Cost to Serve: Making the Link

 

Understanding supply chain cost dynamics can help companies recognise their profitable customers.

Many companies fail to recognise the true profitability of their customers and product/service mix. Traditional reporting methods aggregate revenues and costs to the extent that poorly performing sectors of the business are hidden from view. Using the cost to serve (CTS) model enable companies to reduce cost and improve EBIT (earnings before interest and tax) performance by up to 20%. Evaluating the benefits of CTS is a must for companies new to the concept.

 

What is CTS?

CTS is understanding the total cost of servicing individual customers and individual products so that the business can match service and cost, to achieve business goals. CTS is not about quantifying distribution cost as a percentage of sales, nor about knowing the cost of processing an order.

These common measured are generally based on aggregated data that takes no account of the unique needs and cost drivers of certain customers and product types within the supply chain.

It is a rare business that has such a limited range of products and customers that they can service their entire market with a generic service policy. Conversely, it would be rare for a business to incur similar costs for servicing what can be a complex matrix of customers and products. Unravelling this potpourri of information is what CTS is about.

 

Steps to CTS

There are five critical steps in undertaking CTS

1. Identify the characteristics of your customers and products. For example, typical order size, order frequency, geographic location, and brand support.
2. Identify the cost drivers within the supply chain, such as: purchasing, storage, transport, customer service, sales, and account management.
3. Determine cost allocation rules for each unique customer and product grouping identified.
4. Conduct a trial data set through the model to test assumptions and results.
5. Implement the CTS discipline and identify areas of opportunity to (a) reduce costs, and (b) improve sales.

CTS typically highlights unprofitable products and customers. This enables the company to reduce the CTS by allowing it to adopt alternative approaches to servicing its customers. Such approaches include changing market channels, varying the service level to certain customers, utilising lower-cost transport solutions for certain geographic locations, re-balancing inventory across the business to improve service and reduce costs. Hence, the bottom-line benefits can be substantial.

The knee-jerk reaction within many businesses when realising that certain customers and products have a negative impact on the bottom line is to try to delete them from the range or customer base. This is the wrong approach. Instead, they should be using the knowledge that CTS provides to turn those customers and products into improved profit.