Chapter 3 • Supply Chain Drivers and Metrics 59

many instances a study of the six drivers may indicate the need to change the supply chain strat-
egy and, potentially, even the competitive strategy.
Consider this framework using Walmart as an example. Walmart’s competitive strategy
is to be a reliable, low-cost retailer for a wide variety of mass-consumption goods. This strat-
egy dictates that the ideal supply chain will emphasize efficiency but also maintain an ade-
quate level of responsiveness in terms of product availability. Walmart uses the three logistical
and three cross-functional drivers effectively to achieve this type of supply chain performance.
With the inventory driver, Walmart maintains an efficient supply chain by keeping low levels
of inventory. For instance, Walmart pioneered cross-docking, a system in which inventory is
not stocked in a warehouse but rather is shipped to stores from the manufacturer with a brief
stop at a distribution center (DC), where product is transferred from inbound trucks from the
supplier to outbound trucks to the retail store. This lowers inventory significantly because
products are stocked only at stores, not at both stores and warehouses. With respect to inven-
tory, Walmart favors efficiency over responsiveness. On the transportation front, Walmart runs
its own fleet, to keep responsiveness high. This increases transportation cost, but the benefits
in terms of reduced inventory and improved product availability justify this cost in Walmart’s
case. In the case of facilities, Walmart uses centrally located DCs within its network of stores
to decrease the number of facilities and increase efficiency at each DC. Walmart builds retail
stores only where the demand is sufficient to justify having several of them supported by a DC,
thereby increasing efficiency of its transportation assets. Walmart has invested significantly
more than its competitors in information technology, allowing the company to feed demand
information across the supply chain to suppliers that manufacture only what is being demanded.
As a result, Walmart is a leader in its use of the information driver to improve responsiveness
and decrease inventory investment. With regard to the sourcing driver, Walmart identifies effi-
cient sources for each product it sells. Walmart feeds them large orders, allowing them to be
efficient by exploiting economies of scale. Finally, for the pricing driver, Walmart practices
“everyday low pricing” (EDLP) for its products. This ensures that customer demand stays
steady and does not fluctuate with price variations. The entire supply chain then focuses on
meeting this demand in an efficient manner. Walmart uses all the supply chain drivers to
achieve the right balance between responsiveness and efficiency so its competitive strategy
and supply chain strategy are in harmony.
We devote the next six sections to a detailed discussion of each of the three logistical and
three cross-functional drivers, their roles in the supply chain, and their impact on financial per-
formance.

3.4 Facilities
In this section, we discuss the role that facilities play in the supply chain and critical facility-
related decisions that supply chain managers need to make.

Role in the Supply Chain

Firms can increase responsiveness by increasing the number of facilities, making them more
flexible, or increasing capacity. Each of these actions, however, comes at a cost. Increasing the
number of facilities increases facility and inventory costs but decreases transportation costs and
reduces response time. Increasing the flexibility or capacity of a facility increases facility costs
but decreases inventory costs and response time. Thus, each supply chain must find the appropri-
ate tradeoff when designing its facilities network. Whereas IKEA has become profitable by
opening a few hundred large stores (no more than one or two per city) to grow efficiency, Seven-
Eleven Japan has grown profitability by opening a highly dense network of stores (often hun-
dreds per city) to provide responsiveness. Both companies are successful because the facility
decisions are aligned with the supply chain strategy.
60 Chapter 3 • Supply Chain Drivers and Metrics

EXAMPLE 3-1 Toyota and Honda

Both Toyota and Honda use facilities decisions to be more responsive to their customers. These
companies have an end goal of opening manufacturing facilities in every major market that they
enter. Although there are other benefits to opening local facilities, such as protection from cur-
rency fluctuation and trade barriers, the increase in responsiveness plays a large role in Toyota’s
and Honda’s decision to place facilities in their local markets. The flexibility of Honda facilities
to assemble both SUVs and cars in the same plant allowed the company to keep costs down in
the downturn of 2008. While competitors’ SUV production facilities were idle, Honda facilities
maintained a high level of utilization.

Components of Facilities Decisions

Decisions regarding facilities are a crucial part of supply chain design. We now identify compo-
nents of facilities decisions that companies must analyze.

Role Firms must decide whether production facilities will be flexible, dedicated, or a combi-
nation of the two. Flexible capacity can be used for many types of products but is often less
efficient, whereas dedicated capacity can be used for only a limited number of products but is
more efficient. Firms must also decide whether to design a facility with a product focus or a
functional focus. A product-focused facility performs all functions (e.g., fabrication and assem-
bly) needed for producing a single type of product. A functional-focused facility performs a
given set of functions (e.g., fabrication or assembly) on many types of products. A product focus
tends to result in more expertise about a particular type of product at the expense of the func-
tional expertise that comes from a functional methodology.
For warehouses and DCs, firms must decide whether they will be primarily cross-docking
facilities or storage facilities. At cross-docking facilities, inbound trucks from suppliers are
unloaded; the product is broken into smaller lots and is quickly loaded onto store-bound trucks.
Each store-bound truck carries a variety of products, some from each inbound truck. For storage
facilities, firms must decide on the products to be stored at each facility.

Location Deciding where a company will locate its facilities constitutes a large part of the
design of a supply chain. A basic trade-off here is whether to centralize to gain economies of
scale or to decentralize to become more responsive by being closer to the customer. Companies
must also consider a host of issues related to the various characteristics of the local area in which
the facility is situated. These include macroeconomic factors, quality of workers, cost of work-
ers, cost of facility, availability of infrastructure, proximity to customers, the location of that
firm’s other facilities, tax effects, and other strategic factors.

Capacity Companies must also determine a facility’s capacity to perform its intended func-
tion or functions. A large amount of excess capacity allows the facility to respond to wide swings
in the demands placed on it. Excess capacity, however, costs money and therefore can decrease
efficiency. A facility with little excess capacity will likely be more efficient per unit of product it
produces than one with a lot of unused capacity. The high-utilization facility, however, will have
difficulty responding to demand fluctuations. Therefore, a company must make a trade-off to
determine the right amount of capacity to have at each of its facilities.

Facility-Related Metrics Facility-related decisions affect both the financial performance

of the firm and the supply chain’s responsiveness to customers. On the financial side, facilities
decisions have an impact on the cost of goods sold, assets in PP&E (if facilities are owned), and
 Chapter 3 • Supply Chain Drivers and Metrics 61

selling, general, and administrative expense (if facilities are leased). A manager should track the
following facility-related metrics that influence supply chain performance:
• Capacity measures the maximum amount a facility can process.
• Utilization measures the fraction of capacity that is currently being used in the facility.
Utilization affects both the unit cost of processing and the associated delays. Unit costs
tend to decline (PPET increases) and delays increase with increasing utilization.
• Processing/setup/down/idle time measures the fraction of time that the facility was pro-
cessing units, being set up to process units, unavailable because it was down, or idle
because it had no units to process. Ideally, utilization should be limited by demand and not
setup or downtime.
• Production cost per unit measures the average cost to produce a unit of output. These
costs may be measured per unit, per case, or per pound, depending on the product.
• Quality losses measure the fraction of production lost as a result of defects. Quality
losses hurt both financial performance and responsiveness.
• Theoretical flow/cycle time of production measures the time required to process a unit if
there are absolutely no delays at any stage.
• Actual average flow/cycle time measures the average actual time taken for all units pro-
cessed over a specified duration, such as a week or a month. The actual flow/cycle time
includes the theoretical time and any delays. This metric should be used when setting due
dates for orders.
• Flow time efficiency is the ratio of the theoretical flow time to the actual average flow
time. Low values for flow time efficiency indicate that a large fraction of time is spent
waiting.
• Product variety measures the number of products or product families processed in a
facility. Processing costs and flow times are likely to increase with product variety.
• Volume contribution of top 20 percent SKUs and customers measures the fraction of
total volume processed by a facility that comes from the top 20 percent of SKUs or cus-
tomers. An 80/20 outcome, in which the top 20 percent contribute 80 percent of volume,
indicates likely benefits from focusing the facility so separate processes are used to process
the top 20 percent and the remaining 80 percent.
• Average production batch size measures the average amount produced in each produc-
tion batch. Large batch sizes will decrease production cost but increase inventories.
• Production service level measures the fraction of production orders completed on time
and in full.

3.5 Inventory
In this section, we discuss the role that inventory plays in the supply chain and how managers use
inventory to drive supply chain performance.

Role in the Supply Chain

Inventory exists in the supply chain because of a mismatch between supply and demand. This
mismatch is intentional at a steel manufacturer, where it is economical to manufacture in large
lots that are then stored for future sales. The mismatch is also intentional at a retail store where
inventory is held in anticipation of future demand or when the retail store builds up inventory to
prepare for a surge in sales during the holiday season. In these instances, inventory is held to
reduce cost or increase the level of product availability.
Inventory affects the assets held, the costs incurred, and responsiveness provided in the
supply chain. High levels of inventory in an apparel supply chain improve responsiveness but
also leave the supply chain vulnerable to the need for markdowns, lowering profit margins. A
higher level of inventory also facilitates a reduction in production and transportation costs