An interview with Transformation and Supply Chain Consultant Henry Martin
In the increasingly sophisticated world of supply chain management, understanding the true cost to serve (CTS) is extremely valuable for all businesses. In particular, it is valuable for manufacturing and distribution organisations. Not only is a CTS model an effective tool that can help you negotiate trading terms with customers, but the reporting can enhance overall business performance. Hunter Campbell talks with Supply Chain expert Henry Martin about how a CTS methodology can transform your business and how to get started analysing the CTS in your organisation.
Henry – what is the cost to serve model and what is it designed to do?
Rather than looking at overall profit, a CTS model provides an analysis of the profitability of individual customers and products.
This granular view is useful in helping you determine which customers are profitable and those that may be making you a loss. It’s natural to assume that larger customers are more profitable, but that’s not always the case.
With accurate data, you can adopt a more individual, tailored approach. With customers that are more profitable, you can find opportunities to do more business with them. With those that are less so, it makes sense to understand how you can turn this around.
A CTS analysis is done by allocating costs against certain cost drivers, e.g. apportioning part of your warehouse costs to pick, pack and dispatch and allocating these costs against the number of cartons picked to get a cost per carton picked. This will help you determine the true cost of providing a good or service to a customer. Once costs are allocated, they are subtracted from the amount charged and this provides the CTS and a view of true customer profitability.
What are some examples of the way data can be used?
A good CTS model helps to identify efficiencies and improvements that can be made in the supply chain including ways to significantly reduce lead-times and handling costs as well how to manage peak days or even optimise product ranges.
The data helps you make more informed decisions. A retailer might approach you asking for a reduction of 6% off the list price to deliver direct to their distribution centre and avoid the need to pick, pack, dispatch and deliver to their 120 stores throughout the North Island. This could look like a good deal but without the right information, you simply won’t know.
Profit is key to any business, however, so is customer satisfaction. Any changes made as a result of the information you find out must balance both of these elements. As an example, some customers might value the ability to order frequently in small order quantities. If this cost is understood and customers value the service, then you might find they are willing to pay more to retain this option. Alternatively, this information could be used to begin a discussion around reducing order frequencies.
How can you use CTS data to negotiate better trading terms?
Factors set out in trading terms such as minimum order quantities, order frequency, volumetric discounts and service levels all have an impact on the CTS. So it pays to be forearmed with this information before negotiations around new trading terms begin.
Operations can certainly be made simpler by bundling trading terms with a customer into one overall trading term. But before agreeing to anything like this, a business needs to be sure they understand exactly what they are paying for, what they are getting in return, and that they are getting what they have paid for.
Is the CTS model something that is mainly of benefit to complex organisations?
I think it works for all businesses. Even those with a simple product range can be dealing with multiple suppliers and needs to manage factors including traceability, compliance and differing customer expectations among other things. Furthermore, there is usually always room for improvement in what we do.
What other advice would you give a business when they’re starting to analyse their CTS?
Reducing costs is one of the main ways organisations aim to increase profit but it’s not always the only option. A good CTS methodology will give you insights that identify specific actions to deliver higher profitability without impacting on your ability to provide what your customers need.
Also, start small. Reporting should be meaningful but not too detailed that it becomes time consuming and difficult to build a clear picture. You don’t have to do everything at once – you could start with a particular product line and master that before moving into other areas.
How should you get started on analysing your CTS?
It is worth asking these four questions to help agree the objectives and keep the project on track:
- What is the specific problem the CTS analysis will answer?
- How will the outputs from the analysis be used?
- What will be done differently once the analysis is completed?
- How often do we want to repeat this exercise?
You’ll need the right data and the right model to make sure costs are allocated against the right drivers.
All the input costs that go in to serving a customer have to be identified. Most ERP systems allocate some of these costs to a product and/or a customer but not all. Costs will include marketing, order processing, storage, picking, packing, transportation, merchandising, returns and wastage. Every individual organisation will have additional costs on top of this so it’s not an exhaustive list.
The cost drivers then need to be assigned to all the activities your business does. In a warehouse for example, activities would include product receipt, product put-away, replenishment, pallet picking, carton picking, order checking and dispatch, inventory control and then finally, returns processing.
Now it is time to allocate activity costs based on the cost driver. This can be done in Excel, however for more complex supply chains or if the CTS process is going to be a regular process, it is worthwhile considering a database or specific CTS software.
With insight into the CTS, it is time to look at what the analysis is telling you. Specific problems can be reviewed and analysed then options, actions and recommendations presented to the decision makers. It is likely that other improvement opportunities will emerge from the analysis at this point.
Furthermore, the CTS model should be updated at least annually. This will enable you to see if the changes made have impacted your CTS and met your objectives.
About Henry Martin
Henry Martin has spent nearly two decades working across senior Supply Chain, Transformation and Change Management roles. This includes extensive experience in the FMCG industry in supply chain and sales roles. Henry has assisted a range of clients with developing and executing their supply chain strategy, cost to serve modelling, make or buy procurement analysis and other Transformation and Supply Chain support.
For further information on how you can better understand your customer profitability, please contact Henry on email@example.com or 0275 416 685.