KPI-IN SUPPLY CHAIN & LOGISTICS:
Ajith Watukara - MBA, BSc - MASCI-Australia - CCMP-USA
Global Supply Chain Leader - Transformation & Operations | Lean Management Experts | Certified Digital Transformation Catalyst | Six Sigma Master Black Belt | Corporate Adviser & Trainer | Recruiter
Supply Chain KPIs are Essential – The Right Ones!
Many people get confused about KPIs or Key Performance Indicators in Logistics and Supply Chain operations. Which ones to use?… How many to use?
Sadly, it’s not such an easy question to answer.
Of course, they need to be SMART—Specific, Measurable, Achievable, Relevant, and Time-phased—but this may too rudimentary a set of rules to ensure KPIs are useful. Later in this article, I will suggest some rather more comprehensive guidelines, but for now, aside from applying the SMART acronym, my basic take on KPIs is this…
1) Don’t have too many! I’ve seen KPI “packs” the size of phone books, and even KPI sets circulated as a monthly magazine… that no one reads. Remember what the K stands for!
2) Make sure they “tie” in with your goals and objectives. Do they directly support those objectives?
Unfortunately, even these most basic standards imply that many of your supply chain KPIs may not be stock-standard ones. However, in Supply Chain, you would generally expect to see the following standard set, along with those that are more specific to your business needs.
- DIF – Delivery in Full
- DOT – Delivery on Time
- DIFOT – Delivery In Full on Time
- Cost as a percentage of sales (Logistics or Supply Chain)
- Inventory stock turns in Days.
KPIs in Supply Chain – The Basics
As in any business activity, supply chain operations need to focus doggedly on improvement to compete in the market place, but how do you know if your supply chain performance is satisfactory, or if it is getting better, or worse?
That’s where KPIs come in.
What’s a KPI, Anyway?
KPI stands for Key Performance Indicator. A KPI is a practical and objective measurement of progress, either:
- Towards a predetermined goal, or
- Against a required standard of performance
If you are driving your car and you wish to maintain a speed of 50 KPH, you will use your speedometer to maintain that velocity. You will drive a little faster if your speedometer needle drops below 50KPH or you will slow down if it climbs above the required speed.
You will use a KPI in the same way as your car’s speedometer. The only difference is that in most cases, you wouldn’t wish to lower performance when a business activity exceeds the required standard. As a similar, and perhaps more accurate example, if your car has a fuel consumption gauge and you use this to try to drive economically, then you are making use of a bona fide KPI.
Why Are KPIs Important?
Using KPIs for performance measurement ensures that you are always evaluating your business activity against a static benchmark. That makes fluctuations immediately visible, and if performance moves in the wrong direction, you can quickly respond.
When a KPI shows that performance is consistently meeting or exceeding the required level, you can decide to raise the bar and set a higher standard to achieve. For this reason, KPIs are essential for any business improvement strategy.
That’s especially true in any business where customers tie into agreements or contracts. Service level agreements, in particular, will be monitored through KPIs agreed between an enterprise and its customer, with the probable application of penalties should performance fall below agreed levels.
In short, KPIs provide visibility of business performance and allow objective quantitative and qualitative evaluation. When you align them with business goals, they take away the guesswork and sharpen the focus on improvement.
Supply Chain KPIs
When measuring the effectiveness and cost of your supply chain, you will need to set up and monitor KPIs that give visibility of cross-functional activity as well as those applicable to individual supply chain components.
Later in this article, we’ll look at some examples of functional and cross-functional KPIs. Broadly speaking though, the following areas are those where KPIs will be necessary:
- Order capture
- Inventory management
- Purchasing and supplier management
- Production/manufacturing
- Warehousing
- Transportation
Cross-functional KPIs are likely to provide snapshots of the following end-to-end performance factors:
- Perfect order (the degree of accuracy to which customers’ requirements are met)
- Inventory levels
- Stock losses and/or damages
- Gross profit
- Cost of goods sold
- Total logistics cost
Try to construct cross-functional KPIs in a way that allows each function to see its contribution to overall supply chain performance.
Why Do Companies Have Too Many KPIs?
At the beginning of this article, I stressed the importance of not having too many KPIs. In the course of my consulting activity, I come across this issue repeatedly. The most common cause is a state of confusion about what constitutes a KPI.
There is nothing intrinsically wrong with capturing a large number of metrics, especially with today’s sophisticated analytics software solutions to help. However, it is beyond realistic to expect anyone to scrutinize them all on a day-to-day or even week-to-week basis.
KPIs should comprise a handful of metrics that your teams CAN realistically monitor and react to continuously. They don’t need to be exceptionally granular, but should instead track the most vital elements of supply chain performance.
How Many are Too Many?
Of course, the difference between KPIs and metrics will vary at different levels of your organization, so while a metric recording “receiving accuracy” in a warehouse would undoubtedly be a KPI for a warehouse manager, it would be utterly extraneous as an executive-level KPI.
The Importance of Hierarchy
Another reason not to have too many KPIs is the need to apply various levels of detail to each one. Because of this particular necessity, the development of even half a dozen logistics KPIs will ultimately result in two to three times this number in total… at the very least.
Therefore, as you might imagine, an excess of KPIs will soon have your portfolio approaching the volume of the aforementioned telephone directory, making it hard to monitor and act on the mass of data generated.
The Two-Level Hierarchy
If you wish to keep things as simple as possible, you should find that two levels, or tiers, of logistics KPIs, are sufficient. You might call the highest level the “primary tier” and the second level the “secondary tier”.
The first-tier KPIs would be the ones monitored at an executive level in your company, and would perhaps include metrics like:
- Logistics costs as a percentage of sales
- Inventory turns
- Total inventory days
- Source-to-deliver cycle time (the time from sourcing raw materials to delivery of finished goods)
- DIFOT
At the secondary level, you would have KPIs that provide more granularity and highlight the causes of fluctuations in tier 1 metrics. Examples of these secondary KPIs could include:
- Warehouse costs as % of sales
- Transportation costs as % of sales
- Finished goods inventory turns
- Raw materials inventory turns
- Inventory obsolescence
- Work in progress days
- Finished goods days
- Raw material days
- Inbound delivery in full
- Inbound delivery on time
- Outbound delivery in full
- Outbound delivery on time
- Manufacturing cycle time
The Three-Level Hierarchy
A three-tier KPI solution is a little more involved, with the top two tiers comprising end-to-end supply chain metrics with Tier 2 being more granular than Tier 1. Meanwhile, the third tier can include KPIs that show performance at a functional level, and highlight how each function’s primary activities are contributing to end-to-end performance.
Cross-Functional and Functional KPIs: How to Apply the Right Ones
Functional KPIs offer value of course, but when you combine and integrate them to offer an end-to-end view of performance trends, you can magnify that value considerably. It can be helpful, therefore, to identify the processes involved in your supply chain before deciding upon the functional-specific measures that collectively, will show how these processes are performing.
You can identify and categorize your company’s processes in any way that suits you, but it’s worth briefly discussing, as an example, one of the process cycles commonly used when monitoring supply chain performance. That cycle typically goes under the heading of order-to-cash.
Order to Cash
Order to Cash (OTC) is the end-to-end process involved in capturing and fulfilling a customer’s order and can be measured using a carefully coordinated range of functional KPIs. The OTC cycle loosely comprises the following sub-processes:
- Customer-order capture
- Order picking and packing
- Dispatching, shipping, and delivering the order
- Billing the customer
- Receiving and recording the customer’s payment
OTC is a process that illustrates clearly, how the supply chain comprises a broader range of business functions than you might have thought.
For example, the sales function is not typically seen as part of the supply chain, but if your sales team captures orders from your customers, the first step in the supply chain is very much sales-related.
Similarly, it’s easy to forget that a supply chain comprises the flow of information and money, as well as goods. That necessarily implies a need for financial functions to be measured if you want a full picture of end-to-end supply chain performance.
Who’s Involved in Order to Cash Measurement?
When you measure the order-to-cash cycle, you will need to set appropriate KPIs for your sales department, warehousing and transportation functions, and for some areas of finance, such as accounts receivable. To illustrate how much this matters, consider the possible consequences of any failure or delay in recording a customer’s payment.
Let’s assume a system or process issue that results in the delayed posting of the customer’s payment. If the customer makes frequent purchases, receipt of payment for the previous delivery might not be recorded before the customer places a fresh order.
Because there is no record of payment, the customer’s account might be put on hold in your ERP system, and the whole process of supplying that customer stops until somebody spots the problem and resolves it. That’s a supply chain performance issue, just as much as if your warehouse team fails to pick the order.
Functional KPIs in OTC
If you’re beginning to think that order-to-cash cycle measurement sounds incredibly complicated, you can relax a little, because it need not be that hard. For one thing, a made-to-measure (see what I did there?) KPI exists that’s relevant to pretty much any type of supply chain operation. It’s a composite KPI called perfect order, and it incorporates functional measurements for all stages of the OTC process.
You can use the perfect order KPI to track OTC performance, by breaking it into its components and applying the metrics as relevant to the different functions in your supply chain. The breakdown should look something like this:
- Sales function: Percentage of orders captured accurately (reliant on customer feedback)
- Warehouse function: Percentage of orders picked in full
- Transport function: Percentage of orders delivered in full; Percentage of on-time deliveries
- Finance function: Percentage of orders billed correctly
- All functions: Percentage of orders with correct and accurate documentation
The functional KPIs mentioned above are the highest level of metrics that you will use. They will likely need breaking down further to maximize the identification of performance issues and aid in solution planning—always remembering to keep things simple by only holding people responsible for the KPIs they can directly affect.
For instance, in the warehouse, the percentage of orders picked in full might be broken down into…
- Percentage of orders picked with errors – incorrect quantity
- Percentage of orders picked with errors – incorrect product
- Percentage of order lines picked with errors – incorrect quantity
- Percentage of order lines picked with errors – incorrect product
At this level of granularity, the picking-performance measurement will allow you to see trends and patterns in picking accuracy. You might notice for example, that a significant number of orders are picked with minor errors, or that a small number of orders contain many errors.
Furthermore, by applying codes to highlight the exact nature of each error, you will gain an even higher level of visibility. You might notice, for instance, that a particular product is affected more than others by picking errors, and then determine if the problem lies with that product’s markings, labels, storage location, or proximity to a similar product in the slotting plan.