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The success or failure of any business, regardless of its size, industry, or activity, will rely heavily on its ability to track and measure the right Key Performance Indicators (KPIs). Put simply, KPIs are important metrics that help ensure that organizations are on the right track in achieving their business goals and objectives. However, there are many companies out there that are uncertain or even unaware of the existence of these KPIs. And contrary to popular belief, effective performance indicators are more than just numbers that need to be reported. They are used to gauge the performance and overall effectiveness, or lack thereof, of any specific activity.
When tracked and measured correctly, KPIs can help businesses make critical corrections to their processes and stay on course towards achieving their goals. At the end of the day, if you can't measure something, you won't be able to improve it. What's even worse, you may not even realize that something is wrong before it's too late. It's for this reason why those in procurement need to keep their eye on the right metrics and constantly measure for performance. And what they need to look towards are procurement, sourcing, and supply chain KPIs. Below, we'll be exploring the different KPIs that fall within each of these three categories.
Overall Procurement KPIs
Put simply, procurement refers to the process of getting the necessary goods and/or services needed to fulfill the organization's business model. Among the tasks that are part of procurement include developing quality standards, price negotiations, financing purchases, buying goods, inventory control, and risk management, among others.
As part of the overall supply chain process, procurement typically stops the moment the organization has possession of the goods. In order to make a profit, the cost of procuring these goods will need to be less than the amount paid to sell them, minus the costs associated with the value-added processing. Even if the number of steps that go into the procurement process can be quite extensive, the nature and size of your business will ultimately determine the extent to which these steps will be implemented.
A multinational corporation, for instance, may need to undergo a thorough Identification of Requirement phase. A small business, on the other hand, will probably undergo a much simpler process. But using online purchase orders, generated by an e-procurement platform is essential, regardless of the size of the company. The same thing can also be said about keeping track of the most relevant procurement metrics and KPIs.
Top Procurement KPIs You Should Be Measuring
Spend under management - This KPI represents the total amount of spend that's actively managed by the procurement department. This figure includes all figures that procurement is working with, regardless of region or category, and can be divided into separate metrics that represent these factors. Spend under management is an important KPI because it reflects both the maturity and control of procurement over the organization's overall spend.
Spend vs. budget - This metric tracks the realization of procurement spend and compares it to the budget spend, either per business unit or as an overall. Spend management is ultimately decided based on tracking the realized spend against budgets. It also ensures the alignment with key stakeholders such as the finance department, for instance. When evaluating the spend vs. budget KPI, success is not always measured by a cost decrease but by also the budgeting accuracy.
The total cost of ownership (TCO) - The TCO represents the cumulative cost of all spend purchases. It takes into account all incurred costs during the procurement process, including direct and indirect costs. This KPI goes beyond just the purchase price and includes also the transaction fees, warehousing, and various incidental costs. The TCO is an important metric since it provides the basis for the total economic value of an investment.
Cost savings - Measuring cost savings is achieved through the cumulative amount of savings gained. Cost-saving KPIs can be further broken down so they can be more easily tracked. Over time, these will indicate how cost reduction targets have been met. They are achieved by combining spend across business units, ordering in larger quantities, introducing more supplier competition, removing long-term contracts, standardizing and rationalizing spend, implementing a vendor-managed inventory system, among other such strategies.
Cost avoidance - This KPI describes the effectiveness of any actions taken to help the company avoid absorbing any inevitable additional costs. These costs can be the result of inflation, exchange rate fluctuations, shorter payment terms, additional features and/or service requirements, etc. Cost avoidance helps in keeping future costs down, but will not be reflected in any budget or financial statements. Nevertheless, it can be used to measure procurement performance.
Average payment terms - This KPI measures the average time that invoices are paid. It's also calculated by using every instance of payment term information. By improving payment terms among suppliers, businesses will also help improve their working capital. Similar to cost avoidance KPI, the improvement in working capital will not be reflected in financial statements. Nevertheless, savings can still be calculated based on proxies such as the cost of borrowing. An increase in the average payment terms across managed contracts can save on interest charges costs, for example.
Vendor accountability - This KPI measures the suppliers' performance in terms of how responsible they are when it comes to handling claims and errors. Some examples of vendor performance measurements include lead times, defect rates, and the cumulative amounts of incidents per supplier. The aim of this metric is to ensure that the best possible product or service is delivered. Vendor accountability is also used to develop a more strategic approach towards improving supplier relationships.
Supply Chain Management KPIs
While procurement is the process that gets the goods a company needs, the supply chain represents the infrastructure needed to get those goods in the hands of the organization. It consists of the entire network of stakeholders involved in getting the product into the hands of the customer, going from gathering the raw materials, through to manufacturing, transportation, warehousing, processing, and all the way through to the end-user. It also includes all of the tasks and functions that contribute to this process, such as procurement, sourcing, quality control, sales, and more.
Supply chain management, as its name might suggest, is the act of overseeing and managing the supply chain. In doing so, it will ensure that all steps are operating as efficiently as possible. Among other things, this will ensure that suppliers are maintaining the desired level of quality and ethical business practices. Ultimately, supply chain management should be considered one of the many responsibilities that fall upon the procurement department. By understanding the key performance indicators that fall within this category, it will become easier to understand all of the intricacies that go into the umbrella term that is procurement.
Supply Chain KPIs That Need Your Attention
The main goals of tracking supply chain metrics are to increase productivity and customer satisfaction. Below are some of the most important supply chain KPIs that will keep your organization on the right track.
Perfect Order - This is one of the most important KPIs when measuring the effectiveness of the supply chain. The Perfect Order KPI calculates the error-free rate of each stage of a Purchase Order (error in order forecasting for procurement, error in warehouse pickup process, error in invoicing, and error in shipping orders, etc.). This KPI can help gauge customer satisfaction. If, for instance, you have a low percentage of on-time or damage-free deliveries, it will indicate that your customers aren't serviced on time. The formula for measuring the perfect order KPI is: ((Total Number of Orders – Number of Error Orders) / Total Number of Orders) * 100
Cash to Cash Cycle Time - While this metric sounds mostly financial in nature, it also reveals important insights into a company's supply chain operations. Basically, it indicates the number of days between paying for materials and getting paid for the product. Cash to cash measures the amount of time operating capital is tied up. During this time cash is not available for other purposes. A fast cash to cash KPI indicates a lean and profitable supply chain. The cash to cash cycle time metric is calculated as follows: Materials Payment Data – Customer Order Payment Date
Customer Order Cycle Time - This metric provides insights into product service and supply chain responsiveness. It indicates the period between the purchase order was received and the moment the order was successfully delivered. If the aforementioned cash to cash cycle time is increasing but this metric isn't, it shows issues with your cash to cash cycle time. The formulas for calculating the customer order cycle time are: Actual Delivery Date – Purchase Order Creation Date or Requested Delivery Date – Purchase Order Creation Date
Fill Rate - The percentage of a customer’s order that is filled on the first shipment. This can be represented as the percentage of items, SKUs, or order value that is included with the first shipment. It helps determine customer satisfaction and gives insights into the efficiency of your delivery service. The formula for calculating the fill rate of a supply chain is: (1- (Total Number of Items – Number of Shipped Items) / Total Number of Items) * 100
Days of Supply (DOS) - DOS is the most common KPI used by managers in measuring the efficiency of the supply chain. It's calculated by dividing the average inventory on hand (as value) by the average monthly demand (as value) and then multiplying it by thirty when measuring on a monthly basis. By reducing the inventory days of supply can help you minimize the risk of surplus and/or outdated inventory during periods of peak or low demand. You can calculate the DOS as follows: Average Inventory / Monthly Demand x 30
Inventory Turnover - This KPI provides insights about the number of times the entire inventory is sold over a specific period of time. The Inventory Turnover metric helps determine the efficiency of order fulfillment, marketing, sales, and production operations. It also shows how efficiently the business transforms its working capital that's invested into its inventory into actual profits. Inventory Turnover Ratio = Cost of Goods Sold / {(Opening Stock – Closing Stock) / 2}
Inventory Velocity (IV) - Inventory Velocity is the percentage of the inventory projected to be consumed within the upcoming period. It helps to understand how well the inventory on hand matched the demand. By tracking IV on a monthly basis will provide significant clues in terms of aligning inventory level to the optimal level for matching supply-demand, and preventing excessive stock in the warehouse. Here’s how you calculate inventory velocity: Inventory Velocity = Opening Stock / Next Period’s Sales Forecast
A 60 to 70 percent is considered a good benchmark in terms of inventory levels.
A 75 to 80 percent is recommended when dealing with fast-moving stocks.
Inventory levels that are above 80 percent or below 60 percent, are considered risky as they can lead to serious shortages or excess stock.
Freight Bill Accuracy - Billing accuracy is key to profitability and customer satisfaction and indicates the percentage of freight bills that are error-free. Billing accuracy is the key to profitability and customer satisfaction. It also helps identify any negative trends with the company's billing operations. The formula for calculating freight bill accuracy: (Number of Correct Freight Bills / Total Freight Bills) * 100
Gross Margin ROI - The Gross Margin Return on Investment (GMROI) reveals data about the company's profitability. It indicates the exact amount of money made from a specific amount of inventory investment. This metric helps to identify slow-moving items in the inventory and use that information to improve the company's planning, production, and warehouse operations. GMROI = (Gross Profit) / [(Opening Stock – Closing Stock) / 2] * 100 As a general rule of thumb, a GMROI between 200 and 225 typically shows good profitability.
Sourcing and Supplier Management KPIs
As its name would imply, sourcing is about locating sources of goods and services for the company. Sourcing a subsection of the procurement process. Where procurement is generally concerned with the logistics of acquiring materials, sourcing focuses solely on finding the best and most cost-effective suppliers for those goods. This part of the procurement process includes everything from scouting, negotiating, market research, and testing suppliers for quality. By implementing effective sourcing, the entire procurement process will become more efficient and streamlined.
To put it somewhat differently, sourcing is also about finding a good balance between the quality of raw materials and services, and their affordability. The less the company spends on the goods and services it needs, the more profits it stands to gain. However, if the cost of these materials is too low, their quality also risks becoming too low as well. And it's important for the organization to maintain its quality standards, otherwise risk alienating its customers and lose business.
At first glance, the sourcing process may seem like a one-time thing. The procurement team requests a quote, obtains the vendor information, and uploads it into the procurement software. It determines the lead times, pricing, minimum order quantities, and other such details. And with the exception of updating pricing information, this process is seemingly done once per supplier. However, this is not the case. It's always a good idea to have at least one backup supplier for each product or service, just in case the first one isn't able to fulfill their order. Then, there's the issue of ensuring that all suppliers maintain the desired level of service and quality. Long story short, sourcing is a never-ending process.
Before the sourcing process can even start, businesses will need to assess their purchasing needs, map out a plan, conduct market research, and identify potential suppliers. After this is completed, the sourcing team can evaluate the suppliers and choose the most suitable for each individual need.
Important Sourcing KPIs to Consider
Number of suppliers - By reducing the number of overlapping suppliers within a given category, businesses can experience an increase in efficiency, as well as cost savings. Increasing the number of suppliers in other areas, on the other hand, can help reduce the supply risk.
Supplier Ratings - This KPI takes into consideration the supplier's performance in terms of various parameters. Among these parameters, we can include response rates, on-time deliveries of supplies, invoice accuracy, or material quality. This metric helps identify the strength of the current supplier base and identify the strong and weak suppliers in the list. Businesses can use this data to identify, reward, and retain well-performing suppliers while also taking corrective action regarding the weak ones.
Compliance Rate - This sourcing KPI represents the entirety of basic agreements the organization has with its suppliers. It shows the various requirements like delivery times, special discounts, maximum reaction times in the event of issues, etc. The compliance rate KPI provides guidance into saving costs through better negotiations with suppliers.
Supplier Availability - The supplier availability KPI refers to the number of times goods are available to the supplier or the total number of orders placed with the supplier.
Supplier Defect Rate - This sourcing KPI measures the percentage of products received from vendors and suppliers that don't meet quality requirements and compliance specifications. The supplier defect rate is crucial when it comes to determining the final quality of a product.
Vendor Rejection Rate and Costs - These two metrics should be monitored on a regular basis as the correlation between them informs the procurement team whether there are any existing issues on a more serious level such as increment in both metrics and/or if the buyer can seek replacement goods or damages in a short period of time. By monitoring these metrics, the causing issues can be identified and possible solutions can be implemented to improve future situations.
While these lists of procurement, sourcing, and supply chain management KPIs are not exhaustive, they do highlight the differences between what each of these areas stands for and focuses on. These metrics can help identify problem areas, increase visibility and transparency, as well as streamline and optimize the entire procurement process of the organization.
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