Rethinking Supply Chain KPIs (5)

This is our continuing series in which I consider some of the KPIs (Key Performance Indicators) used by some firms in measuring the performance of purchasing and supply chain management. In doing so, I also offer my candid thoughts on the value of various metrics and, when appropriate, recommendations for improved metrics.

KPI: Inventory (dollars) divided by production (dollars)

This is another one of those statistics where I am at a loss to discover much value to management. What guidance does this provide to management?

Of course, it seems natural that this KPI needs to be subdivided at the very least. How about:

1. Raw materials inventory dollars divided by production dollars – this number would offer some insight as to how many dollars of raw materials inventory are held to support a dollar of production
2. Finished goods inventory dollars divided by production dollars – calculating this value would supply some insight as to how much finished inventory hangs around after production (rather than being shipped and turned directly into Throughput)

Here are some even more meaningful improvements on this metric:

1. Raw materials inventory dollars divided by Throughput – Since different products produce different amounts of Throughput (i.e., Revenue less Truly Variable Costs), what we are really interested is in inventory that supports Throughput, not just more finished goods inventory. Nevertheless, this still does not tell us if the inventory we have on-hand now is the right inventory to support tomorrow’s production of Throughput, since the metric is backward-looking only. (Of course, to be fair, virtually every KPI is backward-looking and not forward-looking.)
2. Refining further, Raw materials inventory dollars (by vendor) divided by Throughput – When we break this down by vendor and monitor trends, we can begin to see how efficient our supply chain and working relationship is with each vendor. If the trend is moving up, we need to find out why more and more inventory is being required to support a dollar of Throughput. Is it price increases? Is it that we are finding it necessary to increase our on-hand quantities due to other factors?
3. And then, what about this version? Raw materials inventory dollars (by sales product line) divided by Throughput – Breaking down the numbers in this way, we can begin to identify inventory investments that support low Throughput (read: profit) product lines from inventory that supports high Throughput product lines. Of course, doing so may require us to prorate inventory dollars (by quantities) if the same raw materials feed more than one sales product line.

As you can see, putting a little more focus on your firm’s real goal—making more money tomorrow than you are making today—can begin to transform relatively meaningless statistics into actual “performance indicators” to be used in moving the company in the right direction.