Logistics and Supply Chain Management (SCM) Key Performance Indicators (KPI) Analysis

Transcription

1 Logistics and Supply Chain Management (SCM) Key Performance Indicators (KPI) Analysis A Canada/United States Pharmaceutical Sector Supply Chain Perspective October 2006

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3 Executive summary The Pharmaceutical global supply chain (GSC) is driven by a constant need to respond to government and end customer traceability mandates, global sourcing from low cost countries, smart border requirements and delivery in a Just-In-Time (JIT) manner. Logistics and supply chain management (SCM) are thus expected to play a key role in GSC and contribute dramatically to productivity growth of Canadian Pharmaceutical firms over the next years. For the last decades, the North American (NA) Pharmaceutical Manufacturing sector has been focusing on developing internal innovation activities, such as high quality products and R&D. The current focus is shifting more towards supply chain level activities such as delivering the product to the end customer at the right time, right place, in a secure mode and at a competitive operational cost. The top three factors that drive a company in the Pharmaceutical industry to implement a lean strategy are Pressure to Improve Operational Performance, Inventory Reduction and Shorter Order Cycle times. Operational performance could be directly linked to logistics and SCM costs while the inventory reduction and the demand to decrease shorter order cycle time are related KPI such as to Just-In-Time (JIT), supply chain agility and inventory turns 1. Measurement of logistics and supply chain management (SCM) key performance indicators (KPI) is an essential part of the agile supply chain concept. It is estimated that 37 percent of North American (NA) firms that have put in place logistics and SCM KPI corporate wide measurement applications have achieved a decrease of 15 percent or more in shipment delays compared to only 7 percent of firms that did not measure those KPI consistently 4. While inventory turns is the main KPI for evaluating supply chain agility, logistics cost KPI allow firms to evaluate the efficiency of their logistics and SCM operations. The combination of supply chain agility and efficient SCM practices is key to long term competitiveness and prosperity of Canadian firms in a global supply chain (GSC) context. Inventory turns Between 1992 and 2005 the Pharmaceutical and Medicine manufacturing sector saw a decrease of 36 percent in its raw materials inventory turns, while the average for the Manufacturing sector actually increased by more than 20 percent during the same period 2. During the same period but on the finished goods side, the Pharmaceutical and Medicine manufacturing sector experienced a decrease of almost 20 percent in its inventory turns, while the Manufacturing average increased by 23 percent 2. 3

4 For the Wholesale industry, Pharmaceutical, toiletries, cosmetics and sundries wholesalers were also below the Wholesale average in 2003 (by 20 percent) in terms of inventory turns. On the Retail side, Pharmacies and Drug Stores were actually above the Retail average in terms of inventory turns, with a difference of only 6 percent. Finally, comparing the Pharmaceutical and Medicine manufacturing sectors for Canada and the U.S. shows that Canada is well below its neighbour in terms of total inventory turns, with a gap of 137 percent. On the Wholesale side, Canada had a slight advantage (7 percent) 2. Logistics Costs In terms of logistics internal costs, the Pharmaceutical and Medicine manufacturing sector was below the Manufacturing average, both in term s of GDO and Gross output share, by 49 percent and 39 percent respectively. Looking at logistics outsourcing costs, the same picture appears. In fact, this sector has one of the lowest logistics outsourcing costs in the manufacturing industry. Nevertheless, it is interesting to note that while it has such a low logistics outsourcing cost, it relatively has one of the largest storage and warehousing costs (4 times higher than that of the average for Manufacturing). Finally, inventory carrying costs in the Pharmaceutical and Medicine manufacturing sector, in terms of percentage of sales, are well above the Manufacturing average, with a difference of almost 100 percent 2. Technology The focus of the Pharmaceutical Supply chain is on traceability issues coming from SCM Mandate Compliance initiatives such as the FDA and Health Canada Code of Federal Regulations. In terms of traceability issues, NA Pharmaceutical firms that are proactive in implementing technology to respond to compliance initiatives have improved their time to complete product traceability by 49 percent and reduce by 31 percent their cost of counterfeiting/gray market counterfeiting initiatives 3. Generally speaking, twice as many SCM high technology adopting firms enjoy a reduction in inventory carrying cost compared to low technology adopting ones 6. Furthermore, in terms of success to implement JIT Lean manufacturing, 79 percent of NA Pharmaceutical Manufacturing firms experienced a reduction in supply chain costs as expected, compared to only 51 percent in average for the whole industry 1. 4

5 Table of contents Executive summary... 2 Introduction... 6 I Industry Productivity and Competitiveness via Logistics and SCM... 7 II - Inventory Management and Just-in-Time Key Performance Indicators Manufacturing (Canada) Overall Pharmaceutical supply chain for Canada Canada/U.S Benefits of indicators to productivity and competitiveness III - Logistics Costs KPIs Logistics Internal costs Logistics outsourcing costs Inventory Carrying costs Total logistics costs IV - Final remarks Annex I Methodology Annex II Definitions Annex III Inventory Management Data Annex IV - Logistics cost data References

6 Introduction The Pharmaceutical global supply chain (GSC) is driven by a constant need to respond to government and end customer traceability mandates, global sourcing from low cost countries, smart border requirements and delivery in a Just-In-Time (JIT) manner. Logistics and supply chain management (SCM) are thus expected to play a key role in GSC and contribute dramatically to productivity growth of Canadian Pharmaceutical firms over the next years. Although Canadian Pharmaceutical firms have used logistics performance indicators internally for decades, there has never been any tool for Canadian firms to benchmark themselves to their supply chain partners, competitors, sectors and U.S. counterparts. Manufacturers, Wholesalers and Retailers in the Pharmaceutical supply chain need quality information on logistics and SCM costs as well as performance indicators in order to provide best practices and benchmarks, justify investment and innovation, and monitor industry performance. Industry Canada has partnered with the Supply Chain and Logistics Association of Canada (SCL) Research Committee to launch a national logistics and SCM performance indicators initiative. The objective of this study is to propose a logistics and SCM key performance indicators (KPI) analysis that can be used as a benchmarking tool for Manufacturers and policy makers. This analysis will help firms understand where they are located with respect to leading enterprises, as well as firms within their own sector and the U.S., and the steps they must undertake in order to become more competitive. Logistics and SCM functions can either be performed from internal activities or outsourced to a third party logistics (3PL) service provider, via wholesale distribution, or in combination. The following report will guide supply chain managers through these different key components in order to provide them with a global view of their supply chain KPI. Analysis is initiated by a general section on industry productivity and competitiveness indicators via logistics and SCM. This will be followed by sections on inventory management and Just-in-Time KPI, and a logistics and SCM cost KPI analysis that includes three components: internal logistics cost, outsourced logistics cost and inventory carrying cost. Finally, sector specific KPI, complete with methodology, calculations and definitions will be tabled in Annexes in order to provide details to help individual firms policy makers develop applicable benchmarking tools. 6

7 I Industry Productivity and Competitiveness via Logistics and SCM As competition becomes more global, innovation is moving from a firm-to-firm level to a supply chain versus supply chain perspective. For the last decades, the North American (NA) Pharmaceutical Manufacturing sector has been focusing on developing internal innovation activities, such as high quality products and R&D. The current focus is shifting more towards supply chain level activities such as delivering the product to the end customer at the right time, right place, in a secure mode and at a competitive operational cost 1. For those purposes, NA Pharmaceutical Manufacturers have been embracing Lean practices at an extremely rapid pace in the last few years. More than 86 percent of the NA Pharmaceutical Manufacturers have initiated Lean practices, mainly in the last three years NA Pharmaceutical Lean Manufacturing Adoption Rate 1 Industry average Pharmaceutical 0% 20% 40% 60% 80% 100% No activity Planned Less than a year 1-3 years 4+ years Lean manufacturing is a management philosophy focusing on the reduction of the seven wastes in manufactured products (Over-production, Waiting time, Transportation, Processing, Inventory, Motion and Scrap). Lean is now a key tool to provide supply chain agility, reduce total costs and provide value added customised products for customers. Supply chain agility is an operational strategy focused on improving velocity and flexibility in the supply chain. A supply chain is the process of moving goods from the customer order through the raw materials stage, supply, production, and distribution of products to the end customer. The top three factors that drive a company in the Pharmaceutical industry to implement a lean strategy are Pressure to Improve Operational Performance, Inventory Reduction and Shorter Order Cycle times. Operational performance could be directly linked to logistics and SCM costs while the inventory reduction and the demand to decrease shorter order cycle time are related KPI such as to Just-In-Time (JIT), supply chain agility and inventory turns 1. 7

8 100% 2 - Top Factors to Implement Lean by NA Pharmaceutical Manufacturers 1 Industry average Pharmaceutical 50% 0% Pressure to improve Competitive advantage in operational performance price and service Customers demanding shorter order cycle time Corporate objective to reduce inventory The measurement of logistics and SCM KPI is an essential part of the agile supply chain concept. It is estimated that 37 percent of North American firms that have put in place logistics and SCM KPI corporate wide measurement achieved a decrease of at least 15 percent in shipment delays compared to only 7 percent of firms that do not measure those KPI consistently. NA firms that measure logistics and SCM KPI also outperformed their industry counterparts on document issues (a key component of Smart Border solutions in JIT 4 ) by a ratio of 3.5 times 4. % NA Firms Achieving > 15% improvement 3 - Performance Advantage from Logistics and SCM KPI Measurement 4 40% 35% 30% 25% 20% 15% 10% 5% 0% Total landed cost Shipment Delays Documentation Issues Corporate wide measurement Measured locally Not measured consistently Contrary to the economy s average, which identifies on-time delivery as the main KPI, the pharmaceutical industry identifies as its top KPI cost per unit, followed by inventory turns and manufacturing cycle time 1. 80% 60% 40% 20% 0% 4 - Identified Key Performance Indicators (KPIs) 1 Industry average Pharmaceutical On-time Delivery Inventory Turns Manufacturing Cycle Time Cost Per Unit 8

9 Pharmaceutical manufacturing is a highly regulated and documentation-intensive process. In the United States, the Food and Drug Administration publishes good manufacturing practices (GMP) documentation, which defines the standards by which pharmaceuticals are manufactured. In Canada, pharmaceutical and chemical supply chain partners must provide a daily inventory through DIN (Drug Identification Number) codes to multiple government agencies. This makes the process extremely complex, costly and inefficient for these firms 7. More than 65 percent of NA firms concerns are about regulatory traceability mandate issues NA Pharmaceutical SCM Traceability Concerns 3 80% 60% 40% 20% 0% Regulatory mandates Brand damage from product recall or regulatory non compliance Customer and trading partner requirements Product recall processes are also becoming critical for safety and corporate image purposes in a number of sectors. Currently, product recalls are mainly completed as general recall processes whereby all products are taken back to the factory. Although lot numbers can be traced at item level for some sectors, most consumer good products lot numbers are written on the product only, with no linkages to the bar code at the Stock Keeping Unit (SKU) level. This product recall process is extremely inefficient and costly. This mass recall process could also have major impact on the brand and corporate image. Brand damage from product recall or regulatory non compliance is the second most important concern for NA Pharmaceutical in terms of traceability issues 3,7. Key NA Pharmaceutical Logistics and SCM Mandate Compliance Initiatives 3,7 : Government Related Mandates: FDA and Health Canada Code of Federal Regulations Hazard Analysis and Critical Control Point (HACCP) USA Patriot Act Current Good Manufacturing Practices (CGMP) EU General Food Law Regulation Control oriented mandates: Sarbanes Oxley Country of Origin Labelling Product Traceability Customer mandated RFID or traceability mandates Secure data transmission and storage Industry Driven Mandates: Nutritional Labelling ANSI Grocery Manufacturers of America Efficient Consumer Response standards Secure Access for Everyone (SAFE) Pharmaceutical Research & Manufacturers of America initiative 9

10 In order for Pharmaceutical Manufacturers to achieve the benefits of these respective logistics and SCM business drivers, the adoption of logistics and SCM technology across supply chains is a key component for developing efficient collaboration networks. In terms of traceability issues, NA Pharmaceutical firms that are proactive in implementing technology to respond to compliance initiatives have improved their time to complete product traceability by 49 percent and reduce by 31 percent their cost of counterfeiting/gray market counterfeiting initiatives 3. 60% 6 - NA Pharmaceutical Manufacturers Benefits of Compliance Initiative 3 % Improvement 40% 20% 0% Time to complete Product Traceability Cost of Counterfeiting/Gray Market Compliance Initiatives Improvement in Regulatory Compliance Audit Furthermore, it is estimated that NA Small and Medium Sized Enterprises (SMEs) that will deploy logistics and SCM collaboration applications will enjoy a 5 percent to 25 percent decrease in logistics costs and a 15 percent to 40 percent increase in quality and time-to-market over competitors that fail to make these investments through % 40% 30% 20% 10% 0% 7 - Logistics and SCM innovation in Canada for the Pharmaceutical Sector 8 Manufacturing Chemical (less Pharmaceutical) Machinery manufacturing Pharmaceutical and medicine Manufacturing methods Logistics innovation Logistics innovation in innovative plants The Pharmaceutical Manufacturing sector invested less than the Manufacturing Average in terms of innovation in logistics processes while investing more in manufacturing methods. This demonstrates the fact that the sector has not yet fully embraced the global supply chain management model by focusing mainly on internal/production methods innovation 8. 10

11 II - Inventory Management and Just-in-Time Key Performance Indicators Key to the success of an agile Lean supply chain is the speed and flexibility with which these activities can be accomplished and the realization that customer needs and customer satisfaction are the very reasons for the network itself to exist. Achieving agility starts with the physical flow of parts, from the point of supply, through the factory, and shipment through agile distribution channels. The main logistics and SCM KPI to measure Lean supply chain agility is inventory turns. Inventory turns can be defined as how many times per year the average inventory for a firm changes, or is sold. This ratio is a common industry standard KPI in inventory management performance analysis. Manufacturing (Canada) In Manufacturing inventory management, it is important to distinguish between raw materials ratios (the inventory of products coming from suppliers), and finished goods ratios (the inventory of products ready to be shipped); inbound and outbound products being indeed quite different, data will therefore be presented on different graphs for each subsequent sub-sector. The Pharmaceutical and Medicine manufacturing sub sector displays low velocity of its inventories. This sector often produces large lots because of its manufacturing processes; for instance, calibration of their equipment takes a long time since multiple tests are required to ensure quality of the product. Also as mentioned earlier, their business focus is currently for item level traceability and supply chain visibility, and not solely on the inventory turns of their products. In the next few figures, the Pharmaceutical and Medicine manufacturing sub sector will be compared with the Meat product manufacturing sub sector. Although some could argue that their manufacturing processes are quite different (for example the importance of R&D in the pharmaceutical sector), it was noted that they indeed share important logistics similarities due to the tight regulations that their products must comply with, such as rules on content calibration, traceability, and visibility. 11

12 Inventory turns per year Raw Materials Inventory Turns for Canada Manufacturing Pharmaceutical and medicine manufacturing Meat product manufacturing On the raw materials side, it appears that the pharmaceutical sector s inventory turns decreased since The same situation occurred in the meat product manufacturing sector, although their inventory turns did not decrease as much (in percentage). This could be explained by the fact that both sectors had to focus on more stringent rules on traceability and quality control 2. The manufacturing sector as a whole actually saw an increase in terms of its inventory turns during the same period. Inventory turns Overall Growth for Raw Materials Inventory Turns in Canada Between 1992 and % 20% 10% 0% -10% -20% -30% -40% Manufacturing Pharmaceutical and medicine manufacturing Growth Total growth Since 1992, Pharmaceutical and medicine manufacturing s inventory turns declined by 36 percent in total. At the same time, the manufacturing (raw) sector increased its inventory turns by more than 20 percent 2. The situation is actually somehow similar on the finished goods side for the pharmaceutical and medicine manufacturing sector. 12

13 Inventory turns per year Finished Goods Inventory Turns for Canada Manufacturing Pharmaceutical and medicine manufacturing Meat product manufacturing We can see above that inventory turns actually decreased since 1992 in the pharmaceutical sector. At the same time, the manufacturing sector itself saw an increase of its turns Overall Growth for Finished Goods Inventory Turns in Canada Between 1992 and % Inventory Turns per Year % 10% 0% -10% -20% Growth 0 Manufacturing Pharmaceutical and medicine manufacturing Total growth -30% Finally the Pharmaceutical and medicine manufacturing s inventory turns actually declined by almost 20 percent in total since 1992, while the manufacturing sector increased by more than 23 percent 2. 13

14 Overall Pharmaceutical supply chain for Canada Inventory turns Pharmaceutical supply chain for Canada in Pharmaceutical and Pharmaceutical and Pharmaceutical, Health and personal medicine manufacturing (raw) medicine manufacturing (finished) toiletries, cosmetics and sundries wholesalers care stores Inventory turns Industry averages Pharmacies and drug stores Looking back at the Canadian simplified supply chain as a whole, it appears that this industry is below the industry sector averages in manufacturing and in wholesale, while its inventory turns as slightly above the average on the retail side. Canada/U.S. The U.S. inventory turns numbers are available only on a total inventory level. This means that instead of separating raw materials, work-in process and finished goods, the available U.S. ratio is composed of all that data merged together (confidentiality reasons). The following inter-country comparisons will therefore be on a total inventory / sales ratio. It is clear from the figure below that Canada lags behind the U.S. in terms of total inventory for the Pharmaceutical and Medicine manufacturing sector. Inventory turns remained unchanged in the U.S. when comparing 1992 to 2005, but the Canadian data shows a decline of 44 percent during that period 2. 14

15 Total Inventory / Sales Canada/U.S. Comparison for Total Inventory Turns in Pharmaceutical and Medicine Products Manufacturing % gap U.S. Canada In order to reach the 2005 U.S. level in terms of total inventory/sales, Canada would need to increase its efficiency by 137 percent 2. Again in terms of total inventory, it appears that both countries are below the industry average when it comes to manufacturing and wholesale, as can be seen on the figure below. Total Inventory / Sales Pharmaceutical Supply Chain Comparison for Canada/U.S. in Pharmaceutical and medicine manufacturing CA Pharmaceutical and medicine manufacturing U.S. Pharmaceutical, toiletries, cosmetics and sundries wholesalers CA Drugs and druggist sundries wholesalers U.S. Health and personal care stores CA Inventory turns Pharmacies and drug stores CA Industry averages The U.S. data was not available on the retail side, but Canadian data is presented for Health & personal care and Pharmacies & drug stores sectors for comparison purposes with the other supply chain partners. As noted previously, Canadian retail s inventory turns are slightly above the industry average. 15

16 Benefits of indicators to productivity and competitiveness Technology and best practices are important factors in inventory management. It is clear that technology-enabled companies in North America achieved higher improvement rates than other firms, as displayed in Figure The concept of high technology/process adopters vs. low technology/process adopters is used to explain the difference between NA companies having better than average technologies and best-practices, and their opposites. Figure 15 displays the percentage of NA respondents that achieved a greater than 15 percent improvement in three logistics and SCM KPIs, namely: increase in the perfect order percentage to the customers; reduction in inventory carrying cost; and reduction in lead times to the customers. This figure shows that companies that use best practices in inventory management technology and processes in their industry achieved significantly better JIT KPI results than their peers, notably for the key lean drivers in the NA Pharmaceutical Manufacturing sector (Improvement of Operational Performance, Inventory Reduction and Shorter Order Cycle times) High Technology Adopters Achieve Better Results in Inventory Management 6 60% % NA Firms Achieving > 15% improvement % of Respondents 40% 20% 0% Increased Perfect Order % to Customers Reduced Inventory Carrying Cost Reduced Lead Times to Customers High Technology Adopters Industry Norm Low Technology Adopters III - Logistics Costs KPIs While inventory turns is the main KPI for evaluating supply chain agility, logistics cost KPI allow firms to evaluate the efficiency of their logistics and SCM operations. The combination of supply chain agility and efficient SCM practices is key to the long term competitiveness and prosperity of Canadian firms in the emerging GSC context. Logistics costs occur internally within firms, are outsourced to logistics service providers and occur via inventory carrying costs. The sum of these three components will enable 16

17 firms to evaluate their sector total costs and benchmark themselves against their own industry, their U.S. counterparts and other key sectors that share similar logistics and SCM processes. The mix of internal, outsourced and inventory carrying costs will also allow firms to evaluate their own logistics and SCM cost structure while enabling them to rethink their business model, if deemed necessary. This section presents logistic costs in the Pharmaceutical and Medicine manufacturing sub-sector for Canada, compared to other selected sectors and the manufacturing average. Logistics Internal costs Internal SCM and logistics costs encompass all logistics activities that occur within a firm. It excludes all outsourced logistics activities and all production processes. The analysis of logistics costs is done in percentage of sector s Gross Domestic Product (GDP) and by percentage of gross output share. Internal cost in percentage of GDP represents the logistics activity that occurs within a firm compared to all internal value added activities. It excludes all service and product sourcing costs. It is the most precise indicator of the size of the logistics activity that occurs within a firm. On the other hand, the percentage of gross output share allows firms to benchmark themselves more easily. The percentage of gross output share includes all the internal costs in addition to service and product sourcing; this often creates some multiple counting issues, which explains why the ratios displayed are quite smaller than the percentage of GDP. The following figure represents internal logistics costs for Canada for the Pharmaceutical sub-sector and its industry (Manufacturing). 8% 16 - Internal Logistics Costs for the Pharmaceutical and Medicine Manufacturing sub-sector in Canada 2 GDP share Gross output share 6% 4% 2% 0% Manufacturing Pharmaceutical and medicine manufacturing Compared to the manufacturing average, the Pharmaceutical and Medicine manufacturing sector has lower logistics internal costs in terms of GDP and Gross output 17

18 shares. GDP wise, there is a gap of 49 percent between this sub-sector and the Manufacturing average. Looking at logistics internal costs in terms of output share, the Pharmaceutical and Medicine manufacturing sector still has a lower logistics internal costs than the Manufacturing average (by 39 percent) 2. Logistics outsourcing costs Logistics outsourcing costs encompass activities assigned to a logistics service provider. Using the purchases that originate from users as part of logistics activities is appropriate, instead of using the sales, because it avoids multiple counting. The next figure studies more specifically the case of Pharmaceutical and Medicine manufacturing and compares it to the Manufacturing industry and the Meat product manufacturing sector (chosen because of similar concerns than those of the Pharmaceutical and Medicine manufacturing sector regarding traceability) and Motor Vehicle manufacturing (chosen because of its very particular characteristics regarding logistics outsourcing costs). 1.5% 1.0% 0.5% 17 - Logistics Outsourcing in the Pharmaceutical Manufacturing subsector in Canada 2 25% 20% 15% 10% 5% 0.0% Manufacturing Motor vehicle manufacturing Pharmaceutical and medicine manufacturing Meat product manufacturing 0% Outsourcing as % of total commodities Storage and warehousing as % of Logistics outsourcing As the previous figure shows, the Pharmaceutical sector has the particularity that it outsources very little logistics processes, but that from that small percentage (0.26 percent), almost 25 percent goes to storage and warehousing, which is by far superior to the percentage of storage and warehousing done by other sectors such as Motor Vehicle manufacturing and more than 4 times higher than the Manufacturing industry average. In fact, the Pharmaceutical and medicine manufacturing sector has one of the lowest logistics outsourcing costs among all manufacturing sectors 2. Inventory Carrying costs Inventory carrying costs are defined as a series of costs that compose a company s supply chain management costs. They include opportunity costs, shrinkage, insurance and taxes, total obsolescence (for raw materials, work in process (WIP), and finished good inventory), channel obsolescence and field service parts obsolescence. It excludes all 18

19 distribution cost related to warehousing, which are captured in the internal and outsourced logistics costs. However, it is important to keep in mind that inventory carrying costs cannot be used to compare the size of the economic activity of a sector since they mainly represents accounting based costs, therefore it should not be calculated in percentage of sector GDP. % of sales 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 18 - Inventory Carrying Cost as % of Sales for Canada 2 Manufacturing Pharmaceutical Meat product % of sales As can be seen in the previous figure, the Pharmaceutical and Medicine manufacturing sector has inventory carrying costs, in terms of sales, that are well above the Manufacturing industry average, by almost 100 percent. Again, when compared to the data for inventory turns, a clear relation appears. For instance, the Meat product manufacturing sector has turns that are, on average, twice as high as those from Manufacturing, which is reflected by the fact that they have inventory carrying costs that are below the manufacturing average. On the other hand, the Pharmaceutical and Medicine manufacturing sector has low inventory turns, this translates into a high inventory carrying cost as inventory turns velocity is one of the key factors in determining inventory carrying costs 2. However, high inventory turns is not the only explanatory variable as very specific conditions for storage in this sector also help increase inventory carrying costs. Nevertheless, since decreasing storage costs is complicated in this sector because of very specific storage requirements, increasing inventory turns and becoming more efficient with respect to logistics processes should be a priority since it would greatly help in decreasing inventory carrying costs, and thus costs in general. Total logistics costs The following figure looks at the overall composition of logistics costs for the Pharmaceutical and Medicine manufacturing sector in Canada and compares it to other selected sectors. 19

20 % of total logistics costs 19 - Total Logistics Costs for Canada in the Pharmaceutical and Selected Sectors 2 100% 80% 60% 40% 20% 0% Manufacturing Pharmaceutical and medicine manufacturing Internal costs Outsourcing Inventory carrying cost Meat product manufacturing As can be seen in the previous figure, the Pharmaceutical and Medicine manufacturing sector has internal costs that are relatively lower than those for both, the manufacturing industry average and the Meat product manufacturing sector (by 1.6 and 1.8 times respectively). In terms of logistics outsourcing costs, the difference between the Pharmaceutical and Medicine manufacturing sector, the manufacturing average and the Meat product manufacturing sector is even more pronounced. The Pharmaceutical and Medicine manufacturing sector has logistics outsourcing costs that are, respectively, 3.8 and 4.1 times lower than those for the manufacturing average and the Meat product manufacturing sector. However, this represents logistics costs as percentages of total logistics costs, and thus, the fact that the Pharmaceutical sector has low logistics internal and outsourcing costs is due to relatively high inventory carrying costs in this sector. In relative terms, the Pharmaceutical and Medicine manufacturing sector has inventory carrying costs that are 2.1 and 2.8 times higher than the manufacturing average and the inventory carrying cost for the Meat product manufacturing sector (respectively). As was expressed before, this difference can be explained by low inventory turns and high storage costs in this sector 2. 20

21 The following figure shows total logistics costs in terms of sales. 7% 20 - Total Logistics Costs as % of sales for Canada in the Pharmaceutical and Selected Sectors 2 6% 5% % of sales 4% 3% 2% 1% 0% Manufacturing Pharmaceutical Motor vehicle Internal costs Outsourcing Inventory carrying cost The trends that were identified in the Figure 19 are verified here. The Pharmaceutical and Medicine manufacturing sector has inventory carrying costs that are well above the industry average and the sector chosen for comparison, in this case the Motor Vehicle manufacturing sector. As before, it also has logistics outsourcing and logistic internal costs that are below the manufacturing average and the Motor vehicle manufacturing sector 2. IV - Final remarks In order to benefit from the productivity of logistics and SCM, individual firms must develop their own personal action plan. The final step in a business case is to make recommendations and develop a roadmap for implementing the proposed action plan. The roadmap exercise consists of documenting the long-term perspective into specific action items linked to deliverables, performance indicators objectives, return on investment and a project time frame. For some firms, the first roadmap action item could be an internal evaluation of their logistics KPI with some participation in associations and networking activities. For others, it could be implementing a pilot project with a customer and a supplier. In all cases, a well-documented roadmap allows firms to gain the support of all their stakeholders for their logistics and SCM competitiveness strategy and to solicit their involvement in the implementation phases of the firm s logistics and SCM action plan. 21

22 Proposed Action Plan: 1- Evaluate internal firm logistics and SCM KPI based on the indicators listed in this document. 2- Map out business processes, global supply chain and technology adoption. 3- Benchmark your firm s KPI to your industry KPI in Canada and in the U.S.. 4- Assess firm s performance KPI to industry taking into consideration supply chain processes. 5- Benchmark firm s KPI to other industries KPI in Canada and in the U.S. that share the same logistics and SCM processes and drivers. 6- Create a multi-function project team. Senior management buy-in could determine the success rate of this initiative, as will a champion at the initial stage. 7- Develop a logistics and SCM competitiveness roadmap. 8- Develop performance measurements of the roadmap initiatives. 9- Educate your company executives across departments, supply chain partners and service providers on the value of the roadmap for each specific stakeholder. 10- Increase supply chain collaboration initiatives that drive value in your specific sector. 11- Partner with supply chain partners to develop with you the technology, processes and information solutions needed to manage the process. 12- Implement KPI program with frequent use of measures focused on cost-effective customer-driven satisfaction issues with supply chain partners. 22

23 Annex I Methodology SCM & Logistics Costs Methodology Every company measures its costs related to marketing, human resources, research and development, etc. Interestingly, very few know how much their logistics costs really are. The last decade saw a growth in interest for concepts such as JIT, Lean manufacturing and Efficient Consumer Response, all of which, in addition with the globalization of the supply chains, brought the importance of Logistics and Supply Chain Management (SCM) from an operational status, often to a strategic status for the company and its partners. It is for this reason that Supply Chain & Logistics Canada s (SCL) Research Committee and Industry Canada have partnered with Jacobson Consulting to launch a logistics cost methodology research initiative. By combining the industry know-how of SCL with the supply chain research experience of Industry Canada and the economical modeling specific expertise of Paul Jacobson, a former director at Infometrica, the partners have developed an optimal research team for this initiative. One of the main sources of logistics costs data available until now is the Annual State of Logistics Report, published in the U.S., which is sponsored by the Council of Supply Chain Management Professionals (CSCMP). This report provides annual data on the cost of the U.S. business logistics system in relation to their Gross Domestic Product (GDP). The data provided goes back to 1984 and is mainly available on a macro level, with categories available such as Inventory Carrying Costs, Transportation Costs and Administrative Costs, but does not look at the sector-level data. It is important for a company to understand the nature and the costs of its logistics and SCM operations. Furthermore, companies should be able to access that type of information on each industrial sector for comparison purposes. Comparing the information to GDP is essential to understanding the importance of logistics on a given sector, while comparing the information to the Gross margin allows companies to benchmark their logistics and SCM costs to their sector, their partners and their competitors. Gross margin = total operating revenue - cost of goods sold Total operating revenue = sales of goods purchased for resale + commission revenue + sales of goods produced + repair and maintenance revenue + revenue from rental and leasing + other operating revenue. Cost of goods sold = Opening inventory + Purchases - Closing inventory. Here, the research initiative will focus on providing sector level information of logistics and SCM costs that occur internally through firms (such as in the manufacturing, wholesale and retail sectors), as well as evaluating supply chain s functions that are outsourced by sectors, and their relative inventory carrying costs. By combining these three categories, individual firms will have the opportunity to have a global view of supply chain management costs by sectors and of the outsourcing trends, thus allowing them to benchmark themselves to their competitors, partners and other sectors in Canada and in the U.S.. 23

24 SCM and logistics costs can be broken down in three separate, but complementary pieces: internal costs, outsourcing costs and inventory carrying costs. Each one is described below, with its methodology and an example when appropriate. Internal SCM and logistics costs: Internal SCM and logistics cost encompass all logistics activities that occur within a firm, such as a manufacturer, wholesaler or retailer. It excludes all outsourced logistics activities and all production process. Individual firms can evaluate their internal logistics cost by adding their respective logistics cost activities and their components as stated in the table below. Internal logistics cost activities Inbound and outbound transportation Transportation management Warehousing Materials handling Order fulfillment Logistics network design Inventory management Supply/demand planning Management of third party logistics services providers Custom brokerage Logistics and SCM technology management Sourcing and procurement processes (excluding purchase of goods cost) Internal logistics cost components of activities Logistics wages cost Logistics infrastructure depreciation Logistics technology investment depreciation Transport equipment depreciation Training cost related to logistics position Logistics management cost Internal SCM and logistics costs are the most complex to calculate since no organization accounts for these. The estimates of internal logistics costs in this report were compiled via the following methodology: 1- Determine the occupational types related to logistics, and link those to logistical activities. In total, twenty-one occupations were found and assigned to one of the four logistics activities namely: Distribution Centers (DC), Office work, Truck transportation and Other transportation (rail, etc.). For example, material handlers are linked to DC activities, while customs & ships brokers and industrial engineering and manufacturing are part of office related activities. 2- Find for each industrial sub sector the number or persons in each occupational sub category. There are sixty sub sectors in manufacturing, thirty in wholesale and thirty in retail. 3- Find the logistics suppliers equivalent to the four logistics activities from above. For example, under Office work were included the consulting services and support to transportation and warehousing personnel. 4- Calculate the wage bill of the four logistics activities after occupations were linked to them. The ratio of the total costs divided by the wage bill is then charged to the sixty sub sectors in manufacturing, to the thirty sub sectors in wholesale and to the thirty sub sectors in retail. For example, for each dollar spent in salaries, it is known that in average 2$ are spent on infrastructures, technologies and management costs. All this allows the estimation of the logistics and SCM costs for each industrial sub sector. Outsourcing costs: Outsourcing costs encompass activities assigned to a third-party. Outsourcing costs come from input-output tables from Statistics Canada that indicate how much each industry requires of the production of each other industry in order to produce each dollar of its own output by compiling the purchases of logistics services by users. 24

25 Using the purchases that originate as part of logistics activities is appropriate, instead of using the sales, because it avoids multiple counting. Example A manufacturing firm writes a check for $10 million to a 3PL to assume all its distribution activities for the current year. That 3PL does not actually own trucks, and hire a transportation broker to actually contract the required vehicles as necessary, for that same amount. The transportation broker will sign multiple deals during that year with transportation companies, again totalling $10 million. By looking at the sales figures in the input-output tables, the logistics activity in that scenario would now total $30 million. Utilizing instead the purchases of logistics services allows isolating the real logistics activity, which is indeed $10 million. An example of the activities that are outsourced and/or done inside a company is displayed in the chart below. In-House and Outsourced Supply Chain Activities in Canada Customs Clearance 4PL Services Customs Brokerage Freight Forwarding Factoring Inbound Transportation Fleet Management Cross Checking Outbound Transportation Freight Bill Reverse Logistics Shipment Consolidation Supply Chain Management Distribution Control Procurement of Logistics Services Inventory Ownership Carrier Selection Warehousing Rate Negotiation Information Technology Order Fulfillment Order Entry Processing Customer Service Inventory Management Outsourced In-House 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% As can be seen, outsourcing differs largely according to the type of activity. Certain activities are largely outsourced, such as Customs Clearance or Customs Brokerage, and others are mainly done in-house, such as Inventory Management and Customer Service. 25

26 Inventory Carrying Cost: Lexi-Com s Glossary of Logistics Terms defines inventory carrying cost as follows. One of the elements comprising a company s total supply chain-management costs. These costs consist of the following : 1) Opportunity Cost : The opportunity costs of holding inventory. This should be based on your company s own cost of capital standards using the following formula. Calculation : Cost of Capital x Average Net Value of Inventory 2) Shrinkage : The costs associated with breakage, pilferage, and deterioration of inventories. Usually pertains to the loss of material through handling damage, theft, or neglect. 3) Insurance and Taxes : The cost of insuring inventories and taxes associated with the holding of inventory. 4) Total Obsolescence for Raw Material, WIP, and Finished Goods Inventory : Inventory reserves taken due to obsolescence and scrap and includes products exceeding the shelf life, i.e. spoils and is no good for use in its original purpose (do not include reserves taken for Field Service Parts). 5) Channel Obsolescence: Aging allowances paid to channel partners, provisions for buy-back agreements, etc. Includes all material that goes obsolete while in a distribution channel. Usually, a distributor will demand a refund on material that goes bad (shelf life) or is no longer needed because of changing needs. 6) Field Service Parts Obsolescence : Reserves taken due to obsolescence and scrap. Field Service Parts are those inventory kept at location outside the four walls of the manufacturing plant i.e., distribution center or warehouse. What inventory carrying costs do not consist of : - all the necessary handling of the goods and/or materials, - the depreciation of the goods and/or materials. Those are actually already included in the internal logistics costs above. Inventory Carrying Cost Rate: The inventory carrying cost rate is applied on the average annual inventory in order to estimate the cost of having inventory into a specific firm or industry. The average industry accepted and used rate is estimated at 20 percent 20. TOTAL SCM & LOGISTICS COSTS = INTERNAL COSTS + OUTSOURCING COSTS + INVENTORY CARRYING COSTS Inventory carrying costs and outsourcing costs cannot be put in terms of GDP, since they are accounting-based, and not a real economic activity. Both are compared to gross margins. On the other hand, internal costs can be compared both to GDP and to gross margin. Logistics and SCM costs vary widely by sector. The proportion of internal costs, outsourcing costs and inventory carrying costs is also different between sectors. For example, in a JIT mode, internal costs tend to increase, but this is balanced by a reduction in the inventory carrying costs; this happens in volatile sectors, such as upscale clothing, computers and perishable goods. 26

27 Annex II Definitions Collaborative Planning Forecasting and Replenishment (CPFR): Trademark registered by the VICS (Voluntary Interindustry Commerce Standards) in 1996 designating an approach of collaboration and integration of the forecasting and planning processes between customers and suppliers. A certain number of test operations have been conducted between manufacturers and distributors in the area of mass consumer products, but it is also starting to be used between manufacturing companies. Partner companies (distributors, manufacturers, suppliers, etc.) exchange information on product sales and forecasts in order to synchronize their operational plans. This approach also integrates the downstream information flow to take account of manufacturing constraints. Fill Rate: The percentage of order items that the picking operation actually fills within a given period of time. Forecast: An estimate of future demand. A forecast can be determined by mathematical means using historical data; it can be created subjectively by using estimates from informal sources; or it can represent a combination of both techniques. Gross margin: This value is obtained by calculating: total operating revenue- cost of goods sold. Total operating revenue: The sum of sales of goods purchased for resale, commission revenue, sales of goods produced, repair and maintenance revenue, revenue from rental and leasing and other operating revenue. Cost of goods sold: This value represents the cost value of goods sold and recognized in revenue, during the reporting period. It is determined by calculating: Opening inventory + Purchases - Closing inventory. Hub: A reference for a logistics network as in hub and spoke, which is common in the airline and the trucking industry. Input: The sum of all goods and services purchased by a firm or an industrial sector. Internal logistics cost: Internal logistics cost encompasses all logistics activities that occur within a firm, such as a manufacturer, wholesaler and retailer. It excludes all outsourced logistics activities and all production process. Individual firms can evaluate their internal logistics cost by adding their respective logistics cost activities and their components as stated in the table below. Internal logistics cost activities Inbound and outbound transportation Transportation management Warehousing Materials handling Order fulfillment Logistics network design Inventory management Supply/demand planning Management of third party logistics services providers Custom brokerage Logistics and SCM technology management Sourcing and procurement processes (excluding purchase of goods cost) Internal logistics cost components of activities Logistics wages cost Logistics infrastructure depreciation Logistics technology investment depreciation Transport equipment depreciation Training cost related to logistics position Logistics management cost 27