by: in Alumni
A supply chain can be defined as a “system whose constituent parts include material suppliers, production facilities, distribution services and customers linked together via the feed forward flow of materials and the feedback flow of information” (Stevens, 1989).
In the last decade, the concept of Supply Chain Management (SCM) has turned into one of the main components of companies’ competitive strategy. Firms want to enhance organizational effectiveness and profitability while satisfying their customers expectations. In the light of this, for companies it has become difficult and expensive to produce their needs on their own (Gunasekaran, Patel and Tirtiroglu, 2001); therefore they started looking for suppliers to work co-operatively in providing improved service, technological innovation and product design (Gunasekaran, Patel and McGaughey, 2004).
In addition to the above-mentioned internal motives, the development of SCM is also related to external motives enabling a deeper collaboration between manufacturers and their suppliers, such as increasing globalization, reduced barriers to international trade, improvement in information availability and environmental concerns (Gunasekaran et al., 2004).
As a matter of fact, managers shall now take into account all the aspects linked to supply chain while making their strategic decisions. They shall also assess whether the supply chain is actually contributing to reach the company’s strategic goals and, if not, what action shall be taken to fix any issue.
In order to do that, a system for measuring the supply chain performance shall be developed. As stated by Gunasekaran et al. (2001): “measures and metrics are needed to test and reveal the viability of strategies without which a clear direction for improvement and realization of goals would be highly difficult”.
Unfortunately, literature concerning supply chain (and logistics in general) has not yet developed a common approach for the performance evaluation of a supply chain. This article wants to provide readers with some insights about how efficiently measure a supply chain performance, and a framework for the relevant measures/metrics that have been considered so far by the literature.
In addition, some preliminary considerations about the features of an effective system for measuring and evaluating business performance will be provided.
Basis for measuring business performance
An effective performance measurement system is characterized by two main goals:
- focusing managers’ attention on the relevant points; and
- correct representation of the phenomena happening within the organization.
In order to achieve those goals, the management shall define:
- which dimension (namely: input; processes; and output) should be measured with priority; and
- which kind of measure should be used (financial vs non-financial).
Measurement dimensions
Considering the performance measurement dimensions, a company’s operations can be described, in general terms, as a set of processes turning input into output. A process generates value when the perceived value of the output is more than the intrinsic value of the input.
Therefore, how can management assess which dimension is the primary one? Four elements shall be considered:
- Capability of measuring the output
- Understanding of cause-effect relationships between input and output
- Measurement costs
- Desired level of innovation
The first two points are interrelated. In fact, the management should elect a dimension as priority by assessing the organization ability to measure the processes’ results as well as the knowledge of the transformation process. This relation is summarized in the following matrix derived from Ouchi (1979):
Regarding the measurement costs, when it is possible to both measure the output and the process, the election of the priority dimension should be based on: i) the actual cost of generating and elaborating the relevant information; and ii) the opportunity cost of sub-optimal decision taken because of a lack of information.
Furthermore, when safety and quality are two important factors of effectiveness, measurement should be focused on process. Nevertheless, when the cost of an input determines the production cost, measurement should focus on that input.
Finally, the desired level of innovation is an important element to be considered when deciding to focus on either process or output. On the one hand, process control limits innovation because it is based on standardized procedures; it shall be implemented when quality, efficiency and security are critical strategic factors. On the other hand, output control promotes experimental autonomy and freedom; it shall be implemented when innovation is a critical factor for success.
Gunasekaran and Kobu (2007) report that succeeding companies have outperformed their competitors in four key operational areas: delivery performance; flexibility and responsiveness; logistics costs; and asset management. Hence those areas can be considered as examples of priority dimensions to be measured.
Relevant measures
The next step for managers is defining whether to use financial or non-financial measures for assessing the correct implementation of the strategy. In the light of this, a useful reminder is that “while financial performance measurements are important for strategic decisions and external reporting, day to day controls of manufacturing and distribution operations is often handled better with non-financial measures” (Gunasekaran et al., 2004).
Martin and Patterson (2009) report that a supply chain generates benefits for companies mostly in terms of inventory (raw materials, finished goods and in stock rates) and cycle time (inventory turnover, cycle times and order fulfilment rates). Financial performance (return on assets, sales, market share and earnings) is found to be not significantly affected by SCM. The two authors provide the following explanation: “earnings are more directly related to sales and product margins. The benefits of lower inventory levels, increased inventory turns, and reduction in production cycle times more directly impact operating capital which may not have a direct influence on earnings”.
Furthermore, Flynn, Huo and Zhao (2010) demonstrate that a higher level of Supply Chain Integration is related to higher level of operational performance rather than business performance.
As stated by Gunasekaran et al. (2004): “the metrics that are used in performance measurement and improvement should be those that truly capture the essence of organizational performance”. Because studies report that SCM mostly impacts the operational areas of companies and, conversely, it has no significant effect on financial performance (at least directly), non-financial measures appear as the most feasible ones to correctly and promptly measure a supply chain performance. Therefore the management shall consider to mainly use non-financial measures as they are identified as the ones better addressing the most critical areas to make a supply chain succeed.
A Supply Chain as an integrated entity
Preliminary condition for an effective and useful performance measurement within a supply chain is a high level of Supply Chain Integration (SCI). Flynn et al. (2010) define SCI as “the degree to which a manufacturer strategically collaborates with its supply chain partners and collaboratively manages intra- and inter-organization processes”. Through SCI, companies aim to optimize the flows of information, products/services, money and decisions in order to provide value to customers in an efficient and timely manner.
Furthermore, an integrated supply chain implies a better control of the performance and enables a quick response in the case of “emergencies”.
For example, a supply chain is made up of a manufacturer, a distributor, a wholesaler and a retailer. The chain faces an increasing bullwhip effect (i.e. “the orders submitted to suppliers have a greater variability than those received from customers[…]The consequence of such orders variance increase is the need for larger stocks, extra production capacity, and more storage space” (Coppini, Rossignoli, Rossi and Strozzi, 2010)). In particular, the distributor experiences the highest level of inventory oscillations due to the bullwhip effect. Eventually, these oscillations are promptly detected by the performance measurement system.
If the supply chain had a high level of integration, the information concerning the “inventory anomalies” reported by the distributor would be spread along the whole chain and proper solutions would be put in place. Demand forecasts could be shared within the whole chain, thus enabling a better synchronization in terms of supply demand and reducing possible backlogs.
Conversely, in a non-integrated supply chain, information about inventory oscillations or demand forecasts would be hardly shared on time, thus leading to several inefficiencies.
Finally, as already reported above, a high level of SCI implies better operational performance for the firms included in the supply chain. On the contrary, SCI is not directly related to business performance. “This may be because customer and supplier integration are related to business performance through operational performance” (Flynn et al., 2010).
A framework for SCM metrics/measures
In their work, Gunasekaran et al. (2004) present a framework for the metrics/measures that could be used for assessing the performance of a supply chain. This framework is useful because on the one hand it presents the metrics that are mostly considered by literature and practitioners; on the other hand, the metrics/measures are grouped according to the level of management to which they refer (i.e. Strategic; Tactical; and Operational) and the four major supply chain activities/processes (i.e. Plan; Source; Make/Assemble; and Deliver).
The framework is provided below:
Conclusions
Performance (financial or non-financial) shall be properly measured in order to verify the actual and effective implementation of the company’s strategy. This post aims at informing readers about the basis for the definition of what shall be measured within a supply chain and how to measure it. While there is a consolidated literature regarding performance measurement of companies as a single entity, discussion is still in progress concerning the measuring of a supply chain performance.
Several metrics have been proposed in the related literature, but, as a matter of fact, non-financial measures seem to be the ones that can better catch the effects of Supply Chain Management on companies’ performance. Indeed, what has been discussed so far showed that SCM provides firms with several benefits in terms of performance. Nevertheless, those benefits are reported to be direclty related to operational performance rather than to financial. Thus, a possible approach for measuring a the performance of a supply chain could be assessing how SCM is affecting the operational performance of each firm along the chain itself.
Last, but not least, for an effective measurement of a supply chain performance, it is important to reach a high level of supply chain integration. Only through a strong integration with customers and suppliers it is possible to benefit from the efficiencies (in terms of inventory and other operating costs) brought by SCM and promptly act whenever the performance of one of the member of the chain is negatively affecting the performance of the others.
References
Coppini, M., Rossignoli, C., Rossi, T. and Strozzi, F. (2010). Bullwhip effect and inventory oscillations analysis using the beer game model. International Journal of Production Research, 48 (13): 3943-3956.
Flynn, B.B., Huo, B. and Zao, X. (2010). The impact of supply chain integration on performance: A contingency and configuration approach. Journal of Operations Management, 28: 58-71.
Gunasekaran, A. and Kobu B. (2007). Performance measures and metrics in logistics and supply chain management: a review of recent literature (1995–2004) for research and applications. International Journal of Production Research, 45 (12): 2819-2840.
Gunasekaran, A., Patel, C. and McGaughey, E. (2004). A framework for supply chain performance measurement. International Journal of Production Economics, 87: 333-347.
Gunasekaran, A., Patel, C. and Tirtiroglu, E. (2001). Performance measures and metrics in a supply chain environment. International Journal of Operations & Production Management, 21 (1/2): 71-87.
Martin, P.R. and Patterson, J.W. (2009). On measuring company performance within a supply chain. International Journal of Production Research, 47 (9): 2449-2460.
Ouchi, W.G. (1979). A Conceptual Framework for the Design of Organizational Control Mechanisms. Management Science, 25 (9): 833-848.
Simons, R. (2004). Sistemi di Controllo e Misure di Performance. Milan: Egea.
Stevens, J. (1989). Integrating the supply chain. International Journal of Physical Distribution and Materials Management, 19 (8): 3-8.
This blog was written by Marco Tuttolomondo, who graduated from Bocconi University in 2014 with a MSc. in Accounting, Financial Management and Control. In 2013 he followed an Exchange Programme at Maastricht University. He is an active committee member of the UM alumni circle Italy (Milan).
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