@ Supply Chain Management

Running down the path of metrics, I came across this take on the use of metrics in the business world. This article by Julie Fraser titled – Are metrics driving or killing your business? can be found at Manufacturing Business Technology.

The question is whether the behavior that most companies are rewarding actually helps performance, or hurts it.

Ms. Fraser’s line is not really what the right metrics are but whether the measured metrics actually help performance or hurt it. In other words, does it work or not?
Here’s the standard example given (and why am I not surprised that manufacturing gets the short end of the stick?)

Many talk about fact-based management, but outdated manufacturing metrics often conflict with corporate goals. For example, a plant that measures equipment utilization as the top indicator of success may in fact lead the company to carry excess inventory. In another scenario, minimizing overtime might hurt on-time shipments to customers and thus, overall revenues.

But both of these metrics are not manufacturing metrics but confusions arising from accounting. It is true that manufacturing measures equipment utilization is measured in addition to cycle times, changeover times and mean time to failure. However, utilization is measured for accounting reasons not because a manufacturing/plant manager is going to feel extremely accomplished because his/her machine was utilized 95% of the time. The concept of unit cost arises in accounting and not in manufacturing and everything else follows from that.
While Ms. Fraser indicates that measuring equipment utilization “may” in fact lead the company to carry excess inventory but that is not only because manufacturing managers are measured using the notion of efficiency but because unit costs are minimized in large batch production. Costs in production as it is/was measured is a fuzzy concept because it is not related to actual demand and the actual price paid by the customer but a weighted factor of allocation of overheads, raw material costs etc. In order to minimize unit costs using the accounting dimensions, utilization is a key lever and it has been pulled many a time.
But what can one make of the following set of metrics led dead-ends?

At the same time, finance and accounting often doom their own manufacturing operations by focusing on metrics that punish plants for doing a good job. Too large a focus on return-on-assets might argue for outsourcing when the local plant is doing a better job than a partner could.

Mind you, the above is without taking into account longer lead times arising from outsourcing, the larger inventories you need to hold in order to cover the longer lead times, supply risks etc. Then, there are issues about quality as well.

Even more pernicious are facility-level accounting metrics that punish innovations such as postponement, the migration to make-to-order, designing specialized products for various channels, or investing in important technology upgrades. Common metrics that thwart progress include expectations that overall manufacturing expense or raw materials and MRO inventory will invariably go down year-over-year. Or that productivity will rise even as the plant is making more complex products, or the warehouse is performing value-add manufacturing as well as materials movement activities.

So what are we to make of this? Is it really then an accounting problem at the root of it all? The language of the firm is dollars. If I were to put on my optimization hat, then the objective function of the firm is to maximize profits (though this same objective can be restated as minimizing costs in the abstract world of optimization but not as easily in the real world). If Profits are stated merely as Sales minus Costs, the firm’s ability to define and/or control Sales is relatively lesser than the firm’s ability to define and/or control Costs. The latter is difficult to do and that is where a substantial disconnect exists between the financial and operational side of the firm. In fact, I would argue that the definition of cost as it is expressed in accounting is a definition in a vacuum. At this juncture, I think it might be prescient to highlight the following post concerning the calculation of cost. Does it makes sense?
This disconnect is highlighted by Ms. Fraser as well,

Disconnects between financial and operational metrics abound. All of these metrics may seem perfectly logical from one pocket of the organization, but not when taken in context.

It is not merely that financial and operational metrics are disconnected but that financial notions of cost assume a primacy in the functions of the firm simply because dollars are the language of the firm. If a manufacturing manager were to say that mean time to failure was increased by 5% for the milling area – what the heck does that translate into in terms of dollars and cents, in terms of the Profit objective above? The disconnect exists not between the financial and operational areas but in the languages of the financial and operational areas and the language of the firm. Nowhere in the above discussion am I trying to say that manufacturing managers or analysts have not done their part to translate the difference between 95% and 98% customer service levels into dollar values. Is it even possible to do that?
However, what I am saying is that simply because the financial side of the firm is closer to the language of the firm, driving the firm from the financial to the operational is simply the wrong thing to do. In my opinion, and taking the control systems analogy, a portion of the financial side is on the feedback loop of the firm when it pertains to operations and the firm in general. As it is currently expressed, what is on the feedback loop for operations are a set of operational metrics that are disconnected from the financial aspects of the firm. Hence, the firm is pretty much operating as an open loop system in the broader picture even though the operational subsystem (and other subsystems as well) is running a closed loop system.
In such a state of affairs, can one even choose a set of metrics that will enhance the performance of the firm? If you have chosen a set of metrics and it works, is it just a coincidence? Or has the choice tapped into an implicit layer of the firm which for the time being works in some sort of desired fashion?

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Tags: Metrics of the firm, Manufacturing Business Technology, Financial Metrics, Operational Metrics, Cost calculation