Where is the Profit?
Contribution by Dennis Weir – Marketing Executive at Barloworld Supply Chain Software
In our rush to grow business and serve customer demand too often we don’t truly understand which of our customers are profitable. When you consider all of the costs associated with getting the product and/or service to your customer it can be easy to sell yourself into a loss. So how do you know how much it costs to serve a customer?
Early in my career I worked in the Accounting department for a large food manufacturing company. One of my responsibilities was to track the financial performance of our division. For the first two months we lost money. A very quick analysis of Revenue minus cost of goods sold minus the cost of the sales people demonstrated that although we were selling a lot of tonnage, the margins weren’t high enough to even pay for the sales person themselves. I started publishing this report and within 2 months our division was the most profitable division in the company.
Just a couple of weeks ago I met a guy, ‘Bobby’, from one of the largest food manufacturing companies in the world. ‘Bobby’ told me he is transferring from Miami to Chicago for a promotion. Upon congratulating him I asked what he’d done to earn the promotion. Bobby explained he’d helped his former region improve its profit. My ears perked up. Bobby explained how the region went from 85K pounds per week to 28k pounds per week yet was more profitable in raw dollars and as percentage revenue. The mantra became for the sales people; if you can’t make X margin…don’t sell anything…sit there and do nothing instead.
[blockquote style=”1″]The Council of Supply Chain Management Professionals, a widely respected industry organization of people I love to talk too publishes a quarterly magazine. In their “Special Issue 2013” they published a survey of Supply Chain costs in a number of different categories. In summary, it describes how Transportation, Distribution Centers (meaning the facilities) and Inventory Carrying Costs accumulate to approximately 10.5% of every revenue dollar. These costs can get lost in the Cost of Goods Sold.[/blockquote]
So how do you find the profit? How can you figure out your Cost to Serve each customer? There are two approaches to solving this problem. Top down or bottom up.
In a Top Down approach accumulate your overall expenses for buying, storing, selling and delivering the products to your customer. You can ignore the cost of the product itself to buy as you should be focusing on the cost to serve. If you aren’t already selling the item for more than it cost you to buy the item you’ve got a much larger problem. The total cost to serve can then be prorated across all of your customers and products to derive a cost to serve. Years ago, when I took this approach, it shed enough light to cause immediate reaction once the naysayers realized the numbers don’t lie.
In a Bottom Up approach you study the effort and related cost for each product. This can include detailing the number of internal transactions your company executes to move a product through your supply chain. Then you can study the effort to serve the customer. This can include the transportation, administrative time and labor costs to get the product into their possession and finally paid in full. This approach is much more effective in analyzing your cost to serve as you will see the specific products and customers that are profitable and those that are losing money.
I have been talking with another company that shall remain anonymous, just like ‘Bobby’. They are the kings of customer service. Books are written about their ability to serve and delight their customers. They are interested in finally measuring their cost to serve so that they can continue to please the customer. To them, knowing how much it costs to put X product in my hands when I want it is important. They have been doing cost analysis for years so this is nothing new to them. What is new to them, and the reason they are talking to us, is because they realize cocktail napkin approaches no longer suffice. They need to get to the detail so they can understand it and monitor it and react to changes and new products and new offering and new customers…basically they are in business and things change.
[blockquote style=”2″]Beyond the Top Down and Bottom Up approaches discussed above there are two different methods by which you can derive Cost to Serve. Anecdotally, as I did years ago, or thoroughly. Anecdotally can be a good first pass to discover if there are opportunities. Ultimately though, a proven methodology and supporting software will insure that any opportunities are captured and managed for the life of the business. A thorough analysis of the products and customers and their unique combination of expenses will insure that you are serving happy customers while remaining a happy vendor.[/blockquote]