Cost to Serve: A Framework for Profitability and Customer Excellence
What is the real cost to meet customers’ specific needs?
How much will it cost to increase service levels or introduce new products and services?
How are challenges with suppliers or trade policies affecting the bottom line?
Global businesses often struggle to answer these types of questions. Thanks to changing preferences, SKU proliferation, fluctuating trade policies, and the inherent complexity of managing supply chains across multiple borders, pinpointing the exact costs associated with products and services is no small feat.
To answer these questions, businesses have historically used the total landed cost (TLC) — the costs associated with a finished product. But TLC doesn’t go far enough. The supply chain doesn’t end at a warehouse or distribution center. It ends with a customer.
As more businesses have come to understand the customer-driven side of the supply chain, a new framework has emerged to answer questions about how the cost of sales, services, and last-mile logistics affect the bottom line. This new way of thinking about profitability in the supply chain is commonly known as cost to serve.
Four Stakeholders Who Benefit From Cost to Serve
Cost to serve models provide a better understanding of which products and customers are profitable, which ones are not, and how current priorities affect performance across the supply chain.
This is accomplished by modeling supply chain activities in the network and properly allocating fixed and variable costs. It can encompass everything from SKU rationalization and total cost of ownership, to sourcing options, new product introductions and service level agreements.
By identifying unprofitable or low margin product and customer combinations as well as high-cost processes, your organization can then develop action plans to address underlying issues and improve profitability. In other words, a cost to serve analysis yields greater context into how decisions throughout the supply chain affect the bottom line. It also provides a framework for cost-effective change management.
That said, don’t assume that cost to serve modeling is simply an exercise in balancing the books. The value of these analyses extends beyond the enterprise and can result in building better relationships with trade partners and driving greater customer satisfaction. Here’s a look at how cost to serve affects stakeholders across the board.
1. Your Customers
Cost to serve analysis is a means of determining the true cost of meeting a customer’s needs. That doesn’t mean it’s an exercise in reducing products or services available to customers. By gaining a clearer picture of the costs associated with serving customers, you can better align your supply chain to customer demands.
The net effect might be an improved product mix, new sales channels, or the realignment of the supply network to improve deliveries. In one example of this, a US. retailer performed a cost to serve analysis to identify how it could expand its footprint. After analyzing 10 scenarios for cost to serve, service levels, changing sourcing locations, and potential new distribution centers (DCs), the retailer redesigned its network for new market growth. The result was increased flexibility in DC-to-customer and DC-to-store shipments. This improved service times, reduced touches, and led to millions in cost savings.
2. Your Operations Team
The visibility of customer costs and service expectations provides a framework for greater segmentation based on specific customers, products, or shipping lanes.
Facing eroding margins due to price pressure, SKU proliferation, and shifting consumer preferences, one UK-based food and beverage company turned to cost to serve. Here, it served as a means to align the company’s production capacity with demand, plus determine whether it should consolidate plants and distribution centers. It resulted in better prioritization of production sequences, a new distribution strategy, optimized routes, and better alignment across operations and finance.
3. Your Suppliers
Cost to serve can help you define terms with suppliers and carriers, unlock working capital for new products or services, and orient the supply chain to maximize customer satisfaction.
A large international cosmetics company manually ran their sourcing process on spreadsheets with no integration in their enterprise ERP and purchasing systems. Purchasers needed to analyze different scenarios and understand the impact of sourcing decisions across both retail and ecommerce channels. They invested to design an app to support multiple key sourcing decisions and scenarios, built with a supply chain model including all key supply chain processes and costs including raw materials, production, freight and duties, and inventory. As a result, their RFQ process setup went from 2 days to under 30 minutes, a significant improvement in understanding actual total landed cost.
4. Your Shareholders
Although the supply chain is directly linked to corporate performance, only 16 percent of businesses report that they have a multi-year supply chain strategy, according to Global Supply Chain Institute research.
That’s a problem, but one that can be overcome. Lacking a long-term plan, the supply chain can still lead the enterprise toward profitability and customer satisfaction by optimizing around cost to serve.
Improving cost allocations and pricing decisions based on an understanding of which products or customers are more expensive empowers supply chain management to make more informed decisions. That leads to cost control, better margins, and the increased availability of working capital to introduce innovative new products or services.
These kinds of improvements can resonate through the enterprise. From the books to the board and beyond, everyone is happier.
Getting Started with Cost to Serve
The first step to improve cost to serve is recognizing that the supply chain is not a fixed cost. Sales growth and increasing order volumes don’t always translate into profits.
By digitally modeling and analyzing supply chain performance from procurement all the way to delivery, you can get a better handle on which products, services and customers are most profitable. In doing so, supply chain leaders can make the right decisions to cost-effectively meet customers’ needs.