When your customers are clamouring at the factory gate!

The Factory Gate Pricing (FGP) and Primary Freight (PF) strategies, as adopted by major grocery retailers are causing a shudder up the spine of many retail suppliers. The reason for this concern is quite simple: many suppliers do not have a sufficiently detailed understanding of their Supply Chain costs, to confidently sit at the negotiating table with their major customers.

For those not fully aware of what FGP and PF strategies are all about, a simplified explanation is as follows. In the past, most suppliers to major grocery chains delivered their products directly to the retail store or their customer’s distribution centres. The price paid by the retailers for these products, took account of all the costs of making and providing the products, including delivery to the customers premises. Otherwise known in shipping terms as FIS (Free Into Store).

Under the FGP and PF models, the retailers collect the products from the suppliers ‘factory gate’. The product pricing therefore becomes ex works. The difference between the FGP and PF strategies is merely the means of recovering this transport cost from the supplier. Under FGP, the supplier agrees to reduce each product by the appropriate delivery cost. Under PF, the retailer deducts an agreed transport costs from the supplier’s invoices.

Now the issue! How many retail suppliers really understand the costs involved in distribution to their customer base, to the extent that they can identify the costs associated to delivering to specific customers? This becomes very important, when dealing with customers of varying sizes, in many different geographic locations, all with different order patterns.

One of the methods available to better understand these costs, or the ‘cost to serve’ (CTS) is to undertake a cost to serve audit of the Supply Chain. The cost to serve process is not only of value to retail suppliers grappling with FGP/PF, but to all businesses wishing to better understand their Supply Chain costs.

To illustrate the application of cost to serve, two brief case studies are taken from very different industries.

Orica Mining ServicesOrica Mining Services (OMS) provide explosives and related services to the mining industry. Products range from packaged explosives (like the plastique you see in the movies), to detonators and bulk slurry type explosives delivered by the tanker load. The related services include surveying blast sites, drilling blast holes and even shot firing crews.

OMS saw a need to supplement their traditional financial reporting systems, to better understand the costs of providing this diverse product and service range across an even more diverse customer base stretching from Pilbara region of WA to Mt Isa in Queensland.

Without going into the intricate detail of the cost to serve process itself, this involved the collection and collation of very detailed sales transaction and cost data. Then a cost allocation exercise took place to improve on the allocation methods used within the financial systems. This invariably includes making more accurate cost allocations from costs that are normally just lumped together at a head office level.

The whole process was completed over a three month period by a joint Orica – Logistics Bureau project team. The results have proved very interesting reading and have formed the basis of a number of commercial negotiation and process improvement projects that are now underway.

Margin Chart

Like many of these projects undertaken by Logistics Bureau, one of the enlightening aspects is to find which products and services are not making any operating margin! This was certainly the case at OMS, though there was already a suspicion that some products may have been under performing. Needless to say, measures are now underway to address the situation.

Plant Margin Chart

Likewise, the operating margins reported by plant, raised a few eyebrows once the traditional reporting methods were re-cut. True cost allocations now allow OMS to better focus on performance measurement and service improvement.
Tony Fedorowicz – OMS Supply Chain Manager remarked “We have struggled with understanding our cost to serve for a long time and this project with Logistics Bureau has helped us enormously. Whilst there are areas that we are now working on to improve as a result, it was also gratifying to objectively identify those areas of good performance”

GlaxoSmithKline

The Cost to Serve project for GlaxoSmithKline (GSK) was conducted for the Consumer Healthcare Division. The Consumer Healthcare Division’s product lines include such notable brands as Panadol, Nicabate, Lucozade, Ribena and Macleans toothpaste. The products are distributed to grocery chains, pharmaceutical wholesalers and hospital customers.

The catalyst for the development of the CTS reporting tool was the push by the grocery retailers into FGP and PF, and the need to better understand the costs of servicing these important customers. However, it was decided by the project team to broaden the scope to include all customers, and both the freight and distribution centre costs. The rationale was, that there was minimal additional effort to include these elements of the supply chain, and the total CTS for all customers and all products, including the impact of FGP and PF on the costs to serve of non-grocery customers, could be monitored over time.

The first part of the project was the data gathering phase. This included site visits, workshops and the collection of financial, transactional and KPI information from GSK, and their third party logistics providers. Due to the effort of all parties, the data collection stage was relatively swift and painless and provided the project team with a solid foundation to build the CTS model. A summary of the main sources of information is included here.

Data Sources

The project team then progressed to a paper based description of the model. This document described how the costs were to be distributed in the model. There was a two stage allocation process. Initially the costs were allocated to activities and then from the activities to customers and products. The purpose of this section of the project was to communicate to GSK stakeholders, including Logistics, Sales and Finance, how the model would work in practice. The communication process ensured that the different stakeholders had input into the structure of model, obtained buy-in and allowed them to contribute to the success of the project.

The next stage was to build and populate the model. Due to the success of the data collection and model documentation phase, the building and population of the model was relatively simple. The model can report the CTS by anyone or combination of the items listed in this chart.

Model Scope

The project team was able to deliver various reports based on the dimensions above. Examples of the type of information included the cost to serve by product group. This graph highlights the range of costs associated with servicing the various products in the company. The range of cost to serve varies dramatically and is explained by differences in customer behaviour, such as order size and ordering frequency and also different product handling requirements.

Chart Cost per case

In addition to viewing the cost to serve by product or product group, the model allowed analysis of the cost to serve by customer and customer group, such as the freight cost to serve per case, of the different customer groups.

The above are just some examples of the information extracted from the model. The model has been deemed a great success and a very short payback is expected. GSK may also review further implementations in other parts of the business.

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Rob O'ByrneBest Regards
Rob O’Byrne
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