Align service measures across supply chain

Service level should be the clearest and most impactful KPI in any supply chain, capturing the ability of the supply chain to enable the company to satisfy customers’ expectations. For many companies it is considered the ultimate performance measure and every other KPI – such as cost, inventory level or forecast accuracy – is either derivative, secondary or simply a means to the end of high service levels. Ralf W. Seifert, professor of operations management at IMD, and Richard Markoff, a supply chain researcher, consultant, coach and lecturer, have taken a closer look at this KPI. Their findings reveal that calculating it and managing around it come with challenges, but that it can nonetheless be a lever to improving the customer orientation in a supply chain organization.

At its most basic, service level measures try to answer the question, ‘Did we ship the order on time?’. Some companies go further and look at the non-serviced volume in the order, in an effort to appreciate the extent of the service disruption. But the curious dynamics of service measures can lead to complications. Imagine a customer that orders 10 units three times a week, where the customer uses the common ‘fill-or-kill’ policy of cancelling non-serviced orders. If the customer’s order of 10 units on Monday is not fulfilled, the order on Wednesday will not be for 10 units, it will be for 20 units: the 10 units for Wednesday plus the 10 units that were ordered on Monday and not shipped. If the stockout persists until Friday, then the customer will not order 10 units as usual, they will order 30 units. So a week-long stockout that should have impacted service levels by 30 units in fact resulted in an impact of 60 units of unfilled orders. The service level impact has been artificially doubled!

Internal friction and misunderstanding

One global consumer goods company supply chain executive shared how a Class-C SKU, a slow mover, was out of stock for three weeks and this dynamic of cumulative ordering managed to drag down his service level and raise alarms across the company, right up to senior management. He explained that some supply chain managers responded to these misleading results by removing orders for SKUs that were out of stock after the first order so that the SKU no longer impacted the service level KPI.

Another major consumer goods company attempted to resolve these issues by asking the commercial teams to enter into the company ERP ‘phantom orders’ that represented typical customer ordering patterns rather than integrating the escalating customer orders. According to yet another company, its commercial teams would hold back on informing customers of product discontinuations in order to delay product returns as long as possible. As a result, the customer – unaware that the product was no longer available – would continue ordering it and not be served, and the service level KPI became deeply corrupted. The result of all these dynamics is a KPI that creates counter-productive internal friction, misunderstanding and an atmosphere of bad faith rather than driving customer satisfaction. But it can also set the stage for a company to resolve these issues by focusing more on the customer expectations.

Service level as a business lever

The advent of EDI and subsequently TMS has allowed companies to think about service in more expansive terms. Rather than limiting service level to the notion of whether an order respected its ship date and volume, companies can now more easily measure when the order arrived at the customer, which is of course more meaningful for the perception of service. This step towards a more customer-centric approach has led to the advent of the ‘perfect order’: the idea that an order that contains all that was ordered, arrives on time and has no damage. This is a more enlightened service measure, and is the KPI often used by Gartner when discussing service level.

The idea that suppliers and customers collaborate on a shared KPI is far from universally accepted, but when companies do embrace a shared vision of the service goals of a supply chain the natural evolution is a spirit of collaboration for the benefit of all supply chain actors. Rather than being a point of contention, the service KPI becomes a lever for an integrated supply chain and deeper best practices for mutual benefit. In many cases, the internal frustrations around service level measures drive the companies to implement vendor-managed inventory (VMI) and improve customer-supplier catalogue synchronization, both valuable customer-oriented supply chain initiatives.

Next-stage service

As companies move deeper into the Age of the Consumer, the role and objective of KPIs like service could benefit from a rethink. Deepening mutual collaboration around service objectives can help create a context for leveraging cost-to-serve analysis. Cost-to-serve techniques can help both the supplier and the customer understand all of the aspects of supply chain service – such as order parameters and lead time – and make informed trade-offs between cost and service. These trade-offs are valid for all supply chain configurations, not only in retail distribution. In e-commerce each company must make choices about lead times and transportation charges. And for project supply chains, a more holistic view of service would include setting objectives or expectations for customer-order lead times and incorporating them into the company’s differentiation strategy.

Hence, looking at service level measures as a key element in the business strategy of market positioning, segmentation and cost structure can turn a point of contention into a lever for supply chain’s contribution to success.