A Non-traditional View of Operational Costs

Going beyond traditional financial metrics to measure supply chains


Supply chain costs will, most likely, be everything but engineering, quality and human resources systems. If a reasonable estimate cannot be made, another approach is to estimate a ratio of supply chain related IT costs based on headcount of supply chain personnel relative to total headcount. Counting supply chain PCs versus total PCs is another potential ratio to consider.

Inventory Carrying Costs
These cover five broad areas:
1. Insurance and taxes on inventory. These costs can usually be provided by the finance of legal department.
2. Storage costs. This includes the full cost of warehouse buildings, off-site rented space and any other storage space (including portions of the factory floor); a portion of the maintenance cost per square foot of storage space; and all employees who handle, move and count the stored goods. By reducing factory floor or warehouse storage space, costs can be realized by eliminating rented properties or avoiding new construction.
3. Obsolescence and deterioration costs. This happens when materials are scrapped or written off due to shelf-life issues.
4. Shrinkage. This can be caused by pilfering, incorrect inventory counts and unreported use of materials. It can usually be determined by taking net inventory adjustments from annual physical inventory counts or ongoing cycle counts.
5. Cost of money based on the investment value of the money tied up in inventory. This is a fairly straightforward calculation for the finance department.

Freight and Distribution Costs
These include the cost of finished goods warehouses (don't double count this with inventory carrying cost). Freight falls into three categories:
1. Incoming materials freight if this cost is included in the cost of the materials, it should be estimated
2. Internal freight the cost to move materials within the company from building-to-building, plant-to-plant or site-to-site
3. Outgoing freight costs from the manufacturing location to distribution warehouses and/or the customer.

Order Management Costs
These encompass all the costs involved in taking orders from customers and usually include the customer service organization.

Analyzing Performance Gaps


After a few weeks of collecting and analyzing data, the following performance issues were revealed:

To compare the pharmaceutical company's Total Supply Chain Management Cost against its competition, benchmark data was found through publicly available data, including annual reports, benchmarking services and professional organizations in the pharmaceutical industry.

After six weeks of this global company collecting and analyzing both sets of data, the following performance issues were revealed:

  • Overall, supply chain management costs were significantly above industry averages. However, IT spending was less than industry average. This suggested that more costly manual processes were being used in place of IT functionality. This idea was reinforced by the high number of people involved in order management (a cost that also was well above average). With proper IT systems, fewer people would be needed to take and manage orders.

  • Another unexpected discovery was inventory carrying costs. A detailed determination of these costs indicated they were higher than the figures in use by the finance department. Using an understated carrying cost resulted in an incorrect assessment of the cost of carrying more inventory.

  • An examination of outgoing freight costs revealed very high spending on airfreight. The disconnect came in the fact that though investment was being made in quick delivery, the distribution system still carried high levels of inventory. The company was taking full advantage of the rapid delivery in which it was investing.

The Value of Metrics

Total supply chain management cost as a key metric can provide a non-traditional view of operational costs and reveal performance gaps and opportunities for improvement that may not otherwise be obvious. Structuring metrics from a supply chain viewpoint is the customer-focused way to examine operations since the customer is one end of a supply chain.

Before companies dig into the details of the performance gap, the first question to answer is, Is my overall supply chain management cost in line, high or low? If it's high then an opportunity to improve competitiveness has been identified and a performance gap has been quantified. If it's low then it may represent a previously unknown competitive advantage.

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