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Cost to Serve: A Framework for Profitability and Customer Excellence

By Matt Gunn  July 19, 2019

4 stakeholders who benefit from cost to serve

What is the real cost to meet specific customers’ needs? How much will it cost to increase service levels or introduce new products and services? How are challenges with suppliers or trade policies affecting the bottom line?

Global businesses often struggle to answer these types of questions. Thanks in part to changing preferences, SKU proliferation, fluctuating trade policies and the inherent complexity of managing supply chains across multiple borders, pinpointing the exact costs associated with products and services is no small feat.

To answer these questions, businesses have historically worked to assess costs associated with a finished product to identify the total landed cost (TLC). But TLC doesn’t go far enough. The supply chain doesn’t end at a warehouse or distribution center – it ends with a customer.

As more businesses have come to understand the customer-driven side of supply chain, a new framework has emerged to answer questions about how the cost of sales, services and last-mile logistics affect the bottom line. This new way of thinking about profitability in the supply chain is commonly known as cost to serve.

Cost to serve models provide a better understanding of which products and customers are profitable, which ones are not and how current priorities affect performance across the supply chain. This is accomplished by modeling all the supply chain activities in the network and properly allocating fixed and variable costs. It can encompass everything from SKU rationalization and total cost of ownership, to sourcing options, new product introductions and service level agreements. By identifying unprofitable and low margin product and customer combinations, as well as high-cost processes, your organization can then develop action plans to address underlying issues and improve profitability. In other words, cost to serve analysis yields greater context into how decisions throughout the supply chain affect the bottom line and provides a framework for cost-effective change management.

But you shouldn’t assume that cost to serve modeling is simply an exercise in balancing the books. The value of these analyses extends beyond the enterprise and can result in better relationships with trade partners and, potentially, drive greater customer satisfaction. Here’s a look at how cost to serve affects stakeholders across the board.

1. Your customers

Cost to serve analysis is a means of determining the true cost of meeting a customer’s needs. But that doesn’t mean it’s an exercise in reducing products or services available to customers. By gaining a clearer picture of the costs associated with serving customers, you can better align your supply chains to more efficiently meet customer demands. The net effect might be an improved product mix, new sales channels, or the realignment of the supply network to improve deliveries. In one example of this, a US retailer performed a cost to serve analysis to identify how it could expand its footprint. After analyzing 10 scenarios for cost to serve, service levels, changing sourcing locations, and potential new distribution centers (DCs), the retailer redesigned its network for new market growth. The result was increased flexibility in DC-to-customer and DC-to-store shipments, which improved service times, reduced touches and led to millions in potential cost savings.

2. Your operations team

Visibility to customer costs and service expectations provides a framework for greater segmentation based on specific customers, products or shipping lanes. Facing eroding margins due to price pressure, SKU proliferation, and shifting consumer preferences, one UK-based food and beverage company turned to cost to serve as a means to align its production capacity and determine whether it should consolidate plants and distribution centers. It resulted in better prioritization of production sequences, a new distribution strategy, optimized routes and better alignment across operations and finance.

3. Your suppliers

When flooding in Thailand raised questions about a global electronics manufacturer’s resiliency, the business employed cost to serve analysis to model its existing network along with various scenarios that would deploy a new mix of suppliers and carriers. It worked with suppliers and carriers to implement a series of changes that both reduced risk and improved delivery time and service levels. Whether the effect is to reduce the number of SKUs offered, prioritize more profitable products or optimize shipping and logistics, all parties benefit when the supply chain is optimized around cost-effective strategies that center on customer performance. Cost to serve can help you define terms with suppliers and carriers, unlock working capital for new products and services and orient the supply chain to maximize customer satisfaction.

4. Your shareholders

Although the supply chain is directly linked to corporate performance, only 16% of businesses report that they have a multi-year supply chain strategy, according to Global Supply Chain Institute research. Lacking a long-term plan, the supply chain can still lead the enterprise toward profitability and customer satisfaction by optimizing around cost to serve. By improving cost allocations and pricing decisions based on an understanding of which products and customers are more expensive, supply chain management can make more informed decisions to control cost and improve margins and unlock the working capital needed to introduce innovative new products and services. These kinds of improvements can resonate through the enterprise in the form of increased profits and happier shareholders.

Getting started with cost to serve

The first step to improving cost to serve is recognizing that the supply chain is not a fixed cost and that sales growth and increasing customer order volumes don’t always translate into profits. By digitally modeling and analyzing supply chain performance from procurement all the way to delivery, you can get a better handle on which products, services and customers are most profitable. And in doing so, supply chain leaders can make the right decisions to cost-effectively meet customers’ needs.

In the next article on cost to serve, we’ll examine how to drive cross-functional buy-in for cost to serve optimization. Follow us on LinkedIn for more insights and blog updates!