Use Global Performance Measures to Align the Enterprise Trading Partners

INTRODUCTION
As firms reach globally for market share and outsource all but their most basic core competencies, they are effectively positioning themselves in the middle of a complex supply chain. The firm has added trading partners downstream toward the customer to extend its geographical reach and has added trading partners upstream toward the supplier through the act of outsourcing. But the enterprise is defined from end-to-end, and the firm now finds itself in the precarious position of being an intermediate link within its own supply chain! This paper explores new behaviors for the firm to successfully compete in this new environment.

A supply chain is defined by the information flow, physical distribution flow, and cash flow required to deliver the product and service needs of the end customer. The Supply Chain Council, Inc. says, "The supply chain stretches from the supplier's supplier to the customer's customer." A trading partner is any organization, external to the firm, whose financial success depends in a significant way upon optimizing the end-to-end throughput of the supply chain. One key principle of supply chain management is to define and apply a set of global performance measures which will effectively keep all the trading partners in alignment with the operational goals of the enterprise-wide supply chain.¹

Figure 1.	Basic Supply Chain Architectures

Three Basic Supply Chain Architectures
Trading partners can be organized into a supply chain using one of three basic architectures (see Figure 1). First, the traditional indirect channel provides good market reach and customer service at the expense of high inventory levels and thin margins. Indirect channel examples abound in the grocery and apparel industries. The customer comes to the retail store to shop, and expects to return home with the goods. Second, the traditional direct channel approach provides good margins with lower inventory levels, but with longer order fulfillment times depending upon geography. Direct channel examples are found in electronic instrumentation and capital goods industries. The customer purchases the product from a direct mail catalog, a manufacturer's representative, or a captive sales force. The recent explosion of the Internet and growing acceptance of secure e-commerce now makes a third supply chain architecture practical. The virtual channel provides the convenience of shopping from home via the Internet and a high return on assets with more difficult inventory control and medium margins. Virtual channel examples include Dell Computer and Amazon.com. None of these three approaches is perfect. Each involves tradeoffs among strategic supply chain decision factors. Each requires the alignment of the trading partners by means of global performance measures.

Goldratt's Theory Of Constraints
In 1984 Eli Goldratt wrote The Goal in which he introduced his Theory Of Constraints including the concept of "drum-buffer-rope." Goldratt stated that the goal of business is to make money. He defined throughput, inventory, and operating expense as three operational performance measures to be used to gauge success. Eli showed how these three measures could be used to predict favorable changes in the financial performance measures of cash flow, net profit, and return on assets. The Theory Of Constraints has enormous applicability to the management of an enterprise-wide supply chain.

Goldratt illustrated that in any production system there will be a capacity constraint, or drum, that effectively determines production throughput. Once the constraint is identified, it must be carefully managed because capacity lost at the constraint can never be regained. Only defect-free materials needed for shippable customer orders should be allowed through the constraint operation; this is Goldratt's concept of buffering the constraint. To avoid letting the other work centers speed ahead of the constraint, creating excessive work-in-process inventory, the rate that new work is released to the factory floor is synchronized to the rate that product flows through the constraint. This synchronization is the rope. A second inventory buffer, called the shipping buffer, is positioned at the very end of the manufacturing process to ensure on-time delivery.

Figure 2.	Trading Partner Alignment

Your Customer Expects A Perfect Order
End customer satisfaction should be expressed in terms of the perfect order. This means the right product and service at the right price at the right place at the right time with no hassle and no returns. Your customer expects nothing less. A supply chain should have performance measurement systems in place to measure the perfect order in the voice of the customer. For example, measuring the product shipment date is not good enough; instead, measure the customer receipt date.

"All You Need Is Love" (Trust)
It is common today to find fabricators, factories, and distributors as three wholly independent firms linked together in a supply chain. A secure information technology infrastructure among these three trading partners is one essential ingredient for success. Information such as point-of-sale, real time customer orders and end-to-end inventory positions must be made available to all the trading partners. But more challenging, by far, is the issue of developing and maintaining trust among the three corporate management teams.

The questions are simple. Why doesn't optimizing each company separately optimize the total supply chain? Which company should control the supply chain? If the companies work together and improve, how will they split the incremental profit? But, the answers cut against the grain of functional silo excellence and general management performance rewards. A supply chain cannot compete without trusting relationships among all its trading partners. Organizations don't trust; only people trust. This means that management at all three companies must work at developing personal relationships with the people on each of the other management teams while learning how to apply the principles of supply chain management. A lack of trust between people is the single biggest barrier to supply chain success.

Measure Supply Chain Throughput Against Total Supply Chain Inventory
Two key performance measures, supply chain throughput and total supply chain inventory, are the rudders for steering trading partner alignment within a supply chain. If one firm tries to overproduce relative to market demand, then the market together with the remaining downstream links will constrain the throughput of goods. This overproduction will bulge the trading partner's finished goods inventory position, lower total return on assets, and have little impact on revenue growth or net profit for the chain. If one firm underproduces relative to market demand, then this firm will become the system throughput constraint, the drum. Its underproduction will lower the revenue and profit margins of every trading partner in the supply chain (see Figure 2). It may become uncomfortable to realize that the fortunes of the firm are largely dependent upon the collective actions of each of the trading partners.

The three trading partners should collaborate on identifying who is the system constraint. Supply chain inventory should be strategically positioned just prior to the system constraint, the constraint buffer inventory, and at the customer end of the chain, the shipping buffer. The level of constraint buffer inventory and shipping buffer inventory can be managed to within days of supply target. Trading partners who have neither the constraint buffer nor the shipping buffer should work to drive their inventory out of the system. The daily production rate of the system constraint should be matched as close as possible to the actual daily market demand. The daily production rate of the other trading partners should be synchronized to the daily rate of the system constraint, the rope. This operational agreement and trust among all the trading partners will result in the best possible end-to-end supply chain throughput.¹

Supply chain throughput equals the net amount of product per unit time consumed at the very end of the supply chain by the customer. When supply chain throughput is stated in terms of the rate of equivalent end products, then supply chain throughput should be the same rate at every node in the chain. For example, if a product requires four different printed circuit assemblies, then 100 units/week of product demand at the customer equals 400 units/week of PCA demand at the supplier. Throughput can also be expressed as the shipment rate minus the returns rate at any node in the supply chain. Total supply chain inventory is defined as the sum of the shipping buffer inventory plus the constraint buffer inventory plus the pipeline in-transit inventory between trading partners plus other undesirable work-in-process and finished goods inventory (FGI). For example, if the shipping buffer is 25 units, the constraint buffer is 40 equivalent units, the middle trading partner holds 16 equivalent units in FGI, and there are 6 equivalent units apiece in the inbound and outbound pipeline, then the total supply chain inventory is 93 equivalent units. And, the middle trading partner has the opportunity to eliminate the 16 equivalent units of FGI.

Think of a quality control chart with upper and lower control limits as a good analogy for how each trading partner can align its optimal operating point relative to the enterprise-wide supply chain. When the firm operates in isolation, lowering production means reduced shipments, reduced revenue, operating toward break-even, and loss of profits. When a trading partner operates as part of a supply chain, lowering production below the supply chain throughput rate means that the system constraint has shifted to this firm, and profits will be lower for every trading partner. When the firm operates in isolation, raising production means increased shipments, increased revenue, operating above break-even, and growth in profits until the firm's output exceeds market demand. After this point any incremental production becomes inventory. When a trading partner operates as part of a supply chain, raising production above the supply chain throughput rate means additional inventory is added to the system inventory which lowers the return on assets. By daily management of supply chain throughput against total supply chain inventory, each trading partner can stay aligned for optimized supply chain throughput, inventory, profit, and return on assets.

CONCLUSION
When all the trading partners align themselves and pull together, the supply chain becomes truly competitive, providing value to its customers while taking market share from its competitors. This results in more profit using less total supply chain inventory, which is the formula for an excellent return on the firm's assets. Satisfied customers, growth in market share, and an excellent return on assets (ROA) drives excellent shareholder value.

In today's global economy the enterprise can best be described as a supply chain defined from an organization of independent firms. The single firm can no longer expect to control market share using the rules of business it learned from the past. Rather, the single firm must navigate an optimal course between the twin lighthouse beacons of supply chain throughput and total supply chain inventory. These performance measures, suggested by the Theory Of Constraints, are the key to the single firm gaining and maintaining enterprise-wide alignment.

About The Author
William T. Walker, CFPIM, CIRM is the architect of supply chain management for the Power Products Division of Hewlett-Packard. Bill's thirty years of HP experience includes process reengineering, new product development, virtual enterprising, international logistics, materials management, purchasing, operations planning, and project management. Mr. Walker holds a BSEE and MSIE from Lehigh University.

Mr. Walker is a volunteer Director of the APICS Educational & Research Foundation. He served the Foundation as President during 1997-98 and as Treasurer during 1994-96. Bill was the 1992-93 APICS VP of Education Development-Specific Industry Groups and the 1990-91 APICS VP of Region 2. He is an APICS certified Fellow and the author of numerous works on supply chain management.

Footnote

1. Alber, Karen L. and William T. Walker, Supply Chain Management: Principles and Techniques for the Practitioner, Falls Church, VA: APICS Educational & Research Foundation, Inc., c1998.