Guest Article: A Framework For Measuring Supply Chain Costs

By Vivek Sehgal, Supply Chain Musings

In defining the long term trends in the environment that will impact supply chain strategies, I talked about two main changes happening in the environment. One was the costs and redistribution of costs/incomes; and second was environmental consciousness.

Let us explore what constitutes the supply chain costs and the specific processes that impact these costs. Some of the supply chain costs are crisply defined, readily available, and widely used in the industry. Others are less well known, and tend to get lost in the heaps of corporate data. However evaluating supply chain costs requires that we understand them, invest in defining them as clearly as possible, have processes to capture, report, and analyze them. Only such a complete picture of supply chain costs can truly drive new initiatives, find gaps in existing processes, and help in continually improving the cost and efficiency of the supply chain operations.

To clearly understand the impact of supply chain costs, corporations need to develop a "cost framework" to define, develop, and measure these costs. The discussions below helps in understanding what such a framework should look like, the scope of such costs, and how they affect the total supply chain costs for an enterprise.

To understand the scope of these costs, we will organize them into three categories as in the picture below. Grouping these costs into these categories will not only help us understand the source of these costs, but also provide an understanding of how to measure them and how to optimize them to make the supply chain more efficient and cost effective. In doing so, though one must use caution, as a single minded focus on cost alone may not be the most optimal supply chain strategy. Since supply chains must address the twin objectives of cost and flexibility (or responsiveness), supply chain performance must be measured using metrics that allow capturing both of these aspects. However, in the current discussion, we will focus on the cost aspects alone, and leave the flexibility for another day.