Part II: The right direction of performance management – Flow Metrics

In my last blog post I reasoned that most of the conventional supply chain metrics are incapable of supporting a company to achieve their primary target of ROI maximization. The reason for this is that conventional metrics often do not focus on the right information, but generate internal conflicts and cause self-imposed supply chain disruptions.

The usually cost-based metrics lead to silo optimization because departments strive for isolated targets disregarding relevant determinants of overall supply chain optimization. Figure 1 summarizes the typical pitfalls of conventional supply chain metrics, described in my first blog post.

Figure 1: Typical pitfalls of conventional supply chain metrics

So what companies need are smarter metrics – metrics that…

  • support driving the organization towards strategic goals
  • measure end-to-end processes
  • must not cause management variability
  • are part of a holistic metric system that considers potential conflicts
  • are aligned with the organizational structure and systems
  • consider all relevant dependencies and connections and drive behavior towards common targets

It’s all about flow

We all know how today’s supply chains look like: High supply chain complexity, short product life cycles, highly competitive markets, high product customization, many long lead time parts and high SKU proliferation are some of the supply chain characteristics we are currently facing within a volatile environment. In short, we call this the VUCA world (volatility, uncertainty, complexity, and ambiguity). Traditional MRP supply chain planning approaches cannot deal with the challenges of the VUCA world. If production is driven by inaccurate forecasts, this results in expediting and scheduling changes as planners inevitably respond to exception messages to protect service levels. This leads to unplanned and higher capacity usage, longer lead times, more service issues and higher inventory levels. In short: Too much of the wrong stuff, too little of the right stuff, and too much overall. A new flow-oriented solution is needed to respond to the challenges of the VUCA world.

Demand-Driven Materials Requirements Planning (DDMRP) is designed to protect and promote flow by positioning a number of decoupling points – independent stock locations within the supply chain – that are sized according to the average demand usage over the lead-time and replenishment cycle and consider a portion protecting against variability. Each buffer position is replenished following its own stable and optimal sequence. Its re-order mechanism considers actual demand (or downstream consumption), stock on-hand as well as on-order. Thereby the entire supply chain responds autonomously to demand without need for schedule interruptions and expedites.

Metrics must be designed to support flow in the organization

Understanding that flow is the #1 conflict-free objective of a supply chain, metrics must be designed to consequently support the flow of relevant information and material in the organization. Flow-based metrics are a proven way to reduce conflicts in departmental coordination in an end-to-end process while providing useful guidance for operational decisions. A simple example from Goldratt (2006) shows how flow-based metrics work: When it comes to the conflict in production of choosing between two products, the decision is usually based on the profit margin. However, this is often not the best choice! For operational decisions, only variable costs are relevant and, if the products pass through a bottleneck resource, the monetary throughput of the product per minute on that bottleneck resource. The concept of bottleneck throughput recognizes the relevance of the flow for a value chain: No unnecessary waiting, no overstocking.

Furthermore, flow is a very natural guiding concept for day-to-day decisions across all functional departments. Take, for instance, the eternal struggle between “large lot sizes” and “low inventories”: The key question in both cases is: Is flow promoted and protected? Large lot sizes do, if the machine in question is heavily constrained in its capacity (related to demand) – in this case, every extra minute spend on setups hurts. If the machine is not a constraint, they don’t. For inventories, it’s the same: They promote flow if they are in front of a bottleneck. In that place, they ensure that the bottleneck always has enough material to work on. They promote flow if they decouple the supply chain and hinder variability to run right through it (i.e. dampening the bullwhip effect). Finished goods inventories promote flow if the customer tolerance time is so low compared to the lead time that finishing the product only after an actual order has been placed is out of the question.

A system that flows well produces consistent and reliable results in terms of meeting customer expectations on delivery performance and quality as well as high service levels lead to increased market shares. Materials are converted to cash at a relatively quick and consistent rate while expedite-related expenses are minimized. On the other side, inventories are reduced, and lead time shortened with increasing flow. And, when focusing on flow, additional activities and expenses to close the gaps in flow (firefighting) become obsolete. The speed of flow drives all benefits concerning service, revenue, inventory, expenses and cash (Fig. 2). Smart metrics that promote and protect the flow of relevant information and material are called Flow Metrics.

Figure 2: The context of flow and ROI

In contrast to many conventional KPIs, Flow Metrics measure end-to-end processes without causing variability inside or outside the organization. On the one hand, they explicitly take the time frame of the present decision into account. On the other hand, they realize that neither the margin nor the full costs, but the throughput is relevant. Flow Metrics consider all relevant dependencies and connections, potential conflicting goals and manage common goals. Flow Metrics are required to efficiently plan and execute orders in the DDMRP concept while ensuring a steady optimization of inventory, planning processes, and customer service through continuous and rapid detection of flow disruptive factors. Surely, many conventional metrics are flow-based, as for example the on-time delivery and fill rates. However, their performance is inhibited by conflicting and/or non-relevant cost-based metrics.

­­­After identifying FLOW as the #1 conflict-free objective of a supply chain, the question is how to design a Flow Metrics framework. This will be the topic of my next blog post.

Part I: When supply chain performance indicators lead into the wrong direction


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