A Non-traditional View of Operational Costs

Going beyond traditional financial metrics to measure supply chains


Going beyond traditional financial metrics to measure supply chains

Traditional financial metrics contained in the profit-and-loss (P&L) statement of any company are key indicators of that company's health, but they do little to identify specific performance gaps relative to competitors, especially from a supply chain standpoint.

Management is missing out on the complete picture by looking only at measurements such as cost of goods sold (COGS) or selling, general and administrative (SG&A) expenses and not taking a supply chain view of performance.

Example

Consider a global pharmaceutical company that closely monitored traditional financial metrics such as COGS and SG&A in comparison to competition. These numbers indicated that all was well and the company was competitive even though a serious inventory problem was developing. In their struggle to improve delivery performance and control inventories, their existing metrics were insufficient.

The answer is that it can be helpful to go outside traditional costs to understand the root cause of operational problems or develop a competitive edge. To gain a deeper perspective on the P&L and how it compared to competitors, the pharmaceutical company decided to examine the cost of managing its supply chain based on a metric defined by the Supply-Chain Council, called Total Supply Chain Management Cost.

The Supply-Chain Council is a non-profit, cross-industry organization that endorses and maintains the Supply Chain Operations Reference (SCOR) model. This particular metric measures the cost of managing source, deliver, return and plan, and typically includes the following: cost of the procurement organization, the cost of all levels of planning, the supply chain portion of IT, inventory carrying costs, freight and distribution costs, and order management costs. These are the costs associated with managing a supply chain.

The methodology is straightforward: (1) collect and itemize each cost within the organization; (2) gather competitive benchmark data for comparison; and, (3) calculate and analyze the performance gap to determine opportunities for improvement.

Collecting Costs

The Supply-Chain Council's definition of each cost has just been updated on version 7.0 of the model (see Figure 1: Definitions for Total Supply Chain Management Cost). There are a number of considerations when determining which costs come into play within each component.

Figure 1: Definitions for Total Supply Chain Management Cost

Procurement
This is usually a straightforward expense because it is often captured within a single cost center. It's important to remember that there may be both local or factory organizations as well as strategic sourcing function at the company level. The key question to ask: If I did not have any procurement activities, what costs could I eliminate?

Planning
There are a variety of planning roles to consider, such as annual supply chain planning, plus lower-level planning like distribution, manufacturing, sales and operations, and materials. This lower-level planning makes collecting costs tricky, since those who occupy full-time planning positions are usually scattered throughout the organization.

It's easier to start with a list of planning activities by considering the meetings, report and ongoing activities associated with planning on a daily basis in order to account for all the labor costs. The idea is to determine full-time equivalent employees and apply a standard burden rate to that headcount. The organization's finance or human resource director can estimate an average cost for salary and benefits to apply to the estimated headcount.

Supply Chain IT
It's best to start with the IT professionals in the organization to determine what portion of the total IT budget supports supply chain costs. Usually, any systems activity related to procurement, planning, inventory management and control, distribution, and order management is appropriate. A breakdown of IT costs should include both hardware and software and related maintenance costs.

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