How to Select Supply Chain KPIs
This article explores the risks of using inadequate KPIs for supply chain management. Starting with stories from the trenches, we structure the pitfalls (narrow focus, reduced collaboration, misalignment with business goals, and lack of ownership and accountability) and propose best practices to mitigate them (finding the right tradeoff between specific and holistic KPIs while selecting the correct number of metrics to alleviate narrow focus).
You can’t improve what you don’t measure.
Often attributed to Peter Drucker.
Key Performance Indicators (KPIs) are essential tools for capturing the status of operations, tracking progress, guiding data-driven decision-making, and federating teams around shared objectives. Without measurable targets and metrics, supply chain managers would be flying blind.
Metrics empower us to track both efficacy (doing the right things) and efficiency (doing things right), forming the foundation of process excellence. For instance, an S&OP manager might monitor forecast value added (efficacy) alongside the time spent refining the forecast (efficiency). If you want to learn more about efficacy and efficiency for supply chain planning, I detail demand planning excellence in my latest book (and outline the concept for inventory planning in this article).
Unfortunately, even if tracking metrics is essential for supply chain management, it is a double-edged sword that can result in unexpected consequences. What if our relentless drive to achieve specific numbers blinds us to create real business value?
This article explores the unintended consequences of tracking inappropriate KPIs and over-pressuring your teams to achieve specific targets, then presents you with a set of best practices to select the right metrics for your teams. First, we will briefly recap why monitoring KPIs is essential for supply chains. Second, through multiple supply chain stories, we will illustrate cases of KPI abuse and how planners can game metrics or corrupt data to achieve targets. Then, we will elaborate on a general theory on why some targets get hacked. Finally, we will discuss best practices to leverage KPIs while avoiding any misuse.
Acknowledgments
Bernard Mirasson, Laurent Staub, Oleksandr Yavlinsky, Jeff Harrop, Jorge Vargas, Mona Wappler, Antonio Rubido Costas, Kristina Soric, Jairo Cavalcanti, Simon Spavound, Julia Ievskaya, Ken Abraham, Apoorva Ganesh, Nathan Courtier, José Siman, Abhijit Padhi, Obinna Ikpengwa, Satyajit Chaudhuri
When Targets Go Wrong
What you measure is what you get.
Learning from Supply Chain Tales
Key performance indicators and metrics are invaluable for assessing a process’s efficacy, efficiency, and progress. However, overemphasizing KPIs and targets can be counterproductive if taken too far. Let’s illustrate the resulting problems with a few stories I witnessed over the years. In all cases, you will see how the team(s) lost track of what was important for their business and instead focused solely on the target by looking for shortcuts or corrupting data. In the following section, we will structure the risks and downsides of pressuring teams with KPIs.
- Demand Planning. Under pressure to deliver accurate forecasts, planners from an international beverage company shared with me their unique method to hack forecasting accuracy: If their predictions indicated sales but none materialized, they categorized these instances as “sales discrepancies” and conveniently marked them as 100% accurate.
- Demand Planning. Numerous companies incentivize their sales teams to exceed sales targets, often established based on demand forecasts. Regrettably, these companies also make the sales team responsible for generating these forecasts. This approach invariably leads to unrealistically low forecasts ill-suited for effective supply planning.
- Inventory Planning. I once encountered a company that used overstock to measure excess inventory. Overstock quantified inventory exceeding the projected demand for the next three months. To artificially reduce overstocks, planners would deliberately inflate forecasts for the overstocked items.
- Production Planning. In the early stages of a colleague’s career, Corporate emphasized that fill rate was the paramount metric. (If you are unfamiliar with fill rate, I explain it in this article.) Notably, it was linked to the annual incentive plan. Responding to this, a plant manager, in a bid to optimize this metric, decided to focus predominantly on high runners. This strategy indeed boosted the fill rate for a while. However, it inadvertently led to a backlog of slow movers — individually of low value but collectively significant. When the repercussions of this strategy became evident, the plant manager was laid off. The aftermath was a painstaking process for the plant to address the accumulated low-volume orders. This incident prompted a restructuring: S&OP was detached from Operations, and new metrics started to be used alongside fill rate: forecast accuracy, past due items, lead time, and inventory turns. Ultimately delivering real business value.
- Customer Service. I’ve seen representatives alter initially requested delivery dates in their order management systems to showcase high service levels to senior management (with the consent of mid-level management). Such manipulations not only paint a misleading picture of business but will also distort future forecasts by introducing erroneous historical order patterns (that might be captured by the forecasting engine as trends and seasonality).
- S&OP. In many companies, rescheduling customer orders in the last week of the month is a common practice to game monthly sales targets, demand forecasts, and inventory KPIs. (I have witnessed the same game with accrued costs and revenues to align each quarter’s results to the budget.)
- S&OP. The executive team of a publicly traded, international FMCG food company chose to evaluate its supply chain performance based on service, cash, and cost. To gauge these areas, they monitored multiple KPIs at the close of each quarter (when they had to report to investors). A notable KPI was cash effectiveness, determined by days-of-inventory — which was only reported at quarter end. To enhance their balance sheet with impressive sales-to-inventory ratios, production would frequently slow down or even come to a standstill as the quarter concluded. This tactic, however, meant that the onset of the following quarter was invariably hectic, with teams facing reduced service levels and a spike in plant operations. Ultimately, more costs, lower services, and more stress.
What Went Wrong
When a measure becomes a target, it ceases to be a good measure.
Goodhart’s Law
Let’s structure the common pitfalls of overemphasizing KPIs,
- Narrow Focus (or Blind Spots). Focusing on a specific KPI can lead to tunnel vision: planners only focus on what’s being measured while overlooking broader business opportunities (or threats). Hyper-focusing on a single KPI is likely to compromise overall business performance.
Example: You only focus on the immediate fill rate while leaving some backorders open for months.
Note that narrow focus can also result from tracking a metric only at a specific point in time.
Example: Inventory levels are only measured at the quarter’s end, so production (and supply orders) always slow down during this period.
- Reduced Collaboration. KPI tunnel vision can breed silos and hinder collaboration. The essence of supply chain collaboration gets lost in the metric rat race. This lack of cooperation will worsen when different KPIs conflict: improving one metric may inadvertently hurt another owned by another function. These metrics are communicating vessels: you can optimize one metric, but only at the expense of another. Pressuring teams on conflicting KPIs will cause stress, resentment, and conflicts.
Example: Inventory planners will fight to reduce inventory and ask for frequent, short production runs. Production planners refuse as they report on running time.
When hosting the Fresh Connection (a supply chain business game), I routinely see players focusing on specific KPIs and losing sight of the global picture (and how their decisions will impact other functions). This always backfires.
- Misalignment with Business Goals. A classic pitfall is chasing a metric that doesn’t perfectly reflect the actual business objectives of your supply chain.
Example: Inventory and production managers are incentivized to reach 100% service level. Unfortunately, this results in massive inventory levels, ultimately causing obsolete inventory and waste.
- Gaming Metrics. Individuals, teams, or even organizations might find ways (and ultimately choose) to hack metrics, corrupt data, or game the system. This might backfire entirely and destroy value for the company. We will discuss this aspect further in the follow-up article, Supply Chain KPIs: When Incentives and Bonuses Are Toxic.
- Lack of Ownership and Accountability. Certain metrics, while pertinent, can be too broad to be attributed to a single team. When multiple individuals or teams share responsibility for the same KPIs, ownership becomes ambiguous, leading to diluted accountability.
Example: Consider tracking the overall profitability or costs of a large business. Individual planners might not feel a direct day-to-day responsibility for this KPI, especially in a company with thousands of employees, as its overall profitability extends beyond their immediate role.
Note that this effect can also go in the other direction: some teams might achieve challenging targets thanks to causes independent of their work (or the work of other teams).
Example: You gave a 95% fill rate target to your inventory manager. In parallel, the demand planning team is launching a machine learning initiative that improves forecasting accuracy by 15%. You are now achieving a 97% fill rate.
- Lack of Agency and Control. When teams are pressured to meet specific targets without being given the necessary tools, control, and autonomy, it leads to frustration and a sense of powerlessness. Supply chain managers should ensure that teams have the resources and authority to meaningfully impact the KPIs they are accountable for.
Example: You make your inventory planning team responsible for OTIF (On-time In-full), but they don’t control forecasting accuracy, production planning, and distribution.
Example: Early 2020, you gave your demand planning team a 70% forecasting accuracy target with a reward plan. They never achieved it due to COVID.
Moreover, if targets are used to bully teams and individuals (maybe even in front of their peers), they will do everything they can to show good numbers — Including corrupting data and gaming metrics. We will discuss toxic management further in a follow-up article.
Example: Once a week, senior management will gather all teams. Individuals who didn’t achieve their targets will be confronted and must provide explanations in front of their peers.
While KPIs and targets are invaluable, they aren’t without pitfalls and risks. Pursuing inadequate KPIs is likely to backfire with unintended consequences. Let’s now discuss best practices to avoid the drawbacks we highlighted.
How to Define KPIs for Supply Chain Management
Choosing the Right Set of Metrics
Tracking KPIs is essential for supply chain management. Yet, chasing the wrong metrics might result in unintended consequences. Fortunately, supply chain leaders have two main levers to set KPIs properly:
- Specificity vs. Breadth of KPIs. Should the KPIs be specific or holistic?
- Number of KPIs. How many KPIs do you select for each team?
KPIs: Specificity vs. Breadth
KPIs can be plotted on a spectrum from specific to holistic.
- Specific KPIs offer precise, actionable insights. Their well-defined nature makes it straightforward to establish clear ownership, empowering teams to control the metrics and hold themselves accountable for outcomes.. However, as discussed in Section 1, overemphasizing too specific metrics can foster narrow focus, reduced collaboration, and misalignment with business goals.
Example: Management is reviewing the forecasting accuracy of the demand planning team solely based on M+2. Demand planners might then neglect to enrich M+1 and M+3 forecasts.
- Broad (holistic) KPIs, such as profitability or total costs, align more with overarching business objectives. However, their expansive nature will dilute individual responsibility, accountability, and ownership.
Example: Planners might struggle to feel connected and responsible for improving the overall profitability of a company with thousands of employees.
Finding the right balance between specific and holistic KPIs is crucial. While more specific KPIs can lead to tunnel vision and siloed operations, overly broad ones can result in a lack of accountability and directionless teams.
Aligning KPIs to Roles
Where operational planners benefit from metrics tied to tactical execution, senior management and executives will thrive with holistic metrics. A top-down approach ensures this alignment, as high-level goals are cascaded down through the organization. This helps employees understand how their individual efforts contribute to achieving broader strategic objectives, providing a clearer sense of their role in the larger mission.
Through this thoughtful cascading process, strategic leaders can monitor holistic KPIs, while operational teams focus on the tasks they are directly accountable for. In this way, individual KPIs serve as the foundational elements for achieving collective organizational goals.
The Right Number of KPIs
Introducing a diverse set of specific KPIs can alleviate some of the drawbacks of specificity (more metrics make it more difficult to get trapped in a narrow focus, hinder collaboration, game metrics, and collectively be misaligned with business goals) while providing excellent control and accountability.
When introducing multiple KPIs, select metrics that balance and complement each other. Ideally, the same team should be accountable for the complete set of related KPIs — or you might face conflicts. For example, balancing service metrics with inventory metrics could spark conflict between customer service and inventory planners. A better approach is combining inventory level metrics (like turnover) with complementary ones like the percentage of items in stock, which reinforces accountability within the inventory planning team. The key points are:
- Specific KPIs should balance/complement each other.
- Accountability works best when one team owns the complete set of related KPIs.
- Balancing across teams can cause issues.
Nevertheless, you should not push this too far by selecting too many metrics. This can lead to confusion, lack of focus, and make prioritization challenging. (Remember, it is called Key performance indicators.)
Example: Management is now reviewing the demand planning team by looking at forecast value added for lags +1 to +6 (more about forecasting horizon here). This is a fair and actionable KPI: every region is evaluated on its capacity to add value (and not absolute accuracy) and actionable as planners know how to improve accuracy for these lags.
Context and Management Matter
Beyond selecting the right metrics, how you introduce KPIs to teams and manage their progress (and failures) is critical.
- Purpose and Alignment. Goals should align across individual, functional, and company levels. Mismatched objectives create conflicts. Connect each goal to the overarching strategy so people grasp the broader impact.
- Autonomy, Control, and Mastery. Ensure teams feel empowered to influence the processes and results they are measured on. Provide the necessary resources, tools, and training to instill a sense of authority, control, and proficiency over their responsibilities. Unattainable targets breed frustration.
- Toxic Management. Don’t wield KPIs punitively. Toxic management styles that publicly shame provoke anxiety and unethical behaviors. Instead, coach, mentor, and lead your teams forward constructively. Focus on progress and growth — rather than blaming failures.
With the proper context and management, teams will view KPIs as fair assessments, not weapons. KPIs are a critical tool to manage performance, but they won’t substitute for people management. Interactions with the teams and discussions based on facts and figures show consideration and recognition for team members and their work.
Conclusion: The Sweet Spot
While KPIs are invaluable navigational tools, they require careful selection and balance between specificity and breadth on the one hand and too many and too few on the other.
When implementing new KPIs, it’s wise to ask: “What behaviors could this metric inadvertently incentivize, and what potential negative consequences may result?” Giving your planners a specific KPI will likely result in multiple pitfalls (narrow focus, reduced collaboration, and misalignment with business goals). Similarly, managing planners using holistic metrics will likely result in a lack of ownership, control, and accountability.
Instead, we advise picking a couple of specific KPIs as
- Specificity facilitates accountability and actionability.
- Selecting multiple metrics limits most risks related to using too-specific indicators.
In our following article, Supply Chain KPIs: When Incentives and Bonuses Are Toxic, we will discuss how to manage and incentivize teams once KPIs have been defined.
