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Tuesday, August 30, 2011

Performance Management: An Introduction

Cooperation in the supply chain can increase the profitability and also improves the delivery performance and service by reducing the logistics costs. The idea of making profits with the proper implementation of SCM can be traced back to the definition used within logistics. Focus here is on reducing the costs of logistics by, for example, reducing transport, inventory and order processing costs.

A total cost analysis can illustrate how much SCM cooperation can contribute to overall savings, and as a result, why it is a good idea to focus on costs. However, SCM cooperation should not be seen solely as a cost reduction project. Factors such as improved lead time, fewer out-of-stock situations and improved quality can just as well contribute to increased value by positively affecting the volume of sales, increasing value by positively affecting the volume of sales, increasing the price margin, or reducing time to market. These factors can sometimes affect the bottom line result more than simple cost reductions. As a result, there will always be a balancing act between potential revenue and the goal that should be set for supply chain cooperation.

Methods of measurement

Before the objectives, focus areas and goals of cooperation can be articulated, it is necessary for each company to have a clear overview of their own key logistics figure as well as how differing logistical initiatives will affect the company’s totally generated value. Few companies have this total overview before embarking on SCM cooperation.

A good starting point would be to get an overview of the company’s total cost of logistics. The analysis of the total cost of ownership can create a baseline for measuring internal and external performance in terms of logistics.

Total Cost of ownership (TCO) can be calculated in the following manner:

TCO = Purchase price + Transportation costs + Warehouse costs + Transaction costs (Purchase Orders, goods receipt, invoices) + Quality Control/ Claims + Handling of goods + Administration costs/Staff

The disadvantage of using exclusively the TCO analysis as the basis for decision making is that there is a risk of making decisions that optimal from a total cost perspective, but which are not appropriate in relation to the company’s total revenue. This is a possibility because, among other reasons, TCO does not include costs generated by assets other than inventory and accounts receivable.

A model that makes it possible to connect logistic performance with the company’s bottom line result is the Economic Value Adding (EVA) model. This model allows stakeholders focus more on measuring and calculating value creation than on maintaining value. Therefore, cost of capital is also included in the calculations.

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