units from raw materials inventory, since a large number of components are usually included in a product and they may not all be in stock. Thus, the derivation of the numerator can be questionable.
Also, the calculation of the denominator assumes that there is a direct relationship between the number of production hours in the measurement period and the number of units shipped. In reality, the number of units shipped reflects customer demand for the product, while the production time is related to the production schedule—not the number of units shipped. For example, if there are seasonal sales, there may be a full production week but no sales at all—which has a massive impact on the denominator.
PERCENTAGE OF PRODUCTS DAMAGED IN TRANSIT
Description: Some types of products are fragile by nature and require special packaging to ensure that they arrive at the customer in good order. If they do not, then a company must deal with unhappy customers, replacement parts, and rush deliveries to replace the damaged items. For these reasons, tracking the percentage of products damaged in transit is an important measurement.
Formula: Divide the number of damage-related customer complaints by the total number of orders shipped. The measure can be separated by freight carrier, since some have more difficulty in moving fragile items than others. Another variation is to measure it by individual customer, since some perceive a product to be damaged and in need of replacement when others would see only minor surface damage on a product that is still usable. The formula is:
Example: The Crystal Ball Corporation, maker of various crystal gifts for children, has had a long-term problem with product breakage during transit. It has created the best possible packaging, but the problem persists. It is now focusing its efforts on the delivery companies that transport its shipments. It has combined its bill of lading and customer complaint databases to arrive at the information for the past year shown in Table 12.17.
Based on the product damage calculation in the table, there is a clear problem with DunRight Shippers, which is damaging more than double the amount of orders of any other shipper. If the International Air Freight Company does domestic deliveries, then its 1% damage rate should qualify it to take over much of DunRight's business.
Cautions: There can be a time delay between the point when a customer complaint is received and the date when the related product was shipped, so that the time period covering the numerator in the calculation is somewhat earlier than the time period covering the denominator. This can result in an inaccurate measurement if the volume of orders changes significantly from period to period. The problem can be mitigated by using larger time periods for the measurement, such as quarterly instead of monthly.
PERCENTAGE OF SALES THROUGH DISTRIBUTORS
Description: A company may use a number of sales channels to move its products to customers, such as direct retail, direct catalog, distributors, retail chains, and so on. Each channel should be measured to see where the bulk of company business is being generated. The header for this measurement is the percentage of sales through distributors, but it can be easily modified to determine the proportion of sales through any sales channel. This measurement is listed in the logistics chapter instead of the sales chapter because the type of distribution channel has a profound impact on the cost structure of the logistics department's shipping costs. For example, sales to a distributor are generally in bulk, which reduces freight costs, while sales directly to consumers require much higher packaging and delivery costs. Also, customer support is sometimes handled by distributors, whereas direct sales require a company to handle this function itself.
Formula: Divide the total dollars of sales to distributors by the total dollars of sales by the company. This measure can be used for any other sales channel, and can also be separated into sales by different product lines or geographic regions. The formula is:
Example: The Shenandoah Golf Company manufactures titanium golf clubs. It began by selling through golf course pro shops in the Virginia area and has since used a variety of sales channels to increase its sales throughout North America. Lately, the sales and logistics department costs have become so large that the president decides to review all of the sales channels to determine whether some can be eliminated, thereby allowing the company to drop those employees who were dedicated to specific sales channels. The president collects the information shown in Table 12.18.
By splitting sales into sales channels and then taking the extra step of determining net margins on each channel, the president can see that the catalog sales channel should be eliminated, given its net losses. Also, sales to retail chains are not resulting in excessively high margins, even though they are positive; this may be an area requiring additional review.
Cautions: Though the measurement of sales volume by channel is important, it is even better if the accounting system can be designed to yield gross margins or (better yet) net margins by sales channel. This is usually difficult to achieve and requires some manual revision of the numbers stored in the general ledger. If this is done, a company sometimes finds that the net profits resulting from direct sales to customers are lower than if sales are made through intermediaries, such as distributors, because of the many expenses involved with direct sales. If only the gross margin associated with the various sales channels is incorporated into the calculation, then the reverse conclusion may be reached, since this measure will show only the reduced prices that are typically granted to distributors.