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COGs: Cost of goods sold (direct manufacturing costs)

COGS (COST OF GOODS SOLD)

In this post it will be explained the concept COGs, cost of goods sold. The COGs is the direct manufacturing cost of a product or service (only manufacturing! logistics is not considered in COGs).

COGs (Cost of Goods Sold). This item, depending on the cost accounting system used by the company could be considered as: (1) Direct cost (expense that only takes into account the manufacturing costs of the product/service, either variable or fixed), (2) Direct variable cost, taking into account only the manufacturing costs per unit sold.

Usually any manufacturing process uses 3 types of resources: (1) R1, raw materials, (2) R2, operator, (3) R3, machinery. If we estimate the usage of R1, R2 and R3 per product/service manufactured, the COGs per unit manufactured can be calculated.

EXAMPLE 1: COGs of HAMBURGERS

Imagine that we sell hamburgers, and the ingredients used in 1 hamburger (bread, lettuce, beef, tomato, etc cost €1 (R1).

The monthly salary of the person that prepares the hamburgers including social security paid by the company is €1,000 per month and works 160 hours per month (9,600 minutes). This «operator» employs 5 minutes of time to prepare the hamburger, therefore the cost of personnel per hamburger manufactured would be 5 minutes*€1,000/9,600 minutes=€0.5208 (R2). Japanese define the cost of the operator per minute as «souchin» (souchin=€0.1041 per minute).

In order to prepare the hamburger, different machineries are used, and the company has estimated that one machinery usage, called as «Cost per shot, cps» is €0.04791 and preparing 1 hamburger requires 10 usages of the machinery («number of shots per hamburger»). Therefore the cost of machinery would be cps*number of shots=€0.04791*10shots=€0.4791 (R3). In this example the COGs=R1+R2+R3=€1+€0.5208+€0.4791=€2 per hamburger sold.

The COGs is usually provided in percentage over selling price excluding VAT, in this case it would be €2/€10=20%. This calculation is very important as we can compare the COGs of our company against others and analyze causes of deviations. Imagine that the competitors COGs on average is 15%. Why do we have a COGs that is +5% greater in absolute terms? The reason is because our supply procedures/ingredients are more expensive, do we pay higher salaries or our technology is not efficient? As the sales plan for the fiscal year is 60,000 units sold, the yearly COGs= €2*60,000 hamburgers=€120,000.

EXAMPLE 2: COGs of MANUFACTURING A MOBILE PHONE

Let’s calculate the COGs of manufacturing a mobile phone. We now the following data:

The manufacturing process of 1 mobile phone employs:

  • R1-Operator. The cost per hour of the operator is €10 and 1 mobile phone requires 404 minutes of operator (the time of operator required to manufacture 1 mobile phone is called Standard Time, SST). The operator cost per minute is called souchin, in this case: €10/60 minutes=€0.1667 per minute of operator.
  • R2-Raw materials. The materials that are used in manufacturing one mobile phone are defined in the BoM («Bill of Materials»), that clearly defines the number of items that comprises the mobile phone. In this case, the BoM is: x1 Screen (€60), x1 Motherboard (€68.63), x1 Battery (€40). The total cost of the raw materials employed in manufacturing 1 mobile phone is: €168.63 per unit.
  • R3-Machinery. The machinery usually is a robot, that is calle «A/I», automatic insertion robot. Imagine that we have invested €1 million in the robot, then the capex undertaken by the company is €1 million, and the value fo the robot («Gross Book Value») is €1 million. If the estimated lifespan of the robot is 10 years, then the Depreciation and Amortization (D&A) is €1 million/10 years= €100,000 per year. In addition, we know that during the lifespan of the robot, the total number of shots that the A/I can do is 100 million, the we know that every time the A/I robot makes a «shot», it will cost: €1 million/100 millions shots=€0.01 per shot. This metric is called cost per shot. We know that in order to manufacture 1 mobile phone, 10,117 shots must be made.

Once we know the cost of the resources, and the units of each resource used in manufacturing one mobile phone, we can calculate the COGs of producing 1 mobile phone:

  • R1-operator=COGs of operator=Souchin*SST=€0.1667 per minute * 404 minutes= €67.33 cost of operator per mobile phone produced.
  • R2-raw materials=COGs of raw materials=The sum of all the raw materials defined in the BoM=€168.63 per mobile phone produced.
  • R3-machinery, A/I robot=COGs of robot=cost per shot*number of shots=€0.01 per shot * 10,117 shots = €101.17 cost of A/I robot per mobile phone produced.

Then we can calculate the TOTAL COGs per unit of product manufactured, in this case, per mobile phone manufactured and sold.

TOTAL COGs per unit=COGs operator+COGs Raw materials+COGs A/I robot=€67.33+€168.63+€101.17=€337.17 per unit.

If we know the yearly sales forecast (let’s assume 120 million units), or expected number of mobile phones that will be sold in one fiscal year of company operations, the yearly COGs will be: COGs per unit*yearly sales forecast=€337.17 per unit*120 million units expected to be sold=€40,455 billions.

Michael Porter, estrategia y ventaja competitiva

MICHAEL PORTER, ESTRATEGIA Y CÓMO CREAR VALOR A LARGO PLAZO

Este miércoles 10 de octubre de 2018 he acudido a una conferencia del profesor de estrategia de Harvard, Michael Porter, donde ha resumido aspectos fundamentales sobre la estrategia de las organizaciones a largo plazo y cómo crear valor.

Los principales puntos donde ha puesto el énfasis han sido:

  1. Las organizaciones, en su nivel del top management deben de estar alineadas entre los distintos departamentos en su entendimiento de lo que es estrategia y las métricas y KPIs que la organización va a definir para medir el performance de ésta. Para Porter, este proceso es clave y complicado, ya que por lo general suelen existir mucho desacuerdos entre el equipo gestor en este punto. Para Porter, estrategia supone «dar pegamento» y «coherencia» de una forma global a todas las áreas funcionales de la empresa, consiguiendo que todas éstas estén alineadas en la consecución de los objetivos de la empresa, y en la definición de los KPIs. A la hora de definir estas métricas, Porter dijo que no había desafortunadamente una que capture toda la «esencia» de value creation o creación de valor, pero que sin duda enterprise value, «asset light strategic models» con elevados ROIC, ciclos operativos negativos (pagar a proveedores mucho más tarde que lo que se tarda de cobrar de clientes) y capitalización bursátil (da una idea de cómo están percibiendo los inversores el valor que crea la empresa) son algunas métricas, entre otras a tener en consideración.
  2. La estrategia de toda organización se fundamenta en 2 pilares, no existiendo bien/ni mal, sino tan solo un conjunto de buenas prácticas recomendadas: (I) Ofrecer una propuesta de valor o «value proposition» que es única y diferente a la de la competencia, sin copiar a otros; tras necesariamente haber encontrado un nicho o grupo de clientes objetivos («target customers») que ningún otro competidor está satisfaciendo sus necesidades. Para Porter una buena estrategia implica necesariamente que la organización ELIGE a su cliente objetivo y no al revés (crear el producto o servicio y buscar a ese nicho o cliente). (II) Una cadena de valor («value chain analysis») y modelo de negocio que sea único en la forma en que satisface las necesidades de esos clientes.
  3. Las dos formas fundamentales en que las empresas pueden competir son: (I) Diferenciación, siendo capaz la empresa de vender un producto más caro que la competencia porque la propuesta de valor percibida por el cliente tiene unas características diferenciales y únicas al resto de competidores por las cuales el cliente está dispuesto a pagar un sobreprecio o «price-premium». La ganancia de la empresa viene a nivel de margen por un precio de venta superior al mercado, aunque los costes de fabricar el producto o servicio sean superiores a los de la competencia. (II) Liderazgo en costes o «cost leadership», donde la empresa mediante su propuesta de valor y value chain, es capaz de fabricar el producto mucho más barato que la competencia, pudiendo vender el  producto/servicio a un precio similar o inferior a la competencia, pero con unos costes de fabricación inferiores. En ambas estrategias es clave la interconexión de todos los procesos y funciones de la empresa, definidos por su value chain. Para Porter, las empresas no pueden ser capaces de ejecutar de forma exitosa ambas estrategias a la vez, porque el mix de recursos para implementar tales estrategias exige cosas diferentes que no son compatibles, y en el largo plazo, aparecerán competidores que te «quitarán los clientes» al tener una propuesta de valor con foco, cliente objetivo claramente definido y estrategia competitiva definida.
  4. Value chain o cadena de valor. Para Porter es como las «cañerías» de un edificio que son las que dan coherencia y unen todos los departamentos. En un negocio se llevan a cabo todos los días actividades, y es fundamental tener un mapa de todas ellas, siendo la principal misión del «value chain analysis» identificar todas estas áreas y procesos, porque al fin y al cabo la ventaja competitiva de la organización vendrá concretamente de una de estas áreas: marketing, ventas, operaciones, recursos humanos, investigación, etc. Y cuando todas estas «piezas» son puestas juntas, aparecen las sinergias y unas refuerzan a las otras.
  5. No existe una regla general donde pueda extrapolarse que el mismo plan de marketing, operaciones o financiero, sea existo para cualquier organización y estrategia, sino al revés, para una determinada estrategia, tiene sentido un determinado plan. Y lo mismo aplica por ejemplo para integración vertical, en unos casos puede tener sentido y en otros no, dependiendo de la estructura de costes, tecnología, ciclo de vida, etc.
  6. Estrategia implica hacer siempre las cosas de forma diferente en el tiempo. Siempre aparecerán nuevas oportunidades en el mercado (creadas a lo mejor por el desarrollo tecnológico como ocurre actualmente). La competencia está innovando constantemente, creando nuevos productos o servicios, y siendo capaz de cobrar un precio superior al del mercado o vender en precio muy similar al mercado pero fabricando más barato. No hayan estrategia correcta o incorrecta, o que siempre vaya a funcionar, lo único que sí es permanente en estrategia es hacer las cosas de forma diferente e innovando.
  7. Porter también habló de los modelos «asset light strategy models» (activos que tiene la empresa que el balance no recoge), que están siendo exitosos en maximizar el return on capital employed («ROIC») con bajos niveles de recursos financieros empleados. Dio bastante importancia a este concepto. Algunos estudios demuestran que modelos de negocio con estas características son capaces de generar rentabilidades superiores a la media en el largo plazo, empresas con más «light assets» presentan rentabilidades superiores, empresas que requieren un determinado return on assets (ROA), empresas con mayor «light assets», requieren un menor uso de recursos tangibles.
  8. El impacto de la tecnología actualmente está motivando muchos cambios y posibilitando nuevos modelos de negocio debido a las oportunidades y nuevas propuestas de valor que pueden ser creadas/ofertadas. Porter puso mucho énfasis en modelos de negocio de realidad aumentada, ya que serán capaces de aunar el mundo e información digital con las personas. Para él este campo tiene excelentes perspectivas, incluso siendo capaz de hacer desaparecer los teléfonos móviles en beneficio de dispositivos como las gafas. Actualmente la realidad aumentada se está desarrollando en la tablets, pero dará el salto a las gafas y facilitará esa unión datos+personas.
  9. Para Porter, el concepto de Corporate Social Responsibility no es suficiente (sostenibilidad, participación en la comunidad, igualdad de género, prácticas éticas, etc). Él no dijo que le parezca mal, pero entiende que por sí solo, este concepto y enfoque no ayudará a resolver los problemas del mundo. Porter introdujo el concepto de «CSV models (» Creating Shared value models»), donde las empresas realmente identifican los problemas claves a los que se enfrentan las sociedades y humanidad, y mediante modelos de negocio innovadores y cadenas de valor efectivas, se buscan las soluciones a estos problemas (no mediante charity business models) construyendo un modelo de negocio. Es decir, se busca crear valore económico y social, conectando el éxito empresarial con el progreso social. Para Porter, este enfoque puede cambiar la percepción sobre el capitalismo. Para Porter CSV supone una nueva forma pensar a nivel empresarial y marca la dirección hacia donde debe ir el mundo y la sociedad, buscando soluciones a los grandes retos de la humanidad.

Para Porter todos estos puntos son fundamentales para desarrollar una marco estratégico exitoso, que esté fundamentado en proporcionar valor al cliente de una forma única y diferente a la competencia.

En el siguiente link os dejo unas reflexiones sobre márketing estratégico que se alinean con estrategia y ventaja competitiva.

Porter agradeció a los estudiantes la asistencia al evento, cerrándolo con la siguiente oración:

«Students should become the solutions, as they have a different mindset than politicians».

The financial plan and its key components

THE FINANCIAL PLAN, KEY COMPONENTS AND HOW TO BUILD A FINANCIAL PLAN SUCCESSFULLY

In the following post, I will explain the key parts of a financial plan for a start-up project or company. It is very important to understand that the 4 key metrics («KPIs») from a management point of view that any CEO should define, monitor and control are:

  1. Enterprise value («EV»), that is directly related to the sustainable long-term cash-flow generation of the business and the strategic position of the company, sustained in its unique value proposition, clear target customer definition, how the company delivers value to the customer through its value chain and business model (competitive advantage). EV could be defined as the net present value of the future cash-flows generated by a company or project.
  2. Customers’ satisfaction.
  3. Employee’s satisfaction.
  4. Corporate Social Responsibility impact.

Second level metrics or KPIs could be defined from this top KPI level, and 2+3 could be summarized in maximazing stakeholders’ satisfaction. All the decisions aimed to increase the enterprise value of a company should be under the umbrella of the CEO and CFO, and should be in some way reflected in the financial plan of a company. Any action undertaken by the company that is not increasing cash-flow generation in a «healthy way» and with a strategic long-term perspective should be avoided (short-term profit versus long-term profit). Please keep also in mind that profit and cash-flow are not the same concepts, as a company can make a sale that the company may never get paid.

The financial plan of a company would be a document that could define the «financial roadmap» of the organization in the next 3-5 fiscal years, and should comprise and integrate the outputs from all the other key parts of a business plan: Human Resources, Marketing and Sales, Operations and Supply Chain Management, Information and Technology Systems, etc.

Any financial plan should take into account the following core components:

1. ASSUMPTIONS AND LIMITATIONS

When designing a financial plan, the management can make certain assumptions that will limit the scope of the financial plan, or some limitations could apply. This assumptions and limitations part would define the framework under the financial plan is estimated. Examples of assumptions and limitations could be: (1) Full costing system for cost accounting, (2) Cost items will be updated using the inflation forecast from the International Monetary Funds, (3) The stock accounting system used will be the FIFO methodology, (4) The payments of VAT and corporate taxes are undertaken at the end of the fiscal year (Dec-31), etc; (5) For the investment appraisal of the project discounted cash-flow techniques will be used, etc.

Once we understand the framework that limits the financial plan modeling, we need to estimate the total funding needs required by the project or start-up to run operations.

2. TOTAL FUNDING NEEDS OF THE PROJECT.

Any project or company, in general terms should get funding to undertake operations, but before deciding which funding sources are used, we need to estimate the total amount of money that the project requires. In the following link is explained the methodology to be used, but it should take into account:

  1. Cash needed for the investment plan («CAPEX»)-> Cash required for purchasing non-current assets.
  2. Cash needed to pay the start-up expenses of the business in t=0. All the expenses that the project/company could have at the start-up (notary fees, local taxes, etc) should be considered.
  3. Cash needed to run the business for «X» months (SG&A), even in the case there is not sales in this «X» period of time. The total funding needs should consider that on a monthly basis there are operational fixed costs that must be paid, and a liquidity buffer to offset these costs for a period of time should be considered. The period of time depends on the entrepreneurs, but it could range x3-x18 months.
  4. Cash needed to build a certain stock level, defined by the days of supply metric (D/S). Imagine a company that sells online premium coffee, a minimum stock level of product must be held, and the cash to buy this stock must be allocated too.
  5. Cash needed for VAT paid in t=0. In order to undertake CAPEX, start-up expenses and build a stock level, these items will pay VAT (Value Added Taxes), and a liquidity buffer must be allocated too, otherwise it will not be possible to undertake 1, 2 or 4.
  6. Cash allocated for unexpected events or expenses. This is called «Cotingency Buffer». This is liquidity buffer for expenses that are not foreseen now, but that could impact in the future, but we are not able to foresee now. This buffer is decided by the management team and could range from zero to «x» months of SG&A.

The sum of 1+2+3+4+5+6 will determine the total funding needs of the project.

3. FUNDING MIX (%E, %D, Ke, Kd, WACC)

Once we have determined the total amount of money required by our project/company, we need to borrow this amount from the funding sources available. Funding sources can range:

  1. Equity funding from shareholders (%E).
  2. Debt funding through financial banking debt (%D).
  3. Grants provided by public or private institutions (%G).
  4. Crowdfunding initiatives (%C).

All these funding sources usually have a cost, as the funding is never for free (grants and crowdfunding could be for free, but equity and banking debt has a yearly cost). The yearly cost of equity in percentage will be defined as Ke («Cost of equity»), the yearly cost of the financial banking debt in percentage will be defined as Kd («Cost of debt»=cost of the banking loan interests), the yearly cost of the grants in percentage will be defined as Kg («Cost of grants») and the yearly cost of the crowdfunding in percentage Kc («Cost of crowdfunding»).

There could be other funding sources, but most of the projects/companies get funding from 2 out of this 4: Equity and banking debt, being these two funding sources the most important one.

The %E at its cost Ke, and the %D at it cost Kd defines the «financing scheme» or «funding mix» of the project, and it is explained in more detail in this link. The average cost of the funding mix, calculated as a weighted average of the funding sources is defined as the «WACC» (Weighted Average Cost of Capital). The funds borrowed from funding sources should generate a profit equal or greater than the WACC, otherwise the project or company’s cash-flow generations can not pay the funding sources cost and the project would not be profitable. In order to calculate the economic profitability of a project, investment appraisal techniques must be used taking into account discounted cash-flow techniques and time-value of money, in order to calculate Net Present Value («NPV»), Internal Rate of Return («IRR») and payback period («PB»).

4. ESTIMATION OF THE FINANCIAL STATEMENTS.

The 4 key financial statements of a company, that should be estimated in a 3-5 years time frame would be, by this order:

  1. Profit and Loss Account (P&L). It provides information of the income generated by the company, the expenses incurred to generate that income, and the net profit that shareholders obtain.
  2. Cash-flow statement, in order to understand the cash generated in a fiscal year by the company, and that is comprised of: (1) CFO or operational cash-flow generated from the main business activity of the company, (2) CFI or investment cash-flow generated from investing activities such as financial assets, undertaking non-current assets purchases , (3) CFF or Financing cash-flow generated from financing activities. Once we have calculated the cash-flow generated by the project or company in a year=CFO+CFI+CFF, we can forecast the balance account.
  3. Balance Account or Balance Sheet. It provides information of how the company gets funding (left side of the balance account: Equity and liabilities) and where this funding is employed (in buying assets, A, right side of the balance account). In the balance account the following equation must be met: A=E+L. Liabilities are also called debt («D»).
  4. Changes in the equity. It provides information about how the equity owners or shareholders change over a period of time (i.e. new investors in the company).

5. FINANCIAL RATIOS ANALYSIS

By definition, a ratio is a division of two metrics X/Y, and from a financial point of view there could be a great number of ratios to be analyzed, however, the idea behind the ratio analysis is to get an overall picture of the «financial health of the company» from 5 categories:

  1. Liquidity: Ability of the company/project to pay in the short-term (less than a year). This ratios are directly related to the ability of the company to convert sales into cash, and involves mainly the following accounts: cash and cash equivalents, accounts payable, accounts receivable, inventories and corporate tax/VAT tax liabilities.
  2. Solvency: Ability of the company/project to pay in the long-term (more than a year). The solvency of the company is directly related to the long-term cash-flow generation and the funding mix equity-debt («leverage of the company»). This ratio %D/%E somehow determines if the company can bear a financial risk in the long term. The higher the ratio %D/%E, the higher the risk, and the higher the probability to being unable to pay the financial costs of the company.
  3. Activity/rotation: Ratios that provide and idea of how fast is the cash-conversion cycle (cash->raw materials->finished goods as stock->sale->accounts payable and receivable->cash. Rotation refers to how many times specific accounts move over time.
  4. Profitability: Metrics that analyze the profit from different perspectives: Gross margin, EBITDA, EBIT, Net Income, ROE, ROA, IRR, ROIC, etc.
  5. Valuation: Ratios that analyze stock market and valuation of the company. Some examples of KPIs such as IRR, NPV, Ke, Kd, WACC, PER, dividend yield, pay-out.

A company could be analyzed using only 15-20 financial ratios. Some of the most important ones:

  1. Liquidity: Acid test-> Cash/ current liabilities.
  2. Solvency: Net Financial Debt/EBITDA, %D/%E, Interest coverage (EBIT/interests).
  3. Activity/rotation: Accounts payable (AP), accounts receivable (AR), days of stock (D/S), net operating cycle (D/S+AR-AP).
  4. Profitability: EBITDA, Net Income, ROIC, ROE, IRR, ROIC.
  5. Valuation: WACC, IRR, NPV, PER, dividend yield, pay-out ratio.

6. BREAKEVEN POINT (in units=BE)

Defined as the total number os units that need to be sold in order to offset the fixed cost and obtain and Earnings before taxes=0 (EBT). The BE point gives an idea of how feasible or not is to achieve an EBT=0. Imagine that we run a business where the yearly BE is 365,000 units, that would mean a daily sale of 3,650 units. If our business opens 8h, it would mean an hourly sale of 3,650/8=456 units per hour, that could be unrealistic.

The break even point is defined as: Income=Expenses=COGs+fixed expenses=COGs+SG&A+D&A+interests.

  1. Income=Selling price excluding VAT*BE=P*BE
  2. COGS at breakeven point=COGs*BE
  3. P*BE=COGs*BE+SG&A+D&A+interests
  4. BE=Breakeven in units=Fixed costs/(P-COGs)=[SG&A+D&A+interests]/[P-COGs]

7. INVESTMENT APPRAISAL OR ECONOMIC FEASIBILITY OF THE PROJECT

The idea of this chapter is to analyze if the project undertaken is profitable or not from a financial point of view and taking into account the time value of money. In finance, in order to determine if a project is profitable 3 KPIs must be calculated:

  1. Net Present Value («NPV»): Projects with an NPV equal or greater than zero are profitable. The NPV means the excess of return in monetary units, that the shareholders obtain over their minimum profit expectations defined by the cost of equity Ke.
  2. Internal Rate of Return («IRR»): It is a compound annual growing rate, providing the yearly return of a project in percentage. If the NPV is greater than zero, then the IRR should be greater than Ke.
  3. Payback period («PB»): It is the total number of years it takes that the cumulative positive cash-flows equal the cumulative negativa cash-flows. It is usually referred as the total number of years it takes to recover the investment made in the project.

8. SCENARIO ANALYSIS.

When the financial plan is being defined, we could have 3 approaches:

  1. Deterministic scenario with 1 potential outcome: We assume that under the assumptions, limitations and inputs of our model, there will be inly one possible outcome (1 financial plan for the most likely scenario that will be called «Base Scenario»).
  2. Deterministic scenario with 3 potential outcomes: We estimate an optimistic financial plan, a pessimistic financial plan, in addition to the base scenario. Therefore we build 3 financial plans (+, base, -) and assign probabilities of occurrence to each scenario in order to get an «expected financial plan». This can be easily done by being conservative or optimistic in the input variables of the model (higher sales plan, lower costs, higher estimation forecast, lower financial costs, etc).
  3. Deterministic scenario with a high number of estimated financial plans. Instead of building 3 financial plans, we change all the potential variables that impact the model and generate «infinite» or a high number of financial plans («almost all the probable scenarios are estimated»). If we get as a result of this automated process and simulation 100,000 financial plans, we could analyze and determine the probability distribution of many of the variable included in the financial plan, and we could apply all the statistics tools in order to analyze and answer questions such as: with a 99.9% probability, what is the expected value of the net present value? What is the probability that the EBITDA is less than 20%? What is the probability that the net income is negative?

When analyzing variance analysis, we can be at stage «1» of the process or at stage «3». For sure stage «3» requires a high level of automatization, and usually, at investment firms, the scenarios and financial plans projected are at the stage 2. In general terms, being at stage «2» could be a good proxy for financial plan estimations and its variance analysis from pessimistic and optimistic assumptions. For those that consider a great workload, it is recommend being in stage «2» and at least for the P&L, estimate an optimistic, base and pessimistic scenario for the variables of the P&L in order to understand the level of variance in magnitudes such as net sales, COGs, SG&A, EBITDA ranges, EBIT ranges and Net Income ranges.

9) CONCLUSION

A financial plan must always have a conclusion, summarizing the key facts of the project and the financial feasibility of it.

Most important KPIs for supply chain management

WHAT ARE THE MOST IMPORTANT KPIs («KEY PERFORMANCE INDICATORS») FOR SUPPLY CHAIN MANAGEMENT AN OPERATIONS?

In this post we will explain the most important metrics that should be defined, monitored and control for the supply chain management and operations business function.

Please note that operations management according to Krajewski, Ritzman, & Malhotra (2013) refers to «the systematic design, direction and control of processes that transform inputs into services and products for internal and external customers. Processes can be linked and synchronized together to form a Supply Chain»

 Therefore operations and supply chain management comprises RAW MATERIALS ACQUISITION+PRODUCTION+LOGISTICS+DELIVERY->END CUSTOMER, and the most important goal of this business function would be that the customer has the product/service when requested and on-time.

There are many KPIs for the operations business function, but the most important ones are:

  1. Days of supply (D/S): It measures the stock level of a company as the total number of days the current stock level can meet the daily demand. If the company defines a company’s D/S goal of 10 days, all the organization should have a stock level being able to meet the demand for 10 days. A D/S level of 30 days it would mean that the company holds a stock level of 1 month of sales, that is no necessary and it has an implied cost (obsolescence, damage, logistics cost, price decrease, etc). Imagine that a company is able to manufacture any product in 5 days, and has a delivery time of the product to the end customer of 3 days. In addition it considers that there should be a security buffer for contingencies of 2 days. Taking into account all this factors, the D/S goal defined as a KPI to be monitor should be D/S=10 days. The next step would be to calculate in a daily, weekly or monthly basis de D/S per product, category, country and company’s overall. The calculation would be based on: D/S= Current stock level in units/Daily sales forecast. If the yearly sales forecast of expected number of units to be sold is 365,000 and the current stock level is 30,000 units, the D/S would be: 30,000 units/(365,000/365)=30 days, that would be above the D/S goal of 10 days. Please note if cost of manufacturing 1 product defined by COGs (see-5.) is a 20% of the retail selling price excluding VAT (€100), the manufacturing cost would be 20%*€100=€20 per manufactured unit. If the current stock level is 30,000 units, the cost of the stock (average method to account stock) would be 30,000*€2=€60,000.
  2. Dealer Hit Rate («DHR»): It measures the percentage of products delivery on time to the end customer. Imagine that a customer (either B2C or B2B) has places an order to receive 1,000 TV sets on Dec, 1 and we only dispatch 300. The DHR would be 300/1,000=30%, that means our delivery service level is very poor, and a root cause analysis must be undertaken to understand the causes of this performance. If we measure the organization following a Six Sigma approach, the dealer heat rate would imply that for every million units dispatched, only 3.4 are not delivered on time, that is almost a DHR=100%.
  3. Backorder. It is the total number of units that should have been dispatched to the end customer but has not been delivered yet on time. Taking into account the amounts from 3, the backorder would be 1000-300=700 units requested by the customer that has not been delivered on time.
  4. Transit times and delivery times, that measures how effectively and fast we can deliver de product to the end customer. Let’s put an example, many times it is discussed that China is considered a good option for manufacturing of products compared to Europe or Eastern Europe. It is true that the manufacturing costs, mainly operators expenses, are lower than in Europe, but if we take into account transit times (from Europe to Europe could range 2-4 days versus 1 month freight shipments from China) and without taking into account the import duties that apply for product manufactured in China rather than Europe (no import duties).
  5. Total Landed Cost, or the total cost that the company bears to place the product at the customer. It takes into account raw materials costs, operators costs, machinery costs, logistics and delivery costs. This is a measure of how effective and cost-efficient is our supply chain business function. The manufacturing direct cost per product is called «COGs» (Cost of good Sold), being a KPI, as it defines how effective is the manufacturing process of a company in terms of cost. Total Landed cost=COGs+logistic & delivery costs.
  6. Forecast accuracy. This metric analyzes how good is the sales forecast versus the actual sales orders. The sales forecast accuracy is key for manufacturing and operations, as it is the driver that triggers all the production process from manufacturing sites at a current days of supply goal and stock level. Imagine a company that has shortage of raw materials for production, and the sales forecast accuracy is +-80%. This would mean if the sales forecast is 100,000 units, the placed orders could be in the range of 20,000 to 180,000 units. The impact on the manufacturing function is huge and could generate overstock or raw materials shortages with an impact in the dealer hit rate metric.
  7. Quality. This topic has a great impact and level of discussion. Quality from a total quality management approach («TQM») should be at the core of any organization, and should be proactively build within the organization at all levels (employees, processes, departments) trying to act before the error happens. There are many quality frameworks (TQM, EFQM, Six Sigma, etc) and Toyota is well known for these methodologies. If we take into account a quality level defined by Six Sigma as 3.4 errors per million, an organization with this level of errors would be at a six sigma quality level. Imagine that we accept a 95% quality level, this would mean for the aviation industry where there 100,000 flights per day with 2.5 million daily passengers (up to 37 million flights per year and 912 million passengers), that 5%*100,000 flight could be at a risk. It is clear that this level of quality would not be acceptable. Under a Six Sigma quality level, the total number of flights t a risk on a yearly basis would be 3.4*37=126 flights rather than 5%*37 millions= 1.85 millions of flights. Even a Six Sigma level for the avian industry would not be acceptable either.
  8. D-Cost: It is directly linked to the quality level of the manufacturing and supply chain processes. It stands for «Defects cost». It is usually named as a percentage. Imagine that we run a food and beverage business such as a Hamburger Shop, and the D-cost is at 3% of the yearly net sales of the business. That would mean that 3% of our sales, are «defective» (food wasted, lost, etc..).
  9. Manufacturing time: It measures the time it takes to manufacture a product or service. The manufacturing time is compared against the «Standard Time» or «SST». If a product should be manufactured using 400 minutes of operator and it takes 900 minutes as manufacturing time, there is a deviation of 500 minutes and an overcost of these 500 minutes*the salary per minute of the operator.
  10. Production achievement: It measures how efficient is your manufacturing process. If a factory should produce 500 TVs in one week of production/work, and it only manufactures 400 TV sets, the production achievement would be 400/500=80%.
  11. ETD and ETA: Estimated time of delivery of a product/service from the factory to the customer. The ETA measures when the company estimates that the product/service will reach the customer. ETA=ETD+transit time.
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