SCM Metrics-Presentation 2

By

K. Sashi Rao

Management Consultant

Presentation 2- Coverage

Economic Value Added( EVA) Cost Management Activity Based Costing ( ABC) ABC and BSC Target Costing Service Quality Management

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Supply Chain Performance

Overall return on investment ---EVA Specific returns on investment in SCM facilities Total cost management Asset management –inventories, logistics assets Productivity of SCM elements Customer order fulfillment Customer satisfaction measurements Continuous improvements/benchmarking

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Economic Value Added (EVA) EVA is a single, value-based performance measure for

business strategies, capital projects and long-term wealth maximization

Value created or destroyed by a firm during a period is measured by comparing profits with the cost of capital used to produce them

EVA sets managerial performance targets and links it to reward systems and performance bonuses

EVA is a financial measure based on past accounting data and hence suffers

EVA focuses on ends and not means, as shareholder wealth could be at cost of customer satisfaction or CSR goals

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EVA as Measure of Business Performance

EVA= Operating Profit minus

Opportunity Cost of Running Business Operating Profit= Sales minus (Cost of goods sold and

overheads) Opportunity Costs= Return (or expectation)

foregone by not investing in a comparable portfolio of projects minus weighted cost of debt and equity capital

Also, EVA= NOPAT( Net Operating Profit After Tax ) minus Cost of capital

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EVA Applications

Measurement- Overall measure of corporate performance over a given period considering “total factor productivity”

Management system- financial management system which guides strategies and operations and covers required policies, procedures, methods and measures

Motivation- As basis used for performance bonuses, all managers will strive for it

Mindset- serves as framework for governance and aids decentralized decision-making

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Strategies for Increasing EVA Increase returns on existing projects Invest in new projects with returns greater

than cost of capital Use less capital to achieve same returns Reduce costs of capital thro innovative

financing models Liquidate capital or cut further investments in

non-performing poor operations

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Increasing EVA from SCM Operations Better utilization and performance from logistics

assets( like warehouses, distribution channels, transportation infrastructure et al)

Optimization of all SCM elements and operations Innovation in design of supply chain networks using

modern technologies( eg. GPS/RFID/Bar-coding/E-commerce et al)

Focus on SCM integrative aspects thro IT support/ERP systems

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EVA-Advantages

Serves not only as a performance measurement system but also a motivational, management compensation system

Focuses decisions on real results Provides for better assessment of decisions linked

to efficient use of capital Decouples bonus plans from budgetary targets Covers all aspects of the business cycle Enables goal congruence between managers and

shareholders

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EVA-Disadvantages

Merits confined to few success stories (like Coca Cola, IBM and AT& T in the past)

Since financial accounting-based, open to manipulation by managers( recent bonus scandals by US financial institutions despite seeking bailouts)

Does not encourage innovation as focused only on immediate results

Lacks ‘proactive’ nature as only ‘reactive’ to past results Discourages collaboration amongst SBUs and ignores

their size and stages in product-life cycle

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Why Cost Management

Basic purpose of any business organization is to earn a surplus for its owners while meeting its customers needs in a fair and responsible manner.

This surplus, at its basic level, means that revenues should exceed it expenditures to generate profits

Profits=Net Revenues-Net Costs in its simplest forms

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Total Cost Management (TCM) Costing being at the core of performance

measurements, calls for a systematic and structured approach providing a holistic framework to manage the costs. This is TCM

TCM also defined as the process of managing the financial outcome of activities, both internal and external, to the organization to support managerial decision making

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TCM Goals

Ensuring effective supply chain management

Adopting activity based costing (ABC) Using target costing for new product

introduction Strategic cost management Activity based management

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Cost Management Imperative

The long term financial success of any business depends on whether its price exceeds its costs by enough to:

- finance growth,

- provide for strengthening current operations and

- yield a satisfactory return to its stakeholders. As competition increases, and supply exceeds demands,

market forces influence prices significantly more. To achieve sufficient margin over its costs, a company

must manage those costs relative to the prices the market allows or the price the firm sets to achieve certain market penetration objectives.

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Cost Management Focus

Cost understanding/identification Cost reduction/control Cost management Initiatives/ Action

Ultimate aim to successfully and favorably manage the (Price-Cost=Surplus) business equation

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Strategic Cost Management

Cost Driver Analysis- study of factors that cause and/or influence costs

Strategic Position Analysis- determining the firm’s basic way of competing in the market place

Value( supply)- Chain Analysis- study of value producing/adding activities from raws to finished product stage and delivering product value

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Cost-driven Competition

Competition based on new technology concepts and /or services

Competition based on quality, reliability, cycle time, and quicker delivery time

Competition based on price when margins shrink and cost reduction is inevitable

Competition where cost reduction is attempted at the product design and development stage itself

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Basic Cost Concepts

Cost- is a measure of resources given up to achieve a particular purpose

Cost object- it is an item such as a product, activity, process, or even customer for which costs are measured and assigned

Cost traceability- ability to assign costs to a cost object by a direct, causal relationship

Direct costs- where traceability is easier and more accurate( eg. material costs)

Indirect costs- where traceability is more difficult but still has to be assigned( eg. heating plant cost to many products/cost objects using this facility)

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Traditional Cost Management Approach Where product cost is a dependent variable

as a result of a product’s cost determined by

its components, functions, features and

performance

And since product costs are assessed much

later in the development cycle, they turn out

to be too high or incapable of control

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Traditional Cost Management Approach

Product Requirements

Production Design

Process Design & Cost

Make-Buy Analyses

Supplier Cost estimates

Cost too High

Production

Periodic Cost Reduction

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Modern Cost Management Approaches Broadly, this has taken 2 directions: One known as Activity Based Costing( ABC) which

will cover in detail Another approach is called Target Costing which is

called for when: - Orienting products to customers affordability or market driven pricing

- Product cost is an independent variable during the product design and development cycle

- Proactively working to achieve target cost during product and process development

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Activity Cost Drivers

Customers

Activities Resources

Costs

ServedBy Activities

ActivitiesUse Resources

ResourcesCost Money

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Activity Cost Drivers-examples

Placing a PO Follow-up on placed PO Inspecting incoming materials Moving materials from warehouse to production location Moving materials from one work station to another Setting up a machine for making a product Expending labor time on a product Machine operation time at each work station Supervisory operations over each work station Testing quality of finished product Packing for dispatch to customer Preparing and processing sales invoice/dispatch documentation Outbound dispatch and shipping the product

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Traditional Costing Vs Activity Based Costing Traditional Costing

Costs-Direct Materials ( direct tracing)

-Direct Labor ( direct tracing)

-Overheads ( direct tracing+

( allocation)

Consumed by

Products

Activity based costing Costs

Consumed by

Activities

Consumed by

Products

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Activity Based Costing( ABC)

It involves determining the cost of activities and tracing their costs to each cost object on basis of this cost object utilizing units of activity

Measures costs of a product/service based on the activities performed to produce the product service

Assumes that activities drive the costs, which are driven by the product or customer , whereas in conventional costing systems products alone driving their costs

Indirect cost and support expenses, first are directed at activities and processes and then to products services and customers.

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Cost Assignment Methodology(1)- schematicCOST OF RESOURCES

Resource Drivers

DriverTracing Allocation

PhysicalObjects

ActivityDrivers

AssumedLinkage

COST OBJECTS/PRODUCTS

Direct

Tracing

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Cost Assignment Methodology(2)- steps Identify, define and classify activities and key

attributes Assign of cost of resources to activities Assign cost of secondary activities to primary

activities Identify cost objects/products and link amount of

each activity consumed by each cost object Calculate primary activity costs/rates Assign activity costs to each cost objects

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Cost Assignment Methodology(3)-activity level classification Unit-level activities- those performed each time a

unit is produced( eg. direct materials/labor) Batch-level activities- performed each time when a

batch of products are made( eg. common purchases/setups/inspection steps

Product-level( sustaining) activities- done to enable various products to be considered (eg. common changes in design/engineering/processes/methods)

Facility-level activities- that sustain a factory’s overall general manufacturing processes (eg .plant management/maintenance/safety/security et al

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A B C Issues

Cost Centres Cost allocation criteria Cost allocation keys/weightage Cost drivers for common resources facilities

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ABC Benefits

Assessing customer wise profitability based on linked activities to examine customization as a differentiation strategy

Evaluating product-wise profitability to help in product market positioning; product-mix decisions and individual customer negotiations

Improving organizational efficiency thro’ more rigorous cost analyses identifying value added and non value adding activities to make improvements.

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ABC and BSC

BSC earlier (in module 1) and now ABC, we have seen them as independent performance measurement tools

Now , they can be used in a complementary manner While ABC focuses on accurate costing for now (operations) and

future( strategy), BSC’s multi-perspective dimensions helps them to link the firm’s overall goals and objectives in short- and long -term

Their synergistic approach enables taking a holistic view to SCM decisions when independent methods could lead to contrary decisions

As example, ABC may suggest closing down warehouses on cost considerations; while a BSC approach could call for additional warehouses to increase market penetration and improve product availability

Another example given in Course Book on alternative logistics strategies

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AHP to link ABC and BSC

AHP is Analytical Hierarchy Process provides a framework to integrate ABC and BSC

First step here is to adopt the MOS( Mission, Objective and Strategy) approach to strategic planning

The BSC helps to serve as a watchdog indicator within the MOS

The ABC plays a more narrow but vital role in the MOS thro’ its rigorous cost understanding and assignment focus

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AHP Framework

This provides a stepwise multi-criteria decision making approach to make the ABC/BSC linkage

Step 1- Construct the AHP linking company mission and objectives to the BSC

Step 2- Use the AHP to determine relative ‘weightage’ to individual key performance measures

Step 3- Employ key performance measures to construct an index to monitor overall firm performance

Step 4- As examples, logistics-oriented or purchasing-oriented performance measures could be used to monitor distribution channel strategy or strategic sourcing strategy respectively

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Target Costing

Target costing is a disciplined process for determining and realizing a total cost at which a proposed product with specified functionality must be produced to generate the desired possibility at its anticipated selling price in the future

Current live example is of the Tata Nano car at Rs 1 lakh - a target set by Ratan Tata

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Target Cost Concept

Product Need & Market Price Analysis

Target Price Profit

Balance Target Cost & Requirements

Make or Buy Product Designs Cost Projections

Product OptionsSupplier Costing DFMA Analysis

Production

Continuous Cost Reduction

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Target Costing Implementation Reorient cultural and work attitudes Establish a market-driven target price Determine target costs Balance target costs with requirements Establish a target costing process and team-based organization Brainstorm and analyze alternatives Establish product cost models to support decision making Use cost reduction tools/techniques Reduce indirect costs Measure results and maintain management costs.

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Target Costing Benefits

Products better matched to customer needs Product features and associated costs aligned with

customer willingness to pay Reduces product costs significantly Increases teamwork within organization across

functions/disciplines Engages customers and suppliers to design the

right product and more effectively integrate the entire supply chain

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SERVICE QUALITY MANAGEMENT

By

K.Sashi Rao

Service/Product Quality Management Focus is on adherence to specifications (internal and external) to

meet customer needs Quality monitoring is based on % compliance to specs; % rejections,

passing performance criteria tests amongst others Quality improvement is thru’ improved processes, techniques,

systems and supervision Other approaches include lean manufacturing, 6 sigma, SQC

techniques which all aim to get it right , get it right the first time and get it right always

Approach to QM is same whether products or services !

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Services as Operations

Basic Features: Intangible outputs that cannot be inventoried Involve close customer contact Have shorter lead times More people/labor intensive in nature Service quality more subjective Demand pattern non-uniform

Types: Involving quasi-manufacturing- physical goods still dominant over intangible services with

little/no customer participation e.g. bank backroom services or aircraft maintenance operations Customer-as –participant- high degree of customer involvement with physical goods forming a

significant part, like supermarket retailing or consumer durable use with standard or customized services

Customer –as- product- where product/service actually performed on the customer, like hospital services, salons/beauty parlors, dental clinics et al

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Service Quality Management(1) Quality Management is usually associated with

product quality Product quality is very fundamental and

“conformance to product specification” is key to satisfying customer needs

This same quality concept is also extended to “services” when it is the “product” itself (e.g. telecom or hotel services)

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Service Quality Management(2) ‘Service’ as understood here is to mean a package of

services which all add up to provide ‘customer services’ as different from product quality

‘Service Quality’ and ‘Customer Service’ are known primary factors for customer satisfaction

Considering their basic features and types( previous slide), they all still need to be measured for monitoring, control and improvement purposes

Hence, specific tools and techniques are needed for measure service operations quality

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Service Quality Dimensions Tangibles- evaluation of its facilities, equipment and personnel Reliability- ability to maintain consistent service standards Responsiveness- willingness to help customers and provide

prompt service Competence- employees’ mastery of skills and knowledge to

perform specified services Courtesy- politeness, respect, consideration and friendliness

shown to customers Credibility- how well company delivers on promises Security- freedom from danger, risk and conflict Access- relates to approachability and ease of contact with

company members Communication- commitment to keep customers informed and

listen to them Understanding- how well company understands its customers

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Measuring Service Performance Service performance necessarily to be seen from ‘Customer

Perspective’ Various ‘service components’ to be clearly identified as part of

customer satisfaction This can range from pre-sale, (query handling/ quoting….), during-

sale (order handling, delivery commitment…) and post –sale (invoicing, delivery, quality, after sales service, complaints handling) services

Each service feature to be separated in service-quality evaluation form to cover even seemingly qualitative features like attitude, knowledge, responsiveness, accuracy, timeliness etc.

Yet, overall measures like “all things considered” and “bottom line” can also be used as overall satisfaction ratings

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Measuring Service Quality

This involves the perceptions of the customer, the service provider( employee in contact with the customer) and the management e.g. the bank customer, bank employee and bank management

Setting up precise criteria or parameters and measuring performance against customer expectations are not easy

Yet, given the increasing scope of services in any economy, some meaningful methodology is still required

SERVQUAL is one such methodology which uses a detailed questionnaire to measure the gaps between service perception of customers and their expectations

SERVQUAL was developed by Parasuraman, Zeithami and Berry in 1985 as a service quality measurement tool as a model with 5 gaps between various elements in the design and delivery of a service

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.

Service Gap ModelConsumer

Word of mouthcommunication Personal Needs

Past Experience

Expected service

Perceived Service

Service Delivery(including pre-and post-contacts)

Translation of perceptionInto service quality specifications

Management perception ofConsumer expectations

ExternalCommunicationTo consumers

……………………………………………………………………………………………………………………………………Marketer

Gap 1

Gap 2

Gap 3

Gap 4

Gap 5

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SERVQUAL Methodology

It attempts to get customer feedback on below 5 dimensions of customer service:

Tangibles- physical facilities, equipment used to provide services e.g. bank branches, ATMs

Reliability- ability to perform the promised services dependably, accurately and consistently

Responsiveness- service provider and its employees willingness to help customers and provide prompt service

Assurance- service provider and its employees competence levels, courtesy, credibility and security

Empathy- customer’s ability to access the service organization and its resources, and employees ability to communicate with and really understand customer needs

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SERVQUAL Criticism

Cronin and Taylor( 1992) did empirical tests with 4 alternative service quality models as below:

SERVQUAL: Service Quality= Performance- Expectations Weighted SERVQUAL: Service Quality= Importance x(Performance -Expectations) SERVPERF: Service Quality= Performance Weighted SERVPERF: Service Quality=Importance x Performance They concluded that SERVPERF gives the best results. Hence, service quality

may not be a function of the gap between customer expectation and actual service quality received, but a function of value that is delivered to the customer

Another accepted criticism is that the 5 service quality dimensions are not generic in nature, but has to be developed in individual contexts and situations

Despite all its criticisms, SERVQUAL is still widely used, as once the quality dimensions are contextualized , it serves as a benchmark for step-wise/dimension-wise/ process-wise improvements, as against a single SERVPERF measure of customer value

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Service Performance and Importance Every organization (whether service type or not) needs to measure

its service quality; so useful for both B2C and B2B In SCM operations, this could be for vendor(product-cum services)

evaluations; like service providers for logistics, warehousing and transportation , freight forwarding, custom clearing operations services amongst SCM elements

Quality of service (performance ratings) has to be linked to what customers seek (importance ratings)

Performance/ Importance Analysis (P/I) is an useful tool for management of service quality

Such a P/I analysis serves as an assessment measurement tool to finally help in making service improvements on a customer focused/ cost and time based system

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Service Performance/Importance Analysis

Step 1- Measurement of Service Performance

Step 2- Identification of Important Services /Features of

Customer Satisfaction

Step 3- Creation of a Performance –Importance Matrix

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Importance of Service Dimensions Service evaluation questionnaire should identify importance of

services /dimensions ( by ranking amongst various customers

segments)

Such rankings useful to know relative importance and tips for

improvement for maximum impact

Such ratings can be a part of overall ‘vendor ratings’ under broad

“‘responsiveness” others being quality, price/cost, delivery/time

utility)

Any ‘service’ improvements are determined by what needs to be

done, to what extent, at what costs and within what time

Thus, concept of cost-time matrix also arises

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Performance-Importance Matrix• Very important

•Must improve and to be fixed now

Very important•Needs upgrading

• Very important•Very well done• Should not lose edge

• Still important• Also to be improved 2-1

Maintain Maintain

•Less important•Eliminate and focus on (3-1) Maintain at low key Downscale services

3-1 3-23-3

100%

High

Customer Level Importance(%)

Low

0%

A

B

Low Medium High 100%

C

0%Service Performance Quality(%)

2-2 2-3

1-1 1-2 1-3

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Performance-Importance Matrix-coordinates A - Slow response to emergency situations - Incorrect items or quantities sent

B - Customer quoting system - Meeting delivery requirements

C - Credit limits enhancements - Frequent salesmen visits

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Cost-Time Matrix

Quality improvements have to be identified for service problems as seen from performance-importance matrix

Yet, all improvement measures/ steps require time and money

Hence, a matrix is needed to establish the cost-time dimensions to set action priorities and budgets

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Cost-Time Matrix (Priorities 1-9) Quick Fix

5

High Cost -long termchanges

9

Quick Fix

4 6 8

Low cost/ Quick fix

1

Low cost approach

2

Low cost approach

3

High

Cost/Mgmt.Implications

Medium

Low

7

Short-term( 1 year ≤)

Medium(1-3 years)

Long term(≥3 years)

Time PeriodK.Sashi Rao/2011