A Hierarchical Framework For Supply Chain

Performance Measurement
Performance measurement systems (PMS) are an important planning and management
decision support tool that represent a prerequisite to assure effective supply chain and
logistics operations. In developing and enhancing its performance management system,
a firm must have a framework for its PMS that provides an ongoing perspective and
guidance regarding how its individual performance measures fit together. In this article
we present a “hierarchical” framework for capturing and linking all key performance
measures that a firm may develop to monitor its supply chain. This framework
differentiates measures both by their individual level in a hierarchy and by their focus
(e.g., internal organizational efficiency or external effectiveness with customers).

There exist a number of well known models and frameworks for operations, logistics
and supply chain management. The interested reader is referred to the SCOR Model
(see e.g., Francis, 2007), the Balanced Scorecard (see e.g., Kaplan and Norton, 1992),
as well as an overview article by Lambert, Garcia-Dastugue and Croxton (2005) for a
starter sample of the extensive literature available on this subject. The contribution of
the article presented herein is to offer the additional dimension of a “hierarchical”
perspective to a PMS framework.

A Hierarchical Supply Chain Performance Measurement System

This section presents a three level hierarchical performance measurement framework

that can link a wide array of functional areas and performance measures. The three
levels of the hierarchy consist of the strategic, tactical and operational levels, as is
common in traditional supply chain frameworks (see e.g., Miller, 2002 and 2007).
However, the hierarchy levels have a different connotation in this PMS. In traditional
frameworks, the dimension of time or planning horizon differentiates the hierarchy
levels (e.g., strategic is 2+ years, tactical is 12 to 24 months, and operational is 1 to 18
months.) In our PMS framework, it is the scale of an operation or activity that a
particular performance measure monitors which determines its place in the hierarchy.
Also within the hierarchy of the firm, the level of a functional unit that a measure
monitors determines where it (i.e., the measure) falls in the performance measurement
hierarchy.

Within each of the three levels of the measurement system, we further differentiate
performance measures into two categories: (1) external measures and (2) internal
measures. External measures focus upon the effectiveness of an activity or function
while internal measures evaluate the efficiency or productivity of an activity or
function. In particular, external measures evaluate the effectiveness of flows and links
across a supply chain, while internal measures evaluate the cost or efficiency of a
function or organization in producing its outputs and services. Two typical external
performance measures are order and line item fill rates on customer orders. When a
customer (e.g., a mass merchandiser) places an order on a supplier (e.g., a
manufacturer), the order and line item fill calculations measure whether the supplier
delivers the total order and the individual line items on time and complete as ordered.
These measures do not evaluate the supplier’s cost in delivering the order. Thus, if a
supplier had to deliver an order by expensive air freight rather than normal surface
transportation because of inventory shortages or other problems, the order and line fill
calculations would not capture this. If the shipment arrived on time and complete by air
transport, the order fill and line fill measures would identify this particular shipment as
a successful fulfillment of a customer order (i.e., the manufacturer was “effective” in
delivering the order on time and in full to the customer). In contrast, internal
performance measures focusing on the efficiency of an activity would evaluate this
order fill example as an “ineffective” effort. “Distribution cost per case” and “freight
cost per lb.” represent two common internal measures, and this air freight delivery
would increase the firm’s average distribution cost per case and freight cost per lb.

As noted, at the strategic level, a few key indicators will measure the overall
performance of the distribution organization. At the tactical level, the performance of
each major sub-function of a functional area is measured. In this example, warehouse
operations and transportation represent the two primary components of distribution.
Therefore, we will need a few internal and external performance measures for each of
these sub-functions. At the operational level of this framework, the performance of each
key sub-function [of each sub-function of the tactical level) is monitored.
In this example, Figure 1 illustrates that warehouse operations has five major sub-
functions; namely, receiving, putaway, storage, picking and shipping. Thus, each of
these five areas would require both external and internal performance measures.
Similarly, the major sub-functions of transportation would each require their own
measures.

The performance measure examples shown in Figure 2 for warehouse operations (at the
tactical level) and warehouse receiving operations (at the operation level) follow a
similar theme. The percent of lines or orders picked correctly and the percent of orders
picked on the scheduled day represent external measures because they evaluate the
impact of warehouse operations across the supply chain. Specifically, when a
warehouse picks an order correctly, it contributes to the ultimate successful delivery of
products to a customer that has placed an order. In contrast, an incorrect pick will result
in an unsuccessful delivery to a customer. Similarly, when a warehouse picks an order
on-time (i.e., on the scheduled day), this contributes towards a successful on-time
delivery of products to a customer. The third tactical measure shown in Figure 2, total
warehouse costs per unit of throughput, represents an internal measure, as it offers a
summary view of the internal cost (and efficiency) of the warehouse operation.

At the operational level, the warehouse receiving function uses the percent of cases (or
lines) received correctly (i.e., accurately) as an external performance measure. We
categorize this measure as external because the accuracy with which this function
receives inbound shipments will impact the next stage of the supply chain. For
example, suppose that the receiving area miscodes an inbound receipt as product A,
when in fact it received product B on a delivery. If this error remains undetected, the
shipment will then be put into inventory classified as product B and at some future
point, could be picked and delivered to a customer who ordered product A. In contrast,
total receiving cost per unit has an internal orientation and will be of most immediate
concern to receiving and warehouse personnel.

Benefits Of A Hierarchical Performance Measurement Framework

Employing a hierarchical performance measurement framework offers a number of

important benefits. First of all, this approach provides a unified framework for
aggregating performance measures across a company. By implementing a hierarchical
measurement approach, a firm positions itself to organize its key performance
measurements into a structure that leads to a relatively few, high level, strategic
measures (e.g., between 10 and 25) that monitor overall firm performance. At the same
time, this structure facilitates having many other performance measures that monitor
smaller components of a firm’s operation, yet which align with overall firm objectives.
In particular, a hierarchical measurement system allows both large and small functional
areas within a firm to:

1. develop and maintain their own measures, and

2. contribute to and be part of an overall measurement system

This hierarchical approach thus helps to keep measures both “simple” and
“meaningful” because each function and sub-function at each level can focus on a few
key performance measures.

Finally, a hierarchical performance measurement system can also contribute towards

aligning the collective activities of a firm to meet a desired mission and set of
objectives. For example, if a firm has a comprehensive measurement system in place
that covers most or all of its major functional areas and activities, managers can view
the system in its entirety to identify any potential misaligned activities or objectives.

Summary

In this article we have introduced the concept of adding a “hierarchical framework” to

the performance measurement system of a firm and a supply chain. Within each level of
the hierarchy, we have illustrated how (and recommend) that individual performance
measures be further defined as “external” and “internal”. By utilizing this hierarchical
framework, a firm positions itself to have a broad, yet manageable perspective on its
operations through its PMS. Further, its employees will be able to relate to the
individual measures that their specific activities and jobs impact.

References

1. Francis, Joe. (March, 2007), “Team Building with the SCOR Model”, Supply
Chain Management Review.
2. Kaplan, R.S., and Norton, D.P. (Jan-Feb, 1992), “The Balanced Scorecard –
Measures That Drive Performance”, Harvard Business Review.
3. Lambert, Douglas, Garcia-Dastugue, Sebastian, and Croxton, Keely. (2005),
 “An Evaulation of Process-Oriented Supply Chain Frameworks”, Journal of
Business Logistics.
4. Miller, Tan. (November, 2007), “Frameworks For Continuous Distribution And
Supply Chain Performance Improvement”, Future Pharmaceuticals.

5. Miller, Tan. (2002), Hierarchical Operations And Supply Chain Planning,

Springer-Verlag, Heidelberg, Germany.