The ROI of Supply Chain / Value Chain Improvement - The Need for Multiple Measurements

Return on investment, ROI, has become a mantra for organizations when they evaluate, initiate, and manage projects to improve their value chain or supply chain performance. Consulting companies, technology providers, and system integrators sell their products and services with promises based on ROI calculations. While the promise of ROI is seductive, determining what the real return for a project can be extraordinarily difficult. Promised ROI is frequently never realized.


In many cases ROI is calculated when projects are evaluated, proposals are awarded, and budgets are agreed upon. In many (most?) cases, once the project is completed, actual ROI is not tracked. As a result, there is little accountability for results - at least among those not responsibile for the business. While it can be challenging to meet budgets and schedules for a business improvement project, it can be far more challenging to meet overly ambitious business plans that may not depend just on a successful project.

For the small business or the large practitioner, the ROI calculation is essentially the same.

Return on investment is calculated as (the benefit of the project) minus (the cost of the project) divided by the cost of the project. The vast majority of the time, project improvements in supply chain or value chain operations are sold on cost savings or cost avoidance. So, a project that saves $1000 and costs $500 to implement, has an ROI of 1000 - 500 /500 or 1.0 (100%). If the project doesn't realize its promise and saves only $600 the ROI is 600-500/500 or .2 (20%).

For the business owner or executive, using the calculated ROI appears to be easy. If the calculated ROI is negative, it means the project is going to cost more than its "worth." So, you do not approve projects with a negative ROI. If one project has an ROI of 20% and another has an ROI of 50% the second project is given a higher priority. It may be more difficult to make decisions if a project is strategic, or produces positive and negative results. It may be that deploying a direct to cosnumer distribution system eliminates substantial logistics costs but may also threaten revenue when distributors are no longer motivated to sell.

Using an ROI calculation becomes more difficult when you compare projects and outcomes that extend over multiple years. Comparing a short term project with large (one-time) savings with a project that will last 18 months and generates small benefits (or savings) for the next 10 years requires a bit more sophistication. To help address this issue, the ROI calculation can be expressed in Net Present Value or NPV. (NPV is included in Excel worksheet forumulas). The NPV forumula allows an executive or an analyst to compare projects with multiple year time frames. Investopedia has an excellent description of how to calculate the value of money when time is a factor.

The real issue in supply chain and value chain ROI calculations lies in the assumptions. Supply chain and value chain operations include multiple functions and effect multiple business and financial results. If cost reductions lead to a reduction (or appearance in the reduction) of customer service, the result can be lost sales. As a result, a cost savings project can meet all of its ROI objectives and, if revenue is not considered, can produce a real financial loss.

So, how do you reduce the risk of inaccurate or incomplete assumptions? While there is no guarantee that your business executive, business analyst, or project manager will predict the right outcome, there are steps that can be taken to insure they consider different perspectives. One way is require the review of a project using multiple measurement dimensions. While cost and cost savings are almost always considered it is important to consider: impact on product positioning, impact on service level performance (as expressed in meeting customer commitments or expectations, impact on time / velocity, impact on the ability to adapt to marketplace changes, and the impact on the effective use of assets. It may be difficult to trace some operational project results to specific contributions (positive or negative) in revenue, however, the analysis will frequently identify project objectives and risks that would otherwise go unnoticed.

Likewise, not recognizing and accounting for the risks in implementing and deploying a solution can produce painful business outcomes. A company that invests in automating and modernizing a warehouse or manufacturing line and calculates how much it will save in the next 5 years loses its "return" if market conditions or strategy force the an early closing of the facility.

Perhaps one of the most important steps an organization can take to ensure they use ROI effectively is to measure their business performance consistently - before, during, and upon the completion of projects. The proliferation of executive dashboards and business intelligence solutions may be a sign that more and more businesses are learning that monitoring the right metrics and managing the business based on the results provides a competitive edge.

Is this a short term technology fad? How does a business know what or how to measure?

Supply Chain and Value Chain Benchmark Studies and Resources

This list of benchmarking resources is similar to my post on process models. It is intended to be a frequently updated entry that will identify resources for benchmarking specific to supply chains, value chains, and business operations. It is certainly not an exhaustive list.


Academic (Colleges and Universitites)


Center for Supply Chain Research (Smeal – Penn State)
Cranfield University (School of Management)
CAPS Research (with Arizona State University)
The Supply Chain and Logistics Institute (Georgia Tech)


Commercial Research


Aberdeen Group
AMR Benchmark Analytix Service
APQC
ARC Advisory Group
The Benchmarking Exchange
Icognitive Pte, Ltd.
Performance Measurement Group LLC (PMG)
The MPI Group

Government

European Commission (Eurostat)
United States (US-STAT Department of Commerce)

Journals and Media


Industry Week

Please provide any additions or modification to complete the list. If possible, please provide a site name, a link, and a short description of the benchmarking. (The list is not intended to identify every benchmarking study - just those that are specific to business operations / improvement),

Supply / Value Chain Measurement: Metrics and KPIs

Recently SAS sent me an invitation to download a great reprint of a Harvard Business Review article by Thomas Davenport, "Competing on Analytics." It was only coincidence that led me to Gary Cokins blog post "A Word to the Wise..." I suggest you read the article but to paraphrase it, he talks about the confusion and lack of consensus about performance management and recommends speaking about the results instead of the definition. I think he is right - but since in this blog, I will be talking about what to measure and how to measure, I thought it important to give my unscientific, working definitions.

Metrics – “standards of measurement.” - A metric uses numbers to describe a component of the business (for an physical object it would be length, width, height, weight, etc.) Examples of business metrics would be: the value of finished good inventory, order fulfillment cycle time, forecast accuracy, on time in full delivery, etc.

Key Performance Indicator (KPI) – a metric that has been chosen to be pivotal in understanding past, present or future business performance. It is usually a metric on which the business wants to focus attention. For the purchaser of an automobile, average miles per gallon might be a KPI since it might give some insight into the total cost of ownership. You could argue that there are a few common KPIs. Virtually every business, at the executive level, would consider Revenue, Cost of Goods Sold (COGS), Margin, and Profit to be KPIs. A Chief Financial Officer may consider Inventory Turns to be a KPI. The COO or Manufacturing executive might consider Yield to be a KPI. I don't think I have ever seen two companies or two executives in the same company compile the same list of KPIs.

Measurement – the value observed when applying a metric. For example, if the metric is Finished Goods Inventory Turns the measurement might be 10 (x per year) or 20.

Organizations frequently confuse the process of selecting a metric with the process of setting a goal for the metric (measurement objective). For example, in the last several years, organizations have been establishing metrics around the "perfect order." (The order is delivered on time and in full with zero defects in condition or documentation). When the companies initially adopt the metic there can be an organizational preconception that the goal should be 100% perfect orders. Except for the very small or very sophisticated supply / value chain, it can be extraordinarily expensive to achieve perfection. As a result, many companies choose the metric, perfect order, then set the target (e.g. 90%).

Related terms

Benchmark(ing) - I have seen two commonly used definitions. They are not necessarily interchangeable.

1) An exercise where best practice and/or results are exchanged between two companies. For example, it has been common for companies to "benchmark" Toyota and the Toyota production system. It may involve a site visit, tour of the facilities, etc. This type of benchmarking exercise is frequently conducted outside one's own industry. (It is frequently easier to do this type of benchmarking with companies you don't compete with). The benchmarking may focus on practice as opposed to comparing measured results.
2) An exercise where organizations compare their results based on survey information. The most valued of these surveys are based on performance metrics. The breadth, depth, and quality of the benchmarking programs vary widely. Benchmarking programs are operated by universities and colleges, trade and professional organizations, consulting firms, and government agencies.

Thoughts on metrics and measurements -

You cannot manage what you do not measure - (I think the origin is Deming but it has been so often repeated I am no longer sure of the source).

Not all measurements are equally important

Meaurement is expensive. Failing to measure may be more so.

Metrics are the most emotional issue in business.

Business Process Model Wars

Process models are the "standards" or banners in the escalating battle for the hearts, minds, and dollars of analysts, technologists, consultants, business process engineers, program managers, and business leaders.

For reference, I have started capturing the process models and their source. I expect to make frequent revisions to this page.

View Upload your own

APQP - Advanced Product Quality Planning - Automotive Industry Action Group
CCOR - Customer Chain Operations Reference Model - Supply-Chain Council, Inc.
DCOR - Design Chain Operations Reference Model - Supply-Chain Council, Inc.
DFSS - Design for Six Sigma - (Multiple Models)
MSDF - Manufacturing System Design Framework - Lean Advancement Initiative
PCF - Process Classification Framework - APQC
SCOR - Supply Chain Operations Reference Model - Supply-Chain Council, Inc.
SCMF - Supply Chain Management Framework - SCM-Institute
VRM - Value Reference Model - Value-Chain Group

Technical but related frameworks

FERA - Federated Enterprise Reference Architecture - CPDA
ITIL - Information Technology Infrastructure Library

Corrections, additions, and amplifications are welcome.

Logistics – Supply Chain – Value Chain: Evolution of an Idea or Different Approaches?

At times I understand the difference between logistics, supply chain management, and value chain management. At other times I become more than a bit confused. I would like to think my confusion is caused by changes in the state-of-the-art – not an impaired mind. To make matters more interesting, there are variations in the themes: logistics, integrated logistics, strategic logistics, supply chain management, extended supply chains, etc.


I routinely ask the executives and managers I work with how they define supply chain management. After we determine that everyone has a different opinion, the conversation usually ends up with us talking about the difference between logistics and supply chain management. Some say the two are the same. Some logistics is part of supply chain management. Some that say supply chain management is part of logistics.


In 1986, the Council of Logistics Management, now CSCMP, defined logistics management as:

The process of planning, implementing, and controlling the efficient, cost effective flow and storage of raw materials, in-process inventory, finished goods and related information from point-of-origin to point-of-consumption for the purpose of conforming to customer requirements.

Now, the CSCMP defines supply chain management as:

Supply chain management encompasses the planning and management of all activities involved in sourcing and procurement, conversion, and all logistics management activities. Importantly, it also includes coordination and collaboration with channel partners, which can be suppliers, intermediaries, third party service providers, and customers. In essence, supply chain management integrates supply and demand management within and across companies.

Supply Chain Management – Boundaries and Relationships

Supply chain management is an integrating function with primary responsibility for linking major business functions and business processes within and across companies into a cohesive and high-performing business model. It includes all of the logistics management activities noted above, as well as manufacturing operations, and it drives coordination of processes and activities with and across marketing, sales, product design, finance, and information technology.

So what changed? (By the way, if you visit the CSCMP website you will see they haven’t forgotten to include the definitions for logistics). First, the purchasing (buy) function has been included. Second, the production (manufacturing or “make”) has been included. While the new definition specifically mentions coordination and collaboration with partners, you could argue that it was implied in the 1986 definition. No one can argue that the new definition emphasizes an approach that extends outside the “four walls” of the organization.


In Fundamentals of Supply Chain Management (Mentzer, University of Tennessee – I particularly like the case studies) suggests that a supply chain consists of at least three companies which also extends the supply chain perspective outside the four walls.

In Competitive Advantage, 1985, (Porter, Harvard) introduced the concept of the value chain. I have never been sure whether the value chain concept was influenced by the supply chain notion or whether it developed independently from organizational / strategic theory. There can be little dispute that the ideas have influenced each other and have become, to some extent, co-mingled. Porter’s work was the first place I saw an attempt to describe a common process view of business. (Is this the origin of the “business process model?” Like the supply chain definition, the value chain definition includes: inbound logistics, operations, and outbound logistics. The value chain extends the definition to include marketing & sales and service. It incorporates HR. technical development (R&D), and procurement as infrastructure. Using this view, the cost of the raw materials (suppliers) plus direct and infrastructure activities when subtracted from the revenue provided by the customers equals the margin.


I see one obvious difference between the CSCMP’s supply chain management perspective and Porter’s value chain view – the addition of marketing and sales as an integral component of the “chain.” That is not to say that CSCMP overlooks marketing and sales – it is primarily a difference in emphasis. (Similar to the SCOR model which “implies” a relationship with marketing and sales but doesn’t really address it). The Value Reference Model (VRM), a process model that, like the SCOR model does for supply chains, provides process descriptions for describing all of the activities within the value chain. The VRM includes activities to describe product development (NPI or new product introduction), sales & marketing, and service. (HP developed two process models DCOR and CCOR, that when combined with the SCC developed SCOR model approximates the scope of the VRM).


A less obvious difference, but I believe one that is critical when you start implementing logistics / supply chain / or value chain solutions (whether it is an IT project, a lean or Six Sigma project, executive dashboards, benchmarking, process improvement or anything else) is the difference between an organizational perspective and a product / product line perspective. It is my belief that this is the root cause for much of the confusion or overlap between the three definitions. It is also, in my opinion, one of largest barriers in aligning the activities of the business units, the functional managers, the technology providers, and consultants.


Here’s what I mean. A manufacturer that produces different products is likely to have different suppliers, customers, desired business outcomes, production sites. For example, a manufacturer in the electronics industry might make servers and laptops. Clearly products require very different components. Even if both require power supplies, it is unlikely that the two will be interchangeable. It is also quite possible that the company that is the best source of supply for server power supplies is not the best for notebooks. Server production facilities may not be the same as notebooks. It is possible that based on the business model, the production strategies are different. (A postponement strategy could be used for one and not the other). Delivery and distribution could be very different. The notebooks could be sold to consumers and businesses while the servers would be sold primarily to businesses). How many supply chains or value chains are there?


From a functional or IT perspective, there may be only one supply/value chain – electronics products. For each of the products, the company must buy raw material, produce product, distribute, and deliver. Purchasing departments will be reviewed on the overall success of their buys. Production centers will be evaluated based on how well they meet their quotas and capacity utilization. Transportation departments will be rewarded based on their cost per ton and distribution centers will be incentivized to maximize their fill rates. IT departments seek solutions that allow them to install and support a common corporate solution – providing identical capabilities to both business units.


From the business perspective, there may be two very different supply chains. The server supply chain with must satisfy high volume, high revenue accounts with service level requirements that are significantly more demanding than the service level requirements for an individual notebook consumer. Business executives may demand different growth rates, different margins, and seek to support different geographic markets for each product.

The value chain concept is the arguably the logical next step in the reintegration of the enterprise. Integrating product development, marketing and sales, service and support (through the warranty and spare parts business) with “supply chain” activities continues what has become a new business imperative, the elimination of functional (and process silos). Certainly this is not a new idea. Sales and operation planning is a best practice that moves toward integrating two of these major fiefdoms.


I suspect after 30 years with the terms supply chain and value chain management, someone will develop a new term. A number of very smart people suggest that we should start talking about networks instead of chains.

Defining Supply Chain Management - Who's Right? Who Cares?

Ask twenty people to describe supply chain management, you get twenty different answers. For a concept that has been around since the 1960s (p. 42-43, Pennsylvania State University as integrated logistics) and a term that appears to have been introduced in the early 1980s – you would expect more consensus. [Dan Gilmore -Supply Chain Digest Question / Answers and Gene Tyndall (Supply Chain Management Review Leaderboard Blog) have talked about the origin of the term. Keith Oliver, of Booz Allen Hamilton, claims to have coined the term but according to the Global Supply Chain Group it was Dr. Wolfgang Partsch (a snow chain derivative?)


I found the Oliver story to have the ring of truth.

“He began to develop a vision for tearing down the functional silos that separated production, marketing, distribution, sales, and finance to generate a step-function reduction in inventory and a simultaneous improvement in customer service. Looking for a catchy phrase to describe the concept, the consulting team proposed the term integrated inventory management. In a sure sign that consultants should not be allowed near promotional issues, the group expressed confidence that the world would adopt the sophisticated-looking abbreviation I2M. . . “We’re talking about the management of a chain of supply as though it were a single entity,” Mr. Oliver replied, “not a group of disparate functions.”


‘Then why don’t you call it that?’ Mr. Van t’Hoff said.


‘Call it what?’ Mr. Oliver asked.


‘Total supply chain management’”


A June 4, 1982, an article in Financial Times ran an article by Arnold Kransdorff on Booz Allen’s “rather grandly titled supply chain management concept.” When I read the story, I laughed a bit. The meeting where the conversation took place was apparently at Phillips (consumer electronics) and my first thought was that it appeared that Mr. Van t’Hoff (Phillips) coined the term. Booz Allen was certainly a major contributor in popularizing the term if they didn’t invent it.

Why does the definition matter? First and foremost, the definition provides the context for communication. When talking to a partner (supplier, customer), when talking to a colleague (finance, IT, manufacturing, logistics, purchasing, warehousing, etc.) it sets a framework for discussion. As a practitioner, it shaped where I looked for business solutions. The term “supply chain” was and is the equivalent of a password that tells you that someone is conversant with the approach that you are trying to understand or adopt. When I looked for management best practices that were “cross-functional” I could qualify my sources by their use of the term “supply chain.”

Unfortunately, for me, when I discovered supply chain management there were far fewer resources than there are now. I don’t think the term supply chain was used when I completed my MBA even though a number of our research projects were, in hindsight, specific to supply chain. Supply chain was just emerging as a “hot topic in professional organizations (Council for Logistics Management – now CSCMP, APICS, and the National Association of Purchasing Management – now ISM). There is a great snapshot of the state of the art of defining supply chain management, in 2001, in the Journal of Business Logistics – although very academic. (This article is what led me to discover Jay Forrester’s contributions. I found another foundational article – less academic in the Journal of Air Force Logistics which helps put supply chain into business management history context). Relatively early in my investigations I found Penn State’s Center for Logistics Research (now Center for Supply Chain Research).

Besides professional organizations and academia, I had another source of readily available information – the solution providers. Consultants and software companies alike had recognized the emerging market for supply chain solutions. Each had a unique solution. Each had a unique definition. What seemed to be common was each solution provider seemed to define supply chain management in terms of specific industry application. There were unique solutions, definitions, and language for every industry (CPG, retail, aerospace, chemical, electronics, pharmaceuticals, etc). Not surprisingly, the solutions and industries were based on reference accounts. Originally I thought that the greedy and evil consultants and software providers deliberately fragmented the supply chain market to protect or grow their business. Although I still think that is true (to some extent), it is also true that every practitioner thinks that his industry is unique.

The problem that I encountered in the 1990s is not too different than the one today, although there is a lot more information. Definitions come from the IT / technical community, professional organizations, academia, and consultants. A web search for supply chain management definitions returns more than 200,000 hits. How does the practitioner determine which one to use or if, in fact, one is better than another? Perhaps an equally compelling question is should we be looking for supply chain solutions or value chain solutions? Is there a difference?

I think addressing the differences between logistics, supply chain management, and the value chain, at least from my perspective, allowed me to evaluate best practice, technology, and partners. That will be the subject of the next entry.

Supply Chain Management – A Decade Later

In 1996, I joined 70 other companies in the formation of what was to become the Supply-Chain Council, Inc. (SCC) www.supply-chain.org. I was working at Lockheed Martin and we were trying to answer the question: What is supply chain management? In a very short time, we had added three important questions: how do we measure ourselves against our competition and world-class organizations in other industries and regions, how do we identify and adopt best practice, and what information technology should we be adopting?

After a year of consensus-building by practitioner companies (hosted by PRTM and AMR Research), the Supply-Chain Council formally attempted to answer the question with the release of the Supply Chain Operations Reference Model (SCOR) - Version 1.0. For almost the next decade I had the privilege of leading the Council's technical efforts – the body responsible for developing and publishing the SCOR Model (and ultimately the Design Chain Operations and Customer Chain Operations Reference Models – DCOR and CCOR). During my tenure at the SCC, the position of the Chief Technology Officer was a staff position. Because practitioner members could rely on the technical efforts of the Council to be neutral regarding approach and technology and independent of profit-motive, I was fortunate to get unprecedented access to the challenges and initiatives of companies around the world. The workshops I conducted with over 3000 senior leaders were interactive two to three day sessions where I learned as much as I tried to share.

Over the last few years, I have been asked to share some of the lessons learned along the way. There are a lot of people who have far more technical expertise that I have. What I hope to share in this weblog are the anecdotes, observations, and unique experiences that have shaped my understanding in the hope it may prove useful.