THE SUPPLY CHAIN INDEX: A NEW WAY TO MEASURE VALUE

 

By: Dony Saputra

 

The Supply Chain Index of performance improvement is built on the framework of the Effective Frontier. In this model, growth and profitability must be maximized, cycle time should be reduced, and complexity needs to be managed. Using this model, the Supply Chain Index is designed to measure supply chain progress on a portfolio of metrics. To build the index, we chose the metrics of year-over-year growth, return on invested capital (ROIC), operating margin, and inventory turns. The index assumes that its three components—balance, strength, and resiliency— should be valued equally.

Balance tracks the rate of improvement in growth and in return on invested capital, while strength and resiliency factors are based upon progress in profitability and inventory turns.

 

There are three components of a Supply Chain Index score: Objective performance on balance, strength, and resiliency. Each contributes 30 percent of the final score. Maintaining balance in the supply chain is a constant struggle. The two metrics that determine the balance factor are revenue growth and return on invested capital. Researcher indicates that ROIC has better correlation with stock market capitalization and provides a broad perspective on cash-flow generation and profitability, both of which drive shareholder equity. ROIC, then, is a measurement of a company’s use of capital. The goal is to drive higher returns than the market rate of the cost of capital. The balance measure in the Supply Chain Index is a mathematical calculation of the vector trajectory of the pattern between growth and ROIC for Some periods of time . The overall trajectory of this vector from Year 0 to Year n is simplified into a single value that represents the company’s ability to balance growth and ROIC. Companies that were able to drive improvement in both metrics score the best, while companies that deteriorated in both metrics did the worst.

 

The second factor in the index is strength. A successful supply chain is a strong supply chain. There are a rich relationship between operating margin and inventory turns. Similar to the calculation of balance, the strength measure in the Supply Chain Index is a mathematical calculation of the vector trajectory of the pattern between inventory turns and operating margins for some period of 2006 to 2013. The overall trajectory of this vector from Year 0  to Year n is simplified into a single value that represents strength. Sustained improvement on both inventory turns and operating margin indicates a strong supply chain and is reflected in a high strength score.

 

The third factor is resiliency—the concept of resiliency is difficult to define, and there is rarely clarity among stakeholders as to what resiliency is or should be. As we plotted orbit chart after orbit chart, we could see that some supply chains showed very tight patterns at the intersection of operating margin and inventory turns, and that other companies had wild swings in their patterns. (An orbit chart is a plot of the trajectory of two metrics. It is useful in pattern recognition.) We wanted to find a way to measure the tightness, or reliability, of results for these two important metrics. After evaluating several methods to determine the pattern in the orbit charts, we settled upon the Euclidean mean distance between the points (a measurement of the compactness of the chart). The resiliency metric is similar to the cash-to-cash cycle in that companies should work to minimize the value. A lower number for resiliency is an indicator of a tighter pattern and greater reliability in results over the time period. The results for these companies are more predictable and stable for operating margin and inventory turns.

 

Source: LORA CECERE (2014), THE SUPPLY CHAIN INDEX: A NEW WAY TO MEASURE VALUE, CSCMP’s Supply Chain Quarterly