A case for “cost to serve” analysis!

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Lord Kelvin, as a thinker, was a true giant of a man and we owe him much in laying many foundations in physics, engineering and mathematics. He is often quoted as saying “when you can measure what you are speaking about, and express it in numbers, you know something about it; but when you cannot measure it, when you cannot express it in numbers, your knowledge is of a meagre and unsatisfactory kind: it may be the beginning of knowledge, but you have scarcely, in your thoughts, advanced to the stage of science, whatever the matter may be”.

In “cost of goods sold” measurement, the focus is often on inbound logistics costs, raw materials and manufacturing costs, with distribution costs often just seen as an unavoidable expense or black box. By Lord Kelvin’s assessment, there is often very little science involved! But with steadily increasing distribution costs and the growth in e-commerce, really understanding the total cost of servicing your customers at a customer and product level is critical to making the right decisions to remain competitive.

We have found cost to serve (CTS) analysis to be vital in understanding which customers  are actually profitable. By changing the type of products sold, the frequency of delivery and putting in place minimum order quantities, customers which have previously been “margin diluters” can actually become value adding. In other examples, certain routes to customer, required an additional service charge to ensure that they become profitable. This is always preferable to step away from an unprofitable customer.

In other examples, CTS analysis was used to determine the true cost of a client’s existing inhouse distribution versus that offered by a retailer through their DC. This understanding helped illuminate the DC allowance percentage at which both parties in the negotiation benefited. Normally, retailers have the upper hand as they have a great understanding of their own CTS and will demand either a percentage of selling price or a rate per case or unit, depending on which is most beneficial to them. Also, they often “skim off the cream” and take the most cost effective routes to run and leave the supplier with the routes which are difficult and more costly to service.

In some cases, certain products are simply not profitable at all, once the true cost to serve is understood. They may fill the truck and help to share the cost of distribution but often there is a more cost effective way to service a customer than load them with product lines that simply don’t make any money and may even be returned.

Finally, omni-channel options are an expectation for most customers today and you can be sure they have done the “sums” and will choose the optimised solution for their circumstances. Sometimes this results in a shift in volume from what used to be a really profitable retail store to an e-commerce or click and collect option that results in reduced margins for the supplier. Understanding your CTS before venturing into e-commerce solutions is vital. Do the savings, created by reducing your retail footprint, justify the discounted prices and increased CTS of personalised delivery?  Are you really getting profitable growth?

Do you really know what it’s costing you to service your customers?Without this information,  “your knowledge is of a meagre and unsatisfactory kind” and you are “flying blind” in terms of making the right strategic portfolio decisions, customer growth decisions and route to market and supply chain optimising decisions.

Contact us to find out more about what it would take to do a bespoke “cost to serve” analysis for your business!

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