A cost-to-serve analysis can be an eye-opener

By William C. Copacino -- Logistics Management, 4/1/1999

Logistics costs can make the difference between a product, customer, or channel that is profitable and one that is less profitable ... or even unprofitable. Yet companies often are surprised to learn how much impact logistics costs can have.

More and more companies, however, are beginning to gain insight into segment profitability through a cost-to-serve analysis. This analysis not only can save your company significant dollars, but it also positions the logistics group as a key driver of profitability.

Consider the following example. A company sells a product with a 20-percent gross margin to two customers. One customer orders two times per week, is located at a site not logically linked to the supplier's delivery route, is often poorly organized and inefficient in its receiving, and is a slow payer. A second customer orders large quantities once a week, provides a longer leadtime, is located at a site that can be integrated into the supplier's delivery route easily, is organized and efficient in its receiving, and uses electronic ordering and payment.

In a circumstance like this, the second customer can provide a profit contribution of up to 10 points vs. the first customer, when you factor in real ordering costs, order size, delivery frequency, route efficiency, the difference in delivery time and efficiency, and the savings from better planned manufacturing and distribution operations. The supplier then can use pricing policies either to equalize margins or drive out costly customer behavior.

Cost-to-serve analysis can be done with varying degrees of sophistication and depth. Even a simple analysis often yields very valuable insight. Generally, this type of analysis requires the following four steps:

* Identify the key drivers of costs. For each of the major cost categories, understand the key influencers of those costs. For example, order size might be a key driver of delivery costs.

* Analyze and group customers based on their operating and behavioral characteristics in relation to key cost drivers.

*Assess the relative profitability of key customers or customer groups.

* In collaboration with the marketing, sales, and financial teams, determine policy actions (for example, pricing or incentives to change customer behavior) needed to grow profitable segments.

The logistics team is well positioned to drive this analysis and provide further value added to the company. By completing the first three steps, the logistics and operations function can bring meaningful insight to the management team and lead a process that can use cost-to-serve analysis for significant competitive advantage.

William C. Copacino is managing partner of Andersen Consulting's Strategic Services Practice for the Americas. A frequent speaker before business and professional groups, Mr. Copacino has a number of publications to his credit, including the book Supply Chain Management: The Basics and Beyond (The St. Lucie Press, 1997). He is based in Andersen Consulting's Boston office, 100 William St., Wellesley, MA 02181. Phone (617) 454-4480.