As the harsh lessons of the past 18 months have demonstrated, efficient and cost-effective logistics operations can play a role in determining which companies succeed and which ones fail. But as more organizations look to logistics as a basis for business competition, there is a greater need for managers to monitor the health of their logistics activities.

One way they can do that is by establishing meaningful metrics—one of the most difficult but essential jobs facing logistics managers today. Because logistics can be both a significant cost center and a source of competitive advantage, effective performance monitoring helps companies ensure that they're on the path to financial stability and service excellence.

Although the need for measuring logistics performance is clear, knowing what to measure—and how best to do it—is not so obvious. Each company's situation, of course, will be different. But there are some general principles that every logistics manager can follow. The following guidelines, gleaned from experts in the field as well as from the Council of Logistics Management's book Keeping Score: Measuring the Business Value of Logistics in the Supply Chain, can help managers choose the most effective measurements for logistics activities.

According to James S. Keebler, Karl B. Manrodt, David A. Durtsche and D. Michael Ledyard, authors of Keeping Score, meaningful performance measurements meet 10 specific criteria. These criteria, which offer a useful framework for any company that wants to create an effective performance-measurement program, include the following:

Is it quantitative? First and foremost, measures must be quantitative. This means that the measures must have a firm and factual basis and not be structured on feelings or subjective rankings. Examples of objective measures include time (How long does it take to pick an order?), quantity (What percentage of orders are picked with 100-percent accuracy?), and cost (What is the shipping cost for a specific product line?). An example of a subjective rating system is a 1-to-5 scale, in which someone assesses how he or she thinks a supplier performed. That type of rating is based as much on perception as it is on reality, say the researchers.

Is it easy to understand? Many people at all levels of a company will be involved in measuring logistics performance and implementing changes based on what they find. A good performance measure must be able to clearly convey what it is measuring and how that measurement was derived, in a way that is meaningful to all members of the organization.

Does it encourage appropriate behavior? In a recent poll conducted by Logistics Management & Distribution Report, 12 percent of the respondents reported that more than 30 percent of their salary was based on their performance in relation to specific measures. Most respondents, though, said their compensation was not tied to such measures. Although there are pros and cons to both approaches, the potential exists for improper performance measures to reinforce undesirable behavior by employees. For example, an employee might be rewarded by the existing measurement system for ordering low-cost items without regard to quantity. But if that employee buys too much, that extra inventory may not move and will end up costing more in storage and inventory-carrying costs in the long run. That could result in a skewed representation of how the organization is doing financially. In short, performance measurements should be based on what is best for the company rather than what is best for the individual.

Is it visible? Information about how and why the measurements are being used should be clearly understood by everyone involved, say the authors of Keeping Score. The numbers should also be available at all times so that problem areas will quickly become apparent and can be corrected right away.

Is it defined and mutually understood? It's important that all members of the team—both internal and external—clearly define metrics and agree on terminology. Even as common a term as "on-time delivery" can mean different things to different companies. One retailer may define on-time delivery to mean "within a 15-minute delivery window," whereas another retailer may use the term to mean "at some point during the specified day."

"Until the basics are agreed upon by all parties involved in the logistical process, the organization cannot progress to the next level," explains Karl Manrodt, Ph.D., assistant professor of information systems and logistics at Georgia Southern University in Statesboro, Ga. "A child does not go from crawling to driving a car. There are a lot of fundamental steps along the way that cannot be overlooked," he says. "Until all members of the team are versed in the basics and know the definitions, it's impossible to proceed directly to improved logistics activities and enhanced value for customers."

Does it encompass both outputs and inputs? Good measures include both input and output in the supply chain process. According to the authors, that means taking into account all of the processes that lead up to the function that is being measured. Delivering goods to customers on time is extremely important, but if on-time delivery is achieved at a cost to internal operations, then it can't be considered a success. Processes that enable on-time delivery, such as order processing, production planning and production scheduling, must also be taken into account, they explain.

"The key to optimizing the supply chain is implementing performance measures that reflect the entire process, [not just] the individual components that make up the process," agrees Rick Blasgen, vice president of supply chain at Kraft Foods' Biscuit, Snacks and Confections Group in East Hanover, N.J. "By focusing on the entire supply chain, rather than its individual parts, [managers can obtain] a clearer picture of the process." This helps to emphasize the vital importance of the logistics process to the rest of the company and how logistics can affect the financial stability of the organization as a whole, he adds.

Does it measure only what is important? Too many measures will create confusion and make initiatives unwieldy, leading to a breakdown in the entire measurement system. It is management's responsibility, therefore, to identify and measure only those processes that are important to supporting the organization's logistics, supply chain and overall business strategy. Depending on what the company's primary business focus is, however, logistics managers may choose to place more emphasis on one measurement than another. "It isn't that a company that competes on service won't measure its costs. It will simply place more weight on its customer-satisfaction metrics," explains Manrodt.

Is it multidimensional? Effective performance measures address three significant dimensions: utilization, productivity and performance. Utilization measures how much of a resource is used versus how much is available. Productivity is a sum derived from dividing a logistics organization's input (labor resources, for example) versus its output (number of pieces picked per hour). Utilization combined with productivity, the authors explain, equates to efficiency or performance.

Does it use economies of effort? The benefits of the information being collected must outweigh the costs of collecting and analyzing the data. Overly complicated, excessively numerous or simply unmanageable measures have the potential to derail the very process that they were intended to improve.

Does it facilitate trust? One of the most important characteristics of good performance measures is their ability to foster trust among all individuals involved in the process. If all parties understand the measurement process and believe in the accuracy of the measure, they will support the organization's strategy. Customers, moreover, will feel more loyalty toward an organization that has taken the extra step to measure its performance with the ultimate goal of improving its service quality.

Once a logistics organization has created the proper framework of performance measurements, the next step is to collect, analyze and use the data. Effective use of information technology—i.e., software—is key to achieving those objectives, the book's authors agree. Technology is no magic bullet; it doesn't define the parameters of metrics nor does it guarantee the flawless implementation of performance measures. What it does do is make the collection of thousands of pieces of data feasible. Technology also can ensure that comparable information is captured in a consistent way across functions, divisions and subsidiaries as well as from suppliers and customers.

Dennis Bollinger, distribution manager at Transcom Inc., a distributor of seals and bearings in Burnsville, Minn., reports that his company incorporated technology into its performance measurement plans right from the beginning. That strategy paid off, he says. By effectively measuring the performance of the logistics operation with the aid of appropriate technology, Transcom found numerous ways to speed up the order-to-ship process and reduce costs. Other benefits resulting from analysis of performance data, he says, included improved inventory control, increased product turns, increased shipment volumes and reduced line-item labor costs.

Logistics wasn't the only area that benefited, Bollinger continues. "As an added benefit, efficiencies from ... technology not only increased the efficiencies in our distribution center, but [also] created efficiencies in other areas within our organization, including our purchasing, inventory control and customer-service departments."

Those are exactly the kinds of benefits that companies should aim to achieve with an effective performance measurement program in logistics. As Blasgen of Kraft Foods puts it, performance measures should provide a means for improving the entire supply chain. "Ideally, effective performance measures will help a logistics organization evaluate how customers pull inventory from them, resulting in proper adjustments throughout the pipeline, which ultimately ends with how the logistics process pulls from the manufacturer," he says. "By improving what you measure, greater efficiencies can be reached regarding inventory versus cash flow."

Senior Editor Toby B. Gooley contributed to this article.