Tuesday, December 11, 2007

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.

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