Developing a performance measurement system requires top management support, organisational buy-in, and resources to set up procedures for appropriate data col-lection. Top management need to communicate their support for the new system, and emphasise the link with incentives and remuneration, where appropriate.
Figure 11.5 overviews the various stages in developing a purchasing performance measurement system.
1. Determine goals to measure
Driven by the cascading of corporate strategy, business strategy and functional supply strategy, the first step is to identify the critical areas for measurement.
Different categories (discussed in the section above) are going to be more or less important across firms. Specific performance measures are not necessary at this stage, just creating alignment between firm strategy and performance measurement. A key pitfall for many firms at this stage is selecting goals which do not reflect the corporate- and business-level strategy of the firm, or which have not been revis-ited as the firm’s strategy and operations change.
2. Establish performance measures
Ideally, the specific performance measures used to monitor and evaluate per-formance should possess certain characteristics. The SMART test (Specific, Measurable, Actionable, Relevant, and Timely) is frequently used to provide a quick
Figure 11.5 Designing a purchasing performance measurement system
Source: adapted from Monczka et al. (2005)
reference to determine the quality of a particular performance metric. Table 11.2 highlights key characteristics of effective performance measures.
Firms face many challenges in establishing the ‘right’ kind of performance mea-sures. Performance measures can lack ‘power’ to influence behaviour where they are not linked to employee evaluation or incentive plans. Organisations may select too many measures, leading to a lack of focus, or alternatively, select too few mea-sures which may lead to missing information. The meamea-sures may also have a short-term focus, or generate conflicting signals as to desired behaviours.
3. Establish standards for comparison
Three main approaches are possible for establishing standards. It is no good mea-suring performance without having a standard or expectation against which to com-pare the result. Furthermore, personnel should be allowed to participate in setting the standards, as it generally leads to higher commitment to meeting those standards.
n Analysis of historical data. Firms can gather past data about an activity as a basis for setting the performance standard. Where a firm has lots of experience with the activity, this can provide a good basis for predicting future performance.
A continuous improvement aim may also be embedded in the target to aid in cost saving. This approach is often used in purchasing for efficiency-related mea-sures, such as price. However, it is important to guard against relying on these measures excessively. Even seemingly minor changes in the way in the product is manufactured or sourced can make the standard irrelevant. For example, a Northern Irish weaving company recently sourced to China and experienced significant reductions in their input costs – clearly the target would have to be reset!
n Planned performance. Firms may also look at other internal divisions or groups to identify company-wide best practice. For example, TNT, a courier company, would publish a league table of the highest-performing depots, with the per-formance of the top depot being the ‘stretch’ goal for the others. This can Table 11.2 Characteristics of effective performance measurement systems
Measurement systems should:
1 Be linked to corporate objectives (‘goal congruence’)
2 Combine different measures to meet the requirements of different organisational levels (‘cascading goals’ – i.e. the goals of one level are the means of another)
3 Capture elements of both efficiency and effectiveness
4 Allow the identification of trade-offs between different dimensions of performance 5 Include a balanced mixture of qualitative and quantitative measures
6 Include a mix of leading and lagging indicators of performance 7 Be incapable of manipulation
8 Allow data to be collected systematically and analysed over time
9 Differentiate between incremental/control measures and radical objectives 10 Encourage cross-functional working
create a more realistic ‘stretch’ target, but can lead to dysfunctional rivalry among internal business units as they compete, rather than cooperate. In any case, best practice internally may not match the capabilities of the external competitors.
n Competitive benchmarking. Goals may also be set based on detailed analysis of competitors, or firms in other industries, but who manage similar activities. For example, airlines and hotels may collaborate on benchmarking as they both conduct food and beverage purchasing, but compete in distinct industries. By identifying the practices and performance of external companies competitive bench-marking can be motivator for best practice and world-class manufacturing.
4. Monitor progress
At this stage, firms must make decisions about the type of feedback they require from their performance measures. They must identify who the users are, what information they require, how frequently and how this data will be collected.
Measuring progress too often leads to excessive cost and effort for little value.
Conversely, measuring progress too little may lead to potential problems not being recognised until it is too late.
5. Evaluate progress
The purchasing performance measurement system must ensure that it has feedback mechanisms: i.e. close the loop. The performance measures should capture per-formance, and identify exceptions to what is planned. For example, the system may identify an unfavourable material price variance for the month. This would be a signal that follow-up investigation is required. One problem faced at this stage is over-aggregation of the data, which can lead to masking of potentially important events or trends.
6. Implement improvement actions
The final step of the performance measurement process is to undertake corrective action. The firm must move to correct the problems or issues identified. However, a number of cautions are appropriate at this point. Firms must ensure that they are not driving the wrong performance; they must be sure that the measures used will result in the desired actions. Some measures may encourage internal com-petition and discourage teamwork if performance is measured vertically, rather than horizontally across the entire work process.
7. The Purchasing Balanced Scorecard
The Balanced Scorecard, developed by Kaplan and Norton (1992, 1996), was ori-ginally conceived as a means of measuring corporate performance in a manner which reflects not only financial indicators of performance, but also those other critical value drivers that enable an organisation to compete successfully. The Balanced Scorecard attempts to foster a balance between disparate strategic measures, as no single type of measure can provide a clear focus for attention. It is a useful planning
tool which does not place undue emphasis on simple control measures but rather pulls activities into line with corporate strategy. The Balanced Scorecard thus becomes a tool for focusing the organisation, improving communication, setting organisa-tional objectives and providing feedback on strategy.
The Balanced Scorecard shows not only the critical measures of firm success, but also the relationship between those measures in a cause-and-effect manner. It is not simply a ‘laundry list’ of measures, but rather individual measures within the four perspectives must be linked together explicitly. The scorecard is based on four perspectives: financial; customer; internal business processes; and innovation and learning.
n Financial perspective reflects the underlying financial performance of the firm.
It typically includes more traditional measures of corporate performance, focus-ing on profitability, cash flow, and shareholders. Accountfocus-ing information is also backward-looking – showing the results of actions already taken – thus the remain-ing three measures are seen as measurremain-ing the drivers of performance.
n Customer focus is essential to understanding how customers view the business, because without customers, no organisation can create value. This area forces managers to translate their broad goals on customer service into measures that really matter to the customer. It is composed of such issues as time, quality, performance and service, and essentially tries to get managers to see the com-pany from the customers’ point of view.
n Internal business processes refer to the way operations are carried out within the company, which enable customer satisfaction to be achieved. The focus should be on the internal processes that have the greatest impact on customer satis-faction, and therefore which affect cycle time, productivity, quality and design, for example. A capable information system is vital for this to be achieved.
n Innovation and learning is the ability to change and improve on a continuous basis. While customer and internal business processes reflect the parameters that the company considers vital for success, continuous improvement is also neces-sary in a turbulent business environment. It recognises the intellectual assets which are inherent in any organisation and the importance of human resources.
The scorecard approach provides a potentially useful way of approaching pur-chasing performance measurement. Purpur-chasing and Supply departments must satisfy not only certain financial targets, such as cost reduction and price perfor-mance, but also other important areas. Notably, a fifth perspective may be added measuring supplier performance, and assessing how well purchasing performs vis-à-vis its suppliers. Figure 11.6 illustrates a sample Balanced Scorecard, complete with potential performance measures. Financial perspective may assess the price performance, such as material price variances, the total purchasing costs, and other firm-specific measures, such as foreign currency matrices. The Internal Business Process perspective may measure the on-time delivery, order cycle time, or per-centage of spend covered by e-procurement techniques, such as reverse auctions.
Under Innovation and Learning, the levels of professional development, in terms of qualifications or the levels of training of staff, may be important. For Sup-plier Performance the firm may measure the percentage of the supply base that is
certified, the level of supplier satisfaction or the depth of supply base for particu-lar commodities.
Summary
This chapter has overviewed the characteristics of effective performance measure-ment in supply chains. Although Purchasing has traditionally had difficulty in measuring inter-organisational performance, it is slowly developing more sophist-icated systems which assess purchasing performance both internally, with regard to internal customers, and externally, with regard to their suppliers. The chapter also offered a framework for the development of a purchasing performance measurement system, and provided a sample Balanced Scorecard, which might be used for monitoring and evaluating purchasing performance.
Figure 11.6 A sample Purchasing Balanced Scorecard
Copyright © 1996, by The Regents of the University of California, Reprinted from the California Management Review, Vol. 39, No. 1. By permission of the Regents
Seminar questions
1. Outline the basic elements of performance measurement systems.
2. Discuss how performance measurement and strategy interact, giving examples of good and bad practice.
3. Develop a set of performance measurements for evaluating purchasing performance in a firm competing: (a) as an innovative, high-tech manufacturer; (b) a low-cost provider; and (c) a manufacturer of medical equipment.
References
Butler, R. (1995) ‘What You Measure is What You Get – an Investigation into Measure-ment of the Value Added by the Purchasing Function’, in Lamming, R. (ed.), 4th Inter-national Purchasing Supply & Education Research Association Conference (IPSERA), University of Glamorgan, Glamorgan.
Cousins, P. D. (2002) ‘A Conceptual Model for Long-term Inter-organisational Relation-ships’, European Journal of Purchasing and Supply Management, Vol. 8 (2), pp. 71– 82.
Dumond, E. J. (1991) ‘Performance Measurement and Decision Making in a Purchasing Environment’, International Journal of Purchasing and Materials Management, Vol. 27 (2), pp. 21–31.
Kaplan, R. S. and Norton, D. P. (1992) ‘The Balanced Scorecard – Measures that Drive Performance’, Harvard Business Review, January–February, pp. 71–9.
Kaplan, R. S. and Norton, D. P. (1996) ‘Linking the Balanced Scorecard to Strategy’, California Management Review, Vol. 39 (1), pp. 53 –79.
Monczka, R. M., Trent, R. J. and Handfield, R. B. (2005) Purchasing and Supply Chain Management, 3rd edn, South Western, Cincinatti.
Saunders, M. (1994) Strategic Purchasing and Supply Chain Management, Pitman, London.
van Weele, A. (1984) ‘Purchasing Performance Measurement and Evaluation’, Journal of Purchasing and Materials Management, Fall, pp. 16 –22.
Further reading
Lee, H. L. and Billington, C. (1992) ‘Managing Supply Chain Inventory: Pitfalls and Opportunities’, Sloan Management Review, Vol. 33 (3), pp. 65 –73.