Thursday, February 28, 2008

Supply Chain / Value Chain Metrics - Getting Started (4) The Multiple Dimensions of Value Chain Measurement

There is, probably, no single measurement that effectively captures the health of a value chain, even though it may be easier to evaluate a value chain than an organization.

When you are performing a financial analysis of a company you expect to use multiple measures like: sales, costs, profit, and inventory. Managers and analysts understand that profit and loss statements and balance sheets provide multiple measurements in an attempt to capture a total picture of the organization. On the other hand, I have seen countless project teams use a single-point of measurement - cost, as their only measure of success in their value chain improvement project.

If you want to significantly reduce your costs - eliminate your product line. You should be able to drive your costs (and inventory) to zero. Sound crazy? If your only criteria is cost savings or cost avoidance, the elimation of a product makes perfect sense. While it may be a sound strategy if you are trying to close a business or business line focusing on cost reduction may be less important than improving your service level to your customers if you are trying to increase sales.

Just like you use multiple financial metrics to evaluate the business health of your organization, multiple operational metrics are necessary to properly evaluate the operational health of your organization. In a perfect world, your operational metrics will link to your financial metrics.

For a value chain / supply chain analysis, what business dimensions should you attempt to measure? As opposed to identifying metrics and trying to figure out how to use them, it may be useful to determine high level business performance and then derive the metrics that would help to drive changes in performance.

Revenue Value chain operations directly impact sales. Not only are sales and marketing activities directly linked to the generation of demand for products, product development, product quality, product delivery, and customer service / support. Because of the complex interrelationship of these activities it is useful to look at:

  • Demand Generation (How effectively you establish a need for your products and services).
  • Product Development / Introduction (How quickly and effectively you develop and introduce new, or modified, products and services).
  • Service Level (How successfully you serve your customers through meeting their expectations/ your commitments to them).

Cost The cost of your operations will clearly determine how much profit you can make or, in the case of not-for-profit organizations (like government agencies) how much service you can provide. Cost generally falls into two categories:

  • Direct Cost (The costs associated with producing the specific product or service).
  • Indirect Cost (The costs associated with the business that are not specifically attributable to a specific product or service).

Asset Management (How effectively you use your assets changes your financial performance. More effective use of resources translates into a competitive advantage.

  • Inventory Carrying raw, WIP, and finished goods inventory incurs a real cost as well as an opportunity cost.
  • Payables When suppliers extend credit (e.g., 30 days net) to their customers, they are essentially making loaning assets.
  • Receivables On the other hand, when you allow your customers to pay after delivery (e.g., 30 days net) you are making a loan of your assets. While it is may be beneficial, even necessary, for a sale, it means it may take longer for you to see a return from your assets.

Time Time is a critical factor in the success of any business. When evaluating value chains we frequently think in terms of time to market (the time between when a product is conceived to the time when it is first available for sale in the market). Sophisticated businesses understand that equally important may be time to volume. Nimble competitors can overtake a more innovative company if their manufacturing or distribution excellence allows them to imitate a product and make it available while the innovator is still trying to ramp up. Time metrics are interesting because shorter cycles times are usually less expensive and provide higher levels of customer satisfaction. It should be easy to understand that if you replace ground or sea transporation with air, you might get a shorter cycle time at a higher cost.

Agility The ability of the organization or value chain to adapt to unexpected changes in the market place.

These dimensions provide different, equally valid perspectives of the same value chain. While a Vice-President of Sales may focus on revenue, a Chief Operating Officer or a Transporation Manager may focus on cost. In a given quarter, a finance director may be focused on receivables. The challenge in a value chain analysis is to prioritize and balance these dimensions.

It is equally important to understand that priorities are going to shift between business and product lines. Many analysts and businesses struggle when they try to apply a one size fits all strategy to their businesses or products. (IT organizations frequently fall into that trap as they try to develop "common" processes or establish governance). The challenge is identifying common dimensions, metrics, and processes and varying their performance to effectively manage multiple and disparate product lines.

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