Securing the Benefits from Cost-to-Serve

Understanding true profitability

The power of Cost-to-Serve is in creating an understanding of the profitability of products that differentiates between customer segments and routes to market. This is critical in shaping businesses decisions on service mix and operational change.

Our observation is that a major shortcoming of many such studies is their failure to address the real complexity of product mix, the range of products purchased by individual customers and natural customer groupings, and the extended supply chain through which products are sourced and moved to customer.

The supply chain often has a disproportionate influence on product profitability, since sourcing options and handling characteristics can erode Gross Margin, yielding a far lower Net Margin that reflects the true Cost-to-Serve, resulting in lower profitability than planned.

A successful implementation of Cost-to-Serve will deal with supply chain complexity, identifying the real cost drivers and causes of margin erosion, enabling a focus on management for profit.  It will deliver a clear, replicable and agreed cost position for any business, an essential requirement for benchmarking performance and operational improvement.  It will drive supply chain savings for a business and its customers and improve collaboration on key initiatives.

Many companies have encountered barriers to implementing Cost-to-Serve, which often frustrate wider understanding of the output and prevent the true value of Cost-to-Serve being unlocked.

What barriers are encountered?

Some of the typical barriers encountered during a Cost-to-Serve implementation are:

·          Lack of clarity as to which parts of the business to include

·          Overly complicated implementation processes

·          Excessive analysis clouding the decision process

·          Insufficient information on which to base decisions

·          Lack of acceptance of output

These problems can be mitigated by following a robust implementation process that combats these issues from the outset.

The LCP approach to Cost-to-Serve

At LCP we follow a tried and tested approach, applying our proprietary Cost-to-Serve technology, but crucially considering the business principals that apply and selecting the right implementation method and scope.

Beyond the obvious technical analytical approach and methodology that needs to be addressed (see Our Approach), some of the key factors and activities we consider in our approach are given below:

1.       DEFINITION – Some simple questions need to be answered:

·          What is the nature of the issue being explored and what does the business want to achieve? 

·          Which parts of the business are to be focused upon, what is the extent of the study? Whilst we talk about an end-to-end study, from source to point of consumption, often the scope is more limited

·          Is a comprehensive implementation of Cost-to-Serve the most applicable approach?  Again we sometimes find that the issue being evaluated doesn’t justify such a significant investment, instead a higher level Flow Costing Model may be applicable and point to areas of significant benefit more rapidly

2.       PEOPLE - Involving the right people is key … and it involves many functions beyond finance.  There are key stakeholders at each point of the supply chain who are best able to interpret and validate the results of such a study and they will learn much from the exercise. Careful consideration should be given to the project organisation and management to ensure early and constant engagement of all stakeholders

3.       DESIGN – Run a series of collaborative workshops to agree the scope of business processes, their cost allocations and cost drivers.  Getting this right is critical, reducing the time required to configure the Cost-to-Serve  tool and improving understanding and acceptance of the output

4.       DATA COLLECTION & VALIDATION – The ‘raw material’ for Cost-to-Serve, we work closely with many functions to identify, obtain and validate all data prior to undertaking any modelling. We often find that a complete data set can only be created by interrogating multiple software systems

5.       MODEL BUILDING – A well structured model is critical if it is to be replicated, adjusted or embedded alongside business ERP systems, for use on a regular basis.  LCP’s Cost-to-Serve  tool was developed to be configurable, structured and robust to ‘crunch’ the numbers

6.       REPORTING OUTPUT – It is essential that any model developed is capable of producing output that can rapidly report at different levels of detail, from the P&L down to analysis of individual order line at any point in the supply chain. We have invested heavily into this capability … after all, the insights only become real when they are communicated well, understood and capable of being actioned

7.       ESTABLISHING THE NEXT STEPS – The findings from such a study can provide compelling evidence for the need to change.  Resulting decisions should be carefully planned, with a clearly defined roadmap to guide the process and the organisational implications documented fully. Our experience is that success will only be achieved when clear recommendations are endorsed and supported by the Board.

Typical results

The benefits of our approach are demonstrated by the impact it has for our clients:

·          15% reduction in distribution costs and significant improvements in profitability of new customers for a major petroleum client

·          Savings of £millions for a media distributor through changes to supplier terms

·          Significant improvements in profitability for many clients through improved customer management

·          Profit improvements of £millions through improved management of promotional activity for a food manufacturer

·          Major opportunities to reduce supply chain cost through improved fleet utilisation.

For more insight on our methodology and the benefits (see Our Methodology).

Summary

Before embarking on a Cost-to-Serve study, it is important for companies to give proper consideration to what they want to achieve and how best to implement the study.

Gaining clarity and understanding of the issues from the outset and the extent of the supply chain to be considered, will save a considerable amount of time later on, as well as deliver a focused output that shows the true margin impact and crucially meets with stakeholder consensus.

LCP’s Cost-to-Serve methodology and experience in implementation adheres to these principles, enabling companies to understand cost accumulation and to truly drive profitability.