The Analytics of Operational Efficiency in Distribution

Distributors cannot generate high profit rates without high efficiency.
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Back in the olden days (the ’80s), we used to talk a lot about “efficiency.” It was all the rage before we got into “quality,” “kaizen” and lot of other things that have marked changes in our philosophy and priorities.

Over the past two years, I’ve noticed the emergence of certain super-performing companies that have posted profit rates beyond what conventional wisdom thought possible. On closer examination, it seems the advent of sophisticated analytics in these companies has brought them full-circle, back to a focus on efficiency.

At my firm, WayPoint Analytics, we provide an online service where distribution and manufacturing companies maintain several years of invoice and financial data that our system costs out in minute detail, showing precisely where money is made and lost. Overseeing tens of billions in industry activity, we can see the common factors shared by the market-leading companies. I’ll share several of them in this article.

Efficiency not only a critical element of profitability, it’s also directly coupled with profit performance. Companies cannot generate high profit rates without high efficiency. In fact, it’s the single best predictor of company success. 

What, Exactly, is Efficiency?

In the most common terms, efficiency means getting the most out for what you put in. This simple definition is actually suggestive of the analytics that could be invented and applied to numerous areas in any company.

Some familiar real-world examples might be: miles per gallon; miles per hour; hours per charge; etc. In each of these cases, someone has invented a metric that indicates what we get back for some unit of input.

In our environment, a few of the interesting metrics might be:

·  operating cash (gross profit) per order

·  line picks per warehouse person

·  total order value (gross profit) per delivery

·  total order value (gross profit) per total overhead expenses

Measures like these reflect the efficiency and productivity of our people, resources and investments. They can both show where improvement is most useful, and help monitor progress toward greater results.

The Conversion Chain

That brings us to the actual financial function of a business.

Taking a long step back from the specifics of product, companies are really mechanisms for converting revenue into profit by producing something of value for customers. The conversion happens in a chain of activities or actions that cost money in each link, leaving some of the original revenue left over — that which we consider as profit.

In broad terms, there’s a cascade that starts with revenue, much of which is diverted to pay for the product. Then more is diverted to fund our logistical operations, and then sales compensation. The balance represents the bottom line. 

Within the operations step, there’s more relevant detail. The sub-chain might include: order entry; assembly or other value-add; warehouse pick/pack operations; delivery; invoicing and collections; and overhead. Each of these takes its share of the revenue as it passes through the cascade, and represents a potential sensor point for analytics.

Referring back to efficiency, a good metric can be assigned to each step: component expenses divided by revenue, or component expenses divided by gross profit. Both can help compare the relative costs for each step, and through time, reflect improvements that efficiency initiatives deliver.

Operating Cash Used (Conversion Chain Metric)

At WayPoint, we use specific metrics of this type: Operating Cash Used (or OCU). This metric is an indicator of the consumption of the company’s operating cash by various components of the logistical chain. Lower is better.

By way of explanation, “operating cash” is our term for gross profit, used to convey the real purpose and importance of money left after the product is paid for. Operating cash is actually the operating budget for the company, the branch, the territory or for a single sale. Expenses cannot exceed this number or a loss will occur. 

The formula for OCU is as follows, and can be applied to each of the component parts of the operations sub-chain. In other words, there can be a specific metric for each of: order entry; assembly; warehouse; delivery; and overhead.

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If you’d like to compare your company’s performance on these metrics to some industry numbers, you could use these:

·  OCU–Order Entry: 5.0%

·  OCU–Warehouse: 16.1%

·  OCU–Delivery: 11.4%

·  OCU–Overhead: 35.2%

Naturally, the objective is to begin measuring each part of your logistics chain, and then work to improve (reduce) the expenditures relative to the available operating cash. 

This metric is improved by: natural growth in business volume; margin increases; reduction in the cost or consumption of supplies and materials; manpower compliment or cost reductions; increases in capacity utilization.

Operating Cash Processed (Productivity)

Operating Cash Processed is a class of metric that reflects productivity, which can be closely linked to efficiency. It indicates how much value is handled per unit in various areas of your logistics chain. Units are usually things you can count: heads; picks; deliveries; etc. Larger is better.

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Some examples: Op Cash per Full-Time-Equivalent; Op Cash per delivery; Op Cash per Order.

Initiatives you’re considering or have already implemented could positively impact this measure. Delivery routing, pick routing in the warehouse, warehouse automation, software upgrades, picking priorities, zone stations and training can all positively affect this measure.

Metrics in this class can be used to quantify the benefit of these and other initiatives. Some of the specific metrics we use are:

·  operating cash (gross profit) per order

·  total order value (gross profit) picked per warehouse person/hour

·  line picks per warehouse person

·  total order value (gross profit) per delivery

Operating Cash Ratio (Component Efficiency)

Operating Cash Ratio is the granddaddy of efficiency metrics in that it directly reports the return on expenditures. This is my favorite class of performance metric, because it’s directly coupled to efficiency and a good indicator of likely profit performance.

These metrics follow the form of: operating cash per expenses.

MAcLean Blog image 3 5/8/2019

There’s one of these measures for each component in your logistics chain: 

·  total order value (gross profit) entered per order entry expenses

·  total order value (gross profit) picked per warehouse expenses

·  total order value (gross profit) delivered per delivery expenses

·  total order value (gross profit) per total overhead expenses

You could also use similar metrics for advertising and marketing, sales compensation, and other parts of your operations.

Again, here are some benchmarks you can use to compare your company’s performance:

·  Op-Cash Ratio–Order Entry: $45.00

·  Op-Cash Ratio–Warehouse: $9.19

·  Op-Cash Ratio–Delivery: $25.30

·  Op-Cash Ratio–Overhead: $4.90

This particular class of metrics has great utility in direct management of each component of your logistical operations. For instance, the warehouse manager would anticipate that annual salary increases would reduce his op cash ratio, and may be looking for reductions in material costs or other hard cost reductions for an offset. Perhaps efficiency gains in pick routing or zone picking would maintain performance levels without back-filling for staff attrition.

The Real Benefit: Engagement

A powerful and often-overlooked benefit of implementing analytics is that doing so engages more of the company’s managers in executive-level decision-making.

If staff and mid-level managers can begin to act on their own ideas to reduce waste of time or money in a myriad of areas visible just to them, gains can be made in areas that will never be touched by executive-driven initiatives. The company’s efficiency and profitability can be increased both significantly and sustainably, and in ways the competition may never discover.

Analytics that are broadly and deeply implemented give everyone a chance to contribute, and this kind of engagement increases morale and accelerates careers by exposing the ideas and actions of those who can help propel the company to greater success. 

Analytics are a lot more mysterious that they deserve to be. Really, they’re just consistent measures that show how effective, productive or efficient various operational components are, making it easy to spot things that are working well, and those that could use some help.

Implementing a few of those outlined here can make a real difference in shifting focus to getting more done for less cost, and this is the edge that leading operations have. 

Put them to work in your unit and see what top performance feels like.

 

 

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