18

Performance Measurements and Controls: To Track and Improve the Health of the Supply Chain

After reading the chapter, the students should be able to understand:

• Logistics performance levels
• Logistics audit
• Performance controls
• Logistics performance measurement criteria

Irrespective of the size of operations, all business organizations, however small or big, need performance measurement and control for efficient and effective deployment of resources and tracking the health of the supply chain. For the concept of logistical integration to be practised and drive results, a system of performance measurement and control needs to be designed on the criteria of reward and penalty to performers. However, a well-designed performance measurement system supported by logistics information makes cross-functional coordination and integration easier.

“Measurement is the first step that leads to control and eventually to improvement. If you can’t measure something, you can’t understand it. If you can’t understand it, you can’t control it. If you can’t control it, you can’t improve it.”

—H. James Harrington

18.1 WHY PERFORMANCE MEASUREMENT?

When describing the performance measurement system, it can best be compared with the control panel on a machine or the dashboard of a vehicle. These examples provide the insights into the designs of control measures, which are required in logical performance measurement system. Control of the logistical system is not possible through a single measure. It requires multiple measures to direct the logistics operation for efficiency and effectiveness.

System performance is judged by its output with respect to the inputs. A higher output to input ratio is a measure of the system’s efficiency and effectiveness. However, the above ratio is also to be reviewed with respect to the time period. In today’s dynamic business environment, business firms strive to gain the competitive advantage not for growth alone but for survival as well. Owing to fierce competition, industries are being forced to focus on the effective and efficient use of scarce resources. Manufacturing and trading companies have to deploy a lot of resources in logistical operations for the movement of goods and information across the supply chain of the firm. Hence, it becomes necessary to monitor, control and improve the performance of the logistical operation so as to attain the set goals of cost reduction and customer satisfaction. The performance measurement system helps in either reducing or eliminating the non-value-added activities from the system. In the current competitive business scenario, the importance of accurately measuring and controlling the logistical performance cannot be denied, as logistical competency has become more critical in enhancing the competitiveness of the business process.

18.2 PERFORMANCE MEASUREMENT SYSTEM OBJECTIVES

Any performance measurement system shall have the following objectives:

Monitoring. Monitoring focuses on reporting on the current status of the operations. For example, a financial monitoring system will report to the management the total funds outgo and inflow on a particular day. Similarly, the monitoring system for marketing will report on the total orders booked, orders cancelled and the orders completed. The information may be monitored on a daily, weekly or monthly basis, depending on the volumes and the criticality. In the case of logistics, the monitoring system reports on the cost break-up across the various logistical activities such as warehousing, transportation, packaging, material handling and so on. It also indicates the service level parameters such as delivery status, transit damages, wrong dispatches and so forth.

Controlling. Control measures compare the actual performance with the set standard or objectives. They report deviations from the set goals. For example, the control system will report on the current order fill rate in the warehouse as 60 per cent and indicate a deviation of 40 per cent from the set standard of 100 per cent, so that corrective action can be initiated for inventory replenishment. Similarly, a percentage increase in product damages during handling will prompt the management to change the logistical packaging or go in for mechanized product handling instead of the manual that is currently in practice. Decrease in warehouse productivity is a cause that will help to improve on the storage layout, material handling methods and product unitization.

Directing. The objective of the performance measurement system is to motivate the individual in the system to enhance individual performance, resulting in improvement in the overall system performance. The performance measure system will help the management to evolve an incentive scheme for the operating people who cross the targeted productivity level. For example, the warehousing workforce engaged in material handling may be motivated through rewards to cross the targeted tonnage of goods dispatches within a particular time frame. Alternatively, the incentive scheme may be worked out on the basis of a reduction in wrong dispatches or errors in the dispatch documents in the current year compared to the previous year.

18.3 LOGISTICS PERFORMANCE LEVELS

Broadly there are two levels of performance measures—the internal and external measures. According to Vijay Govindarajan and Robert Anthony,¹ the firm must strike the balance between the external measures, such as customer satisfaction, and the internal measure, such as productivity, cost, quality, and asset management, because the companies normally ignore the external results in the belief that the internal measure are enough.

Performance measures must be evaluated through the various perspectives before they are evolved and implemented. In general, a performance measure may be viewed through the following four perspectives:

• Financial
• Non-financial
• Internal
• External

Financial Measures

Operating Cost. Operating cost is the most important performance measure. It reflects the efficiency and effectiveness of the logistics system. The operating cost element covers warehousing cost, freight, material-handling equipment running and maintenance cost, labour cost, cost of returned goods and inventory-carrying cost. Operating cost is expressed as a percentage of total sales of the inventory moved through the system. The typical logistics cost performance measures are shown in Figure 18.1.

• Warehousing cost per unit (number, volume or weight) of throughput
• Freight cost per unit of material transported
• Labour cost
• Cost of goods damaged during transportation
• Logistical packaging cost
• Order processing cost
• Per unit (throughput) cost in the warehousing
• Administration cost

Return on Investment. Return on investment (ROI) has both financial and non-financial perspectives. This is an important financial performance measure to indicate whether the investment made in logistical assets, such as warehouse, equipment, storage system and transportation vehicles, is paying dividends by way of profit enhancement through cost reductions. The numerator in the ratio is the income and the denominator is the investment. ROI also indicates whether the investment is properly utilized so that it generates the desired revenue.

Fig. 18.1 Performance measurement perspectives

Non-financial Measures

Productivity. The productivity of a logistical system is judged by its output with respect to the input into the system. It is an important performance measure to gauge the efficiency of the system. For example, in the organizational context, the incremental increase in head count in the marketing team should bring additional sales revenue as per the norms set by the firm. A firm may decide on productivity norms (based on past experience), so that an incremental sales generation of INR 1 million per sales person will justify the addition of new recruits to the marketing department. In logistics, the productivity performance measures are:

• Units loaded per person per hour onto transport vehicles
• Cases filled and packed per person per eight-hour shift
• Idle time of the handling equipment
• Throughput in the warehouse per hour

Productivity measures are sometimes difficult to compute as the outputs are hard to measure and input utilization is difficult to spread over to match the stipulated time frame of the output.

Asset Management. Asset utilization means the utilization of the capital invested in the assets such as warehouse building, storage system and material handling equipment and also funds tied up in the inventories. The utility of the investment is measured through inventory turnover ratio, returns on investment and inventory stock levels in the number of days.

Inventory turnover ratio indicates the rotation of a given value of inventory with respect to the value of sales in a set time frame. Normally, the time frame is one year. A higher turnover ratio indicates faster cash rotation in the business cycle and higher utilization of the assets. This ratio has both financial and non-financial perspectives.

Order Fulfilment. Order fulfilment is one of the important criteria to judge the level of customer service of the firm. It is the relative ability of the firm to satisfy the customer. This requires a close coordination of all the functional areas of the organization. The various sub-measures covered under order fulfilment are:

• Cycle time (order processing, replenishment, procurement and manufacturing and distribution)
• Delivery—on-time/delayed
• Fill rate (order fill, case fill, product fill)
• Stock out frequency
• Shipping errors (wrong delivery, incorrect invoice and material shortage)

For the firm to enhance its order fulfilment capability, the close coordination of all the arms of logistics is a must. The system needs real-time information support and an exceptional reportgenerating and alarming capability for proactively initiating corrective steps.

Quality. In the order fulfilment process, the perception of the logistical service quality is created through “near to the perfection” approach. This may be interpreted as making order delivery as error-free as possible. The impression of quality logistics service is created through initiating and controlling the following performance measures:

• Transit damage frequency
• Value of the total damage
• Frequency and cost of goods returned from customers (damaged/sub-quality)
• Material shortages frequency
• Delivery commitment deviations—frequency and tolerance

Quality measure is basically an evaluation of the entire logistical process, rather than the individual activities involved in the logistical operation. It speaks of the degree of effectiveness of the entire order fulfilment process to deliver error-free service.

Customer Perception Measures

For initiating the steps to achieve competitiveness in logistical operations, the firm needs to take a regular feedback from the customers on the existing service levels and the gaps. Customer feedback may give the firm a comparative analysis of the service levels and value-added service offerings of the competitors operating in the markets. The feedback on delivery performance, reliability, responsiveness, and the relationship initiatives and practices of the firm vis-à-vis competitor firms needs to be regularly obtained towards the updates on external performance measures and controls thereafter. The firm should regularly conduct or sponsor customer surveys for mapping customer perceptions and initiate measures for improvement in logistical services and enhancing competitiveness. These surveys may be conducted or organized through the firm’s own marketing and service team, or through channel members or consultants.

Innovations

For calibrating the logistical performance measures, firms go in for innovative techniques such as benchmarking with the excellent logistical practices in the industry. The benchmarking may be with competitors, firms in related industry or firms in non-related industry. Benchmarking performance measures help the firms to gain a competitive edge. For example, Xerox Corporation, USA, benchmarked I.L. Beans Corporation for distribution procedure to improve on its lead time in exports sales. Typical benchmarking measures in logistics are:

• Order processing procedure
• Transportation—route, modes and freight rationalization
• Warehousing—storage, material-handling system and automation
• Packaging
• Logistical productivity
• Delivery service
• I nformation flow and connectivity

The benchmarking may be done based on the published information, alliances with firms to be benchmarked or appointing a consulting firm/expert, depending on the criticality of the results.

Federal Express has a point system for measuring results. Every day points are accumulated and conspicuously displayed to front line workers so they can understand system performance and take measures for improvement in performance (see Table 18.1).

Table 18.1 Logistical Performance Measurement System in a Courier Company

For logistical performance measurement and control, Kodak has evolved a unique system of “defects per unit” (DPU). They have divided logistics performance measures on the quality parameters in various logistical activities as shown in Table 18.2.

Table 18.2 Defects Per Unit

18.4 LOGISTICS AUDIT

For enhancing the performance of the logistics system, it is necessary to take stock of the efficiency and effectiveness status of the various subsystems of the logistical chain. This process is known as logistics audit. The shortfalls, bottlenecks and gaps in the logistical supply chain can be identified with logistical auditing so as to improve the system efficiency and effectiveness.

Logistics audit examines and tests the operations of logistics process in terms of quality, technology, productivity and external factors. The auditing process reveals any weakness in the logistics system of the company. The test results can help in offering proposals to the firm for improving the system efficiency and effectiveness by investment in system, equipment or new technology. A logistics audit measures the capabilities and quality of the logistics and highlights resources for rationalization and cost reduction. The areas of logistics audit are discussed below.

Quality

The audit identifies the quality of the logistical service. The errors, constraints and bottlenecks leading up to the present situation are identified. The audit checks the existing standards of stock levels and the delivery performance in terms of speed, reliability and consistency so as to suggest the improvements.

Productivity

The audit notes the output of the system with respect to the system input. It analyzes the productivity of assets, equipments and the labours employed with respect to time and cost frames. It assesses the throughput capacity of the system in terms of orders fulfilled, material packed, material transported and so on.

Packaging System

The audit will indicate the adequacy of the present packaging system in terms of capacity and the technology and cost economy.

Automation

In case the present warehouse has reached its threshold limit of throughput with respect to the labour employed and cost incurred, wherein the manual operations are causing reduction in system productivity, the logistical audit will propose warehouse automation.

Warehouse Capacity

The audit will spell out whether the warehouse is underutilized for its existing capacity or there is a case for hiring or constructing an additional storage space based on the level of order throughput.

Technology

The technology audit may include equipment reliability, speed of information and material flow, warehouse management system (automatic material identification storage, retrieval, picking, sorting, packaging and loading) and transaction system. The audit will compare the critical subsystems with state-of-the-art systems and subsystems.

External Factors

The logistical audit will bring out facts on the changes in buyer and supplier relations, transportation conditions, customer-specific services and emerging technologies in logistics at both macro and micro levels and its likely impact on the logistics operation of the firm. This will help in taking appropriate corrective action.

Strategic Logistics Planning

Even though the main purpose of a logistics audit is to concentrate on process details, it also draws conclusions and helps in preparing strategic plans to bring greater efficiency and effectiveness to the entire logistical supply chain.

18.5 LOGISTICS PERFORMANCE CONTROL

To align the objectives of logistics with those of the organization, or to direct the logistical activities for competitiveness, a powerful control mechanism needs to be evolved and implemented. Invariably, organizations are going in for the following control systems:

Budgetary Control. Irrespective of the organizational reporting structure, the firm fixes up the budget for each of the logistical activities, which are treated as cost centres. Traditionally, these are financial budgets indicating the limits on application of funds on the cost centres. The deviation of cost is judiciously monitored, as the emphasis being on cost saving rather than service to the customer.

Structural Control. The controls are exercised through the proper organizational structure. Typically, an organization having cost as their differentiation strategy will have several layers of reporting structure to cut cost at the subsequently higher level on the investment proposals. In these organizations, customer service-related investment proposals take the back seat.

On the other hand, a customer-focused organization will have a flat reporting structure. The span of control is wider. The degree of authority and responsibility entrusted to the individual is higher. The managers enjoy work freedom, but are accountable for the results. The decisionmaking process is faster. The activities are treated as profit centres. These are result-oriented organizations and performance measures are used for continuously tracking and improving the health of the supply chain to remain competitive.

SUMMARY

Logistics performance measurement process keeps track of the health of the logistical system. For the total integration and coordination of the logistical operation, a well-designed performance measurement and control system is a must. Performance measures have two broad perspectives: internal and external. The former includes financial and non-financial perspectives, while the latter encompasses customer service and innovation perspectives. The measures normally followed are productivity, operating cost, customer service, delivery performance, asset utilization and so on. Logistics audit is used as a tool for measuring the capability and quality of the logistics operation of the firm and to highlight the resources for rationalization and cost reduction. Irrespective of the size of the operations, all business firms need performance measurement and controllership for efficient and effective logistical operations.

REVIEW QUESTIONS

1. “Performance measurement system tracks the help of the logistics process.” Explain.
2. Discuss the various objectives of the performance measurement system and the perspective of various performance measures with respect to logistics operations.
3. Why both internal and external performance measures are important for the logistics system to be effective and efficient?
4. Cite two examples of good performance measurement and control system that you have come across in business firms.
5. For a performance measurement and control system to keep track of supply chain health on a real-time basis, it should be backed by a well-designed logistics information system. Discuss.

INTERNET EXERCISES

1. To study standards on supply chain performance, see the Supply Chain Council website at http://www.supply-chain.org
2. Log on to http://www.performance-measurement.net/news-detail.asp?nID=199, www.som.cranfield.ac.uk and find out how to extend the balance score card across the supply chain.

BIBLIOGRAPHY

Anthony, Robert and Vijay Govindarajan. 2000. Management Control Systems. New Delhi: Tata McGraw-Hill, pp. 259–499.

Blanchard, Benjamin S. 1998. Logistics Engineering and Management. New York: Prentice Hall, pp. 121–126.

Bowersox, D.J., and D.J. Closs. 2000. Logistical Management. New Delhi: Tata McGraw-Hill, pp. 668–698.

Christopher, Martin. 2001. Logistics and Supply Chain Management. London: Pitman Publishing, pp. 122–124.

Harbour, Jerry L. 2003. The Basics of Performance Measurement, New York: Productivity Inc.

Jamaludin, Khairur Rijal. 2007. ‘Overall Performance Measurement For Logistics Operations.’ Technical Report. University of Teknologi, http://eprints.utm.my/2998

Kalkota, Ravi and Andrews B. Whinston. 2000. Electronic Commerce. New York: Addison-Wesley, p. 292.

Paul, R. Niven. 2002. Balanced Scorecard Step-by-Step. New York: John Wiley & Sons.

Paul, Schonsleben. 2003. Integral Logistics management: Planning Control of Comprehensive Supply Chain. Boca Raton, FL: The St Lucie Press.

Van Hoek R.I. 1998. ‘Measuring the Unmeasurable —Measuring and Improving Performance in the Supply Chain.’ Supply Chain Management: An International Journal 3 (4): 187–192.