Supply chain management: monitoring strategic partnering contracts with activity-based measures: second-generation ABC systems may be the wave of the future, not just for TQM but now also in supply chain management. In a creative tale of a fictitious small-town business, the authors illustrate why

Management Accounting Quarterly, Fall, 2006 by Michael F. Thomas, James Mackey

EXECUTIVE SUMMARY Traditional management accounting systems are not designed to link nonvalue-adding activities and the resulting cost variances they can create to their causes, such as poor quality or inefficiencies in upstream activities. To improve supplier performance, management accounting systems should measure activities such as on-time deliveries and complete order filling.

Highlighting the growing importance of the management accounting system's role in supporting supply chain management (SCM), a 2003 Institute of Management Accountants (IMA[R]) article began with this statement: "As competition continues to intensify, more and more companies are competing primarily on the nimbleness of their supply chains. Lean supply management, the growth of outsourcing, and the rise of make-to-order manufacturing have made supply chain management an increasingly critical element in creating and preserving value." (1)

On the other hand, another 2003 IMA article summarizing a survey conducted by UPS Supply Chain Solutions, Alpharetta, Ga., reported that while 61% of responding CFOs believed SCM was crucial to their success, 62% believed that only incremental improvements were possible because of fragmented supply chain control and the inability to measure supply chain costs. (2)

A 2005 IMA report concluded that "if your company doesn't already have a system for vendor measurement, one should be developed. Among the key metrics for vendor performance: How does each one rate for on-time delivery, quality, and other factors that influence your operations? The price on a vendor's invoice is only part of the picture. A low price grows costly when it's accompanied by late deliveries and rejections based on quality." (3)

Today the call continues for basic SCM measures capturing supplier quality, on-time delivery, and equally balanced measures for cost, quality, time, and effectiveness. (4) Thus, management accountants are being challenged to create SCM measures for these value chain activities. This challenge is also an opportunity to expand activity-based management (ABM) metrics to include supply chain activities.

At IMA's 2005 Annual Conference, Michael Hughes, former CIO for Network Services Company, suggested three customer-oriented supply chain performance measures: complete order filling, on-time delivery rates, and warranty return rates. (5) In this article we expand on his presentation, demonstrating how the first two activities can be measured and reported within the management accounting system. We also add a third measure combining warranty and return activities with other downstream quality costs.

These measures are illustrated using a hypothetical scenario presenting problems created by suppliers, their causes, and the development of the SCM measures mentioned above. This scenario mimics real-world discussions and employs a fictitious company, Multree Homes, to illustrate the reasons why it is advantageous for management accounting systems to routinely report SCM measures such as complete order filling, on-time delivery, and the cost of poor supplier quality (i.e., a vendor performance index). Multree Homes produces manufactured houses and is the main employer in Multreeville, a small, fictitious town located in northern California.

Presenting these ideas in a case format can facilitate their inclusion in management accounting classes, especially at the introductory MBA level. This case can also be used as a lead-in to a spreadsheet project for graphically reporting these SCM measures.

A TALE OF SUPPLIER WOES

As usual, supplier problems dominated the weekly production planning meeting at Multree Homes. Bob, the vice president of manufacturing, began the discussion. "I see we've switched back to Woodsman Lumber for our framing stock. I thought we weren't going to order any more lumber from them until they fixed their quality problems. What's going on?"

"Quality's not the half of it!" added Alice, the shipping and receiving foreman. "I've been trying to reach their Shipping Department for a week now, but they haven't returned my calls. I can't keep letting my people stand around waiting for deliveries that don't arrive on time. Just last week, three of five orders were late by a day or more. I've also been caught shorthanded when deliveries arrived early. One of the five orders was delivered two days before we expected it. My people also seem to be spending too much time inspecting these orders. The biggest problem is with incomplete shipments. Only two of last week's five orders were complete."

"That's not all," John, the production supervisor, said. "Alice's people aren't responsible for inspecting the quality of the framing stock, like knots in the wood, warped studs, wrong lengths, and so on. My people do that when they frame the houses. Quality problems cause a significant amount of nonvalue-added activities in Assembly. I've also tried to call Woodsman about this, but my messages have gone unanswered, too."

Tommy, the personnel manager, interjected: "I grew up with most of the people working in our plant. They tell me about their problems over weekend beers and football. Trying to fix quality problems results in many unfavorable cost variances, like direct labor rate and usage, direct materials usage, variable overhead spending and usage, as well as making it harder to meet our production quotas. These folks are really upset because bonuses are based on avoiding cost variances, and they're not getting bonuses because of the supplier problems.