Picture this: you just got hired as the new supply chain manager at an established stainless steel pan company. The CEO has tasked you with figuring out how to boost profitability by 20% — and she wants you to do it within three months. No easy feat considering all the moving parts in today’s modern supply chains.
If you’re going to make it happen, you need to know how much the company is spending to get one pan from the factory floor to a customer’s doorstep. How much labor, packaging, and transportation does it cost? You need a granular view of your supply chain and how it serves your customer base.
That’s where cost-to-serve analysis comes in.
What is cost to serve?
Cost to serve is an analytical framework companies use to understand how much it costs to fulfill the demand for one product or service for a customer.
It focuses on the supply chain and takes into account the cost of sales, services, and last-mile logistics and how those impact the bottom line. Cost-to-serve models provide a better understanding of which products or customers are profitable, which ones are not, and how current priorities influence performance across the supply chain.
There are other measurement metrics used to understand costs, but they differ from cost to serve:
- Cost to serve: Calculates how much fixed and variable costs, including raw materials, production, transportation, warehouse/storage, taxes/duties, and distribution, are needed to get the product to the customer.
- Total costs: Calculates the same as the cost to serve, but also includes marketing, research, and other indirect costs. Sometimes total costs or total landed costs are used interchangeably with cost to serve.
- Cost of goods sold (COGS): Calculates all direct costs associated with producing a product, including materials, labor, and overhead expenses.
Traditionally, cost to serve is calculated using spreadsheets or financial models based on profit & losses (P&L) and an allocation of actual costs to products delivered over a certain period of time.
However, modern cost-to-serve models use digital supply chain replicas (often called digital twins) and advanced algorithms to analyze and optimize supply chain activities — from procurement all the way to delivery.
This approach enables companies to see how costs are allocated at the most granular level.
Why consider a cost-to-serve model for your business
Understanding how to meet customer demand needs while maintaining profitability can be challenging with constantly changing customer preferences, fluctuating trade policies, and managing complex supply chains across borders.
A cost-to-serve model helps bring clarity to all those variables and their associated costs in a company’s operations. By identifying unprofitable low-margin products, customer combinations, or high-cost processes, companies can develop action plans to address underlying issues and improve profitability.
In today’s rapidly complex and changing market, cost-to-serve models are an essential tool in building a sustainable operating model. Companies that use it benefit from:
- Better customer satisfaction. By gaining a clearer picture of the costs associated with serving customers, you can better align your supply chain planning to customer demands and expectations. This might include improved product mix, new sales channels, or realignment of the supply network to improve delivery times.
- Improved visibility across the entire supply chain. Since today’s supply chains are more complex and include more touch points, changes made at one touch point — like expediting shipments at a production facility — inevitably impact touch points downstream—like a distribution center — and the overall costs. A cost-to-serve model gives complete visibility into how those changes impact operations and how to avoid or optimize them for better outcomes.
- Faster and more informed decision-making. Leadership at any company wants to know they’re making decisions that will have the greatest impact. You can support those efforts with cost-to-serve data. Let’s say it costs $46 to produce one brand-new pan. You can see that $25 is going toward materials and production, $15 towards cross-border taxes, $3.50 in distribution, and $2.50 in transportation. With this information in hand, you can recommend to leadership that it would make the most sense to focus on the production and tax costs by evaluating alternate production locations that have more favorable duties or try to lower production costs by finding new suppliers.
How Nestlé creates happier customers with faster supply chain decisions
Multinational company Nestlé produces and moves an incredible amount of food and beverage products across the world every day. With increasing supply chain volatility, it was a challenge to ensure products were exactly where they should be based on customer demand.
They turned to Coupa to build a more efficient and resilient supply chain based on their factory output.
With real-time data on the company’s supply chain, Nestlé teams quickly create and compare scenarios to see how manufacturing, distribution, and logistic changes can get the right products to the right place.
Now, Nestlé makes decisions 60% faster to ensure retailers selling Nestlé products always have access to the specific items customers love — driving sales.
How to calculate cost to serve
Cost to serve is calculated by capturing costs in several different categories and inputting those costs into a formula. Some of the most common cost categories include:
- Transportation
- Production (material, labor, overhead costs)
- Taxes/duties
- Distribution (handling, storing, obsolescence costs)
- Shelf life (if the item is perishable)
- Returns
- Quality control check (applicable to medical companies)
- Byproduct disposal (applicable to mining and energy companies)
Depending on the company’s industry, these categories will vary widely. No matter which categories are used, they get put into the same general formula or analytical model (although it’s important to note companies aggregate cost to serve in a variety of ways). At the most basic level, that formula is:
Cost to serve (one customer) = total cost of service ➗ number of customers in a specific segment
Of course, figuring out the total cost of service can be a daunting task since there are so many variables.
Traditionally, spreadsheets and finance-driven analytical models have been the go-to method for calculation, aggregating how products move through a facility across a certain time frame.
This process can be time-consuming since data needs to be pulled from several different sources and doesn’t allow for proactive planning. That means companies are calculating their cost to serve from historical data rather than making decisions in the real-time context of current or future conditions.
Today, more companies are calculating cost to serve by modeling supply chain activities digitally.
With a supply chain design and planning solution like Coupa’s, companies create a digital replica of their supply chain and apply advanced analytics and algorithms to calculate cost to serve automatically.
With just one click, users can see a detailed breakdown of their cost to serve for each product and customer in their network, with all fixed and variable costs accurately allocated within minutes. Even carbon emissions can be calculated alongside cost to serve with Coupa’s Supply Chain Modeler.
Coupa gives you greater visibility and control over all supply chain components, so you can make decisions based on real-time data, not assumptions. From rolling out a new product to adjusting service level agreements, you can test and validate your changes no matter the scenario or ever-changing market conditions.
How Coupa is changing the way businesses do cost-to-serve analysis
Coupa gives you the power to optimize potential supplier combinations, balance trade-offs, and adjust service levels based on customer segmentation strategy with one comprehensive supply chain and design planning solution.
Understanding your cost to serve is automatic and just a click away — no data pulling or spreadsheets required. Coupa’s digital models have been refined over decades to capture all supply chain costs and include a patented cost-to-serve algorithm.
The other best part about Coupa?
You can extend the power of advanced analytics to all departments, even if they don’t have formal training.
App Studio enables any user to input data, test scenarios, validate outcomes, and share that data easily. Finance and supply chain teams can now work in sync more effectively to improve margins and customer satisfaction.
Coupa’s AI prescriptions also work in the background, helping you better understand your cost-to-serve data, find ways to reduce risk and identify otherwise hidden cost-saving opportunities, from surfacing unnecessary nodes to poor use of carrier capacity.
Creating a sustainable operating model can be tough when market conditions change rapidly, but cost-to-serve analysis is a powerful tool that can make a meaningful difference.
When companies understand the cost of serving customers, they can evaluate changes and make data-driven decisions—like resegmenting customers or opening a new production facility—to drive profitability and customer satisfaction.
