KPI key performance indicators in supply chain & logistics
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Supply Chain KPIs are Essential – The Right Ones! „The information on this page WILL help you get it right.” 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. Still, in this article, I will try to help you evaluate the need for supply chain and logistics KPIs in your organization, and to identify which types of measurement might be most appropriate.
I’ll conclude with a case study illustrating why the above headline talks about the importance of choosing the right KPIs. First though, let’s walk through why KPIs are important, and some of the principles for applying them successfully.
A couple of KPI do’s and don’ts
Of course, your supply chain and logistics KPIs 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.
If you’d like to read more about Supply Chain KPIs, you can download (free) a chapter from one of our Best Selling Books on the topic.
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, and can be defined as a practical and objective measurement of progress, either:
- Towards a predetermined goal, or
- Against a required standard of performance
It might help to think of a KPI as something like an instrument on a car dashboard—a speedometer, for example.
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.
Apart from an internal desire to improve and compete, KPIs play a part in attracting and retaining customers.
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
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 being 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.
Let me try to clarify. A KPI is a metric… but not just any metric. A KPI is a metric focused on a KEY element of business, departmental, or team performance.
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 organisation, 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.
In determining your supply chain KPI suite then, the secret is to identify performance elements critical to those with the power to influence them, and develop appropriate KPIs for that audience.
At no level in a function, or cross-functionally though, should anyone need to monitor more than a few KPIs. Exactly how many is hard to say and will, in any case, vary from business to business, but frankly, if you are tempted to ask if you have too many KPIs, you probably do.
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.
Nevertheless, it is essential to have a hierarchy of KPIs, since, as already mentioned, a level of granularity suitable for one level of management will be either too general, or too detailed, for another. At the same time, it is not wise to have too many levels in your hierarchy.
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)
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.
Whether you choose a two or three-tier system will depend on the specifics of your company’s business, the company’s size, and other similar factors.
Of course, it’s also possible to add further tiers for even more granularity, but again, the more levels you have, the more complex your KPI solution.
Now let’s get a little more granular in this study of supply chain KPIs, and look at some of the specifics involved in tracking cross-functional and functional 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. Still, 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 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 contains 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.
What makes an effective KPI suite?
Earlier, I mentioned that the SMART acronym might be a little too simple to use as a standard for developing KPIs. As a more practical guide, you might wish to apply the following list of golden rules when building up a suite of logistics KPIs for your company:
- Make sure you align all KPIs with the overall business objectives of your company.
- Ensure that each KPI has an “owner”, whether that is an individual or a group of people.
- Design each KPI as a leading metric, able to assist with the prediction of performance issues.
- KPIs should be actionable, providing timely, accurate data that owners can interpret and utilise.
- Each KPI should be easy for its owners to understand.
- Each KPI should reinforce and/or balance others.
- No KPI should contradict or undermine the others.
- Each KPI should have a target or threshold indicating a minimum-acceptable level of performance.
- As each KPI is proved stable and effective, it should be reinforced by incentives or compensation.
- Each KPI should be update-able, as they will lose relevance over time.
The one caveat I would add here, concerning golden rule #9, is that it’s essential to incentivise only behaviours that do not jeopardise health and safety or regulatory compliance, or otherwise put the reputation of your business at risk.
Success with supply chain KPIs: a brief case study
In the early years of this century, a British division of a global brewing company decided to diversify into contract distribution to increase utilization and reduce costs across its national warehousing and logistics operation. The company’s customers mainly comprised pubs and restaurants, which were either under individual ownership, or owned by the brewing company.
However, the traditional model for licensed alcohol sales was undergoing a transformation, with most of the major brewers disposing of their estates following freshly introduced laws, implemented to curb what was seen by the government as a barrier to fair competition in the industry.
As a result of these changes, several large pub companies sprang up, and the brewing company (the subject of this study) determined to sell distribution services to these entities. It won a porterage contract with one of the largest pubcos and suddenly found itself with one customer that represented more than 50% of its business revenue.
Threats and measures: a catalyst for change
It wasn’t long before problems arose, with the customer threatening to exit the contract under a service-level clause. Fortunately, the pubco’s director was an ex-logistics guy who proposed an alternative solution.
The customer and the supplier would work together to develop KPIs that would highlight why many pubs were receiving deliveries with incorrect product quantities, and why even more deliveries were arriving late.
The partners developed a KPI portfolio, which, although hardly simple in the way this article advocates, served to highlight some severe issues in the supplier’s warehouse and transportation functions.
The list of KPIs included delivery on-time and in-full (DIFOT). The in-full KPI was broken down into factors such as:
- Incorrect product quantity
- Incorrect product quality (wrong products)
- Deliveries with broken products/packaging
These KPIs were then cascaded to even greater levels of granularity, with the use of error codes to identify where and how delivery errors were originating.
How supply chain KPIs opened eyes
Over time, the KPIs revealed a range of issues, including picking errors, a lack of checks taking place in the loading of vehicles, unsafe loading practices, unsafe driving, and insufficient load-restraining measures. These problems were all carry-overs from an earlier era when the logistics operation primarily served an internal supply chain.
Quite simply, the logistics functions had not adapted to a new environment in which retail outlets were no longer “tied” to the brewery. Instead, customers could choose to take their business where they wished, which was precisely the pub group’s intention if delivery performance did not improve.
However, given the visibility provided by the new logistics KPIs, improve it did. Within a year, the brewer’s logistics operation was meeting initial “perfect order” targets agreed with the customer and working towards a raised set of service-level objectives.
The outcomes were significant
Improvement in the brewing company’s service provision was made possible because the KPIs had enabled the partners to identify specific issues, and then agree and implement plans to address them.
As a result, the brewing company not only averted the loss of its biggest customer, but went on to achieve a reputation for excellent distribution services, enabling it to acquire contracts with other major pub groups and become known as a leading beverage logistics provider. This success, in turn, helped to strengthen the brand’s presence in the pubs of the groups that it served, and raise its profile in the British beer market.
Remember the headline I began with?
This case study highlights how, as I mentioned at the beginning of this article, THE RIGHT KPIs can help you drive substantial improvements in your supply chain.
Initially, the KPIs were focused on the outbound supply chain, or more specifically, the last mile. Later, the company in question began to follow similar measurement processes in other areas, such as primary distribution (from brewery to distribution centers) and procurement.
In each case, it was the application of appropriate KPIs that made the difference. The issue was not that the company had not been measuring performance, but rather, that it had been using metrics that were no longer relevant for serving a transformed marketplace.
Need further assistance?
Here at Logistics Bureau we have 20 years of experience in assisting clients with Supply Chain Benchmarking, and the development of suitable KPIs. We have benchmarked almost 1,000 Supply Chains! We can help you:
- Select the right KPIs
- For the right level of management
- Set the right targets for those KPIs
- And assess your current performance
So if you need some assistance, just contact me.