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SCDigest Expert Insight: Supply Chain by Design

About the Author

Dr. Michael Watson, one of the industry’s foremost experts on supply chain network design and advanced analytics, is a columnist and subject matter expert (SME) for Supply Chain Digest.

Dr. Watson, of Northwestern University, was the lead author of the just released book Supply Chain Network Design, co-authored with Sara Lewis, Peter Cacioppi, and Jay Jayaraman, all of IBM. (See Supply Chain Network Design – the Book.)

Prior to his current role at Northwestern, Watson was a key manager in IBM's network optimization group. In addition to his roles at IBM and now at Northwestern, Watson is director of The Optimization and Analytics Group.

By Dr. Michael Watson

January 22, 2013


Cost to Serve Modeling

Determining Your Cost-to-Serve Provides Valuable Input - Don't Expect to do it All With a Single Calculation or Tool


Understanding your cost-to-serve customers can help you price better, help you focus marketing efforts, and help determine where to cut costs.  Used more aggressively, it can help you decide which customers you should let your competitors have.


Dr. Watson Says:

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Since logistics cost are a big part of cost-to-serve, you can see why it is popular with logistics managers.
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Since the logistics costs are a big part of the cost-to-serve, you can see why it is popular with logistics managers.  At a high-level, the “cost-to-serve” measures the cost to get each of your products to each of your customers.   When you get to the details of how to actually calculate it, however, various vendor and analyst reports may only confuse matters by leaving out details.

One way to think about determining your cost-to-serve is that you are just allocating costs that you are already tracking.  Some of these costs you can simply allocate by using Excel.  It might require work and debate, but in the end there are no fancy calculations needed.  But, other cost categories require a network modeling tool (or a fancy spreadsheet that works like network modeling tool and uses optimization). 

According to Mike Hegedus, Director of Supply Chain Center of Excellence at Tata Consultancy Services and previously Supply Chain VP for several manufacturing companies, “Better allocating your costs to specific customers and products gives you great insight.  For example, at one of my previous companies, we allocated returns and claims, merchandising allowances, and other sales expenses to specific customers.  This was a simple Excel exercise.  We just took data we were tracking and simply allocated it to a customer.  This led us to take specific steps with certain customers.”

A Supply Chain Forum article by several KPMG consultants provides details on various cost categories you can simply better allocate using Excel.  But, I don’t think their article hits on the value of modeling software. 


Columns by Dr. Watson

Supply Chain by Design: Service Level Measures in the Supply Chain, Part 2

Supply Chain by Design: Service Level Measures in the Supply Chain

Supply Chain by Design: Nike's Phil Knight on the Importance of Supply Chain

Supply Chain by Design: Four Lessons from Hau Lee's Green Car Story Updated for the Era of Machine Learning

Supply Chain by Design: Profitability of Your Assets Depends on how you use Them

Supply Chain by Design: The Most Overlooked and Underestimated Data in Supply Chain Design

Supply Chain by Design: Self Driving Trucks May Create New Roles and New Types of Jobs

Supply Chain by Design: Why Driverless Trucks May Create the Need for More Drivers

Supply Chain by Design: A Non Obvious Way Self Driving Trucks May Impact Your Network Design Strategy

Supply Chain by Design: How You Should be Using Multi-Echelon Inventory Tools

Supply Chain by Design: You Don't Need the Optimization in Multi-Echelon Inventory Optimization

Supply Chain by Design: On Network Modeling - Blaspheming the Baseline

Supply Chain by Design: Profit Maximization Feature and Amazon’s Focus on Lead Time to Grow Revenue

Supply Chain by Design: Using Profit Maximization to Minimize Cost

Supply Chain by Design: Two Big Reasons You Don't Want to Maximize Profit in your Supply Chain Model

Supply Chain by Design: You Can Set Inventory Levels and Other Such Myths

Supply Chain by Design: Six Organizational Issues in Tactical Inventory Planning

Supply Chain by Design: Four Things Nick Saban Can Teach us About Inventory Planning

Supply Chain by Design: Seven Ways You Can Think About Christmas Capacity to Avoid Having the Press Blame Your Supply Chain for Missed Deliveries

Supply Chain by Design: Machine Learning and High Quality Potato Chips

Supply Chain by Design: Simple Models to Solve Complex Fast Delivery Problems

Supply Chain by Design: CSCMP Report - Five Take-Aways on Natural Gas Trucks from the AB InBev and Owens Corning Talk

Supply Chain by Design: CSCMP Report - Six Insights from LLamasoft and JLL

Supply Chain by Design: CSCMP Report - Five Supply Chain Design Lessons from Benjamin Moore and How One is Used by Amazon in their 1-hour Delivery Service

Supply Chain by Design: CSCMP Report - Two Supply Chain Design Lessons from Starbucks CEO

Supply Chain by Design: Four Groups that Need to Step Up to Help Make Network Design More of a Profession

Supply Chain by Design: Top Four Best Practices for Multi-Objective Optimization

Supply Chain by Design: Caesars Entertainment's Customer Data is Worth $1B - How Much is Your Supply Chain Data Worth?

Supply Chain by Design: Using Transactional Data to Estimate Truckload Market Conditions in Near-Real-Time

Supply Chain by Design: Routing Optimization is Hard: Lessons from UPS

Supply Chain by Design: Eli Goldratt's Book "The Goal" is on Jeff Bezos (Amazon) Reading List

Supply Chain by Design: Top Five Rules for Cleaning Data for a Strategic Analysis

Supply Chain by Design: Network Design and Accounting Data

Supply Chain by Design: Sears Case Study - Same Day Delivery

Supply Chain by Design: Three Ways UPS and FedEx Handled Christmas 2014

Supply Chain by Design: Deepen Your Optimization Knowledge Over the Holidays with Free E-book

Supply Chain by Design: Calculating Supplier Lead-Time Variability - Not as Easy as It Seems

Supply Chain by Design: The Myth of the Market Rate and Network Design Projects

Supply Chain by Design: Three Ways the Supply Chain Wastes Big Data

Supply Chain by Design: Three Supply Chain Lessons from the book Scaling Up Excellence

Supply Chain by Design: What to Do About the Rise in Costs Because of the Trucker Shortage

Supply Chain by Design: Modeling Your Competitors

Supply Chain By Design: Just Because the Feature Exists, Doesn’t Mean You Should Use It

Supply Chain by Design: Just Because People are Talking about Big Data Doesn’t Mean it is Clean Data

Supply Chain By Design: Can Western Manufacturing Be Saved: What Does it Mean to Your Firm?

Supply Chain By Design: Optimized Baseline and the "Perfect" Network Design

Supply Chain By Design: Become more Analytics-Driven to Recruit Talent

Supply Chain By Design: Step Up Your Preventative Maintenance with Predictive Analytics

Supply Chain By Design: Demystifying Stochastic Optimization

Supply Chain By Design: More on Big Data in the Supply Chain

Supply Chain by Design: Should You Extend Your Network Design Capability with a Map Portal?

Supply Chain by Design: A New Trend in Network Design: Flow Path Modeling

Supply Chain By Design: Top 5 Skills You Need in a Supply Chain Modeler

Supply Chain By Design: Comment on Biggest Supply Chain Planning Technology Challenges

Supply Chain by Design: Beyond the Square Root of N Rule

Supply Chain by Design: UPS's Christmas Problem Explained in One Graph

Supply Chain By Design: Your One Network Design New Year's Resolution

Supply Chain By Design: 80/20 Rule for Supply Chain Design

Supply Chain By Design: What Makes a Good Inventory Buffer

Supply Chain by Design: Some Things Do Not Change: Cost and Service Trade-Offs with Air Shipments

Supply Chain By Design: The Impact of Natural Gas Trucks On Your Supply Chain Design and Capabilities

Supply Chain By Design: Controlling Inbound Transportation with Inventory

Supply Chain by Design: Three Types of Supply Chain Buffers

Supply Chain by Design: Systems Thinking and the "Limits" of Optimization

Supply Chain By Design: 3D Printing and Robotics - Disrupting the Dominant Supply Chain Model

Supply Chain by Design: Future Supply Chain- Airships and the Physical Internet

Supply Chain By Design: Avoiding Capital Investments - A Hidden Benefit of Network Design

Supply Chain by Design: Three More Reasons the Impact of the New Hours of Service Rules May Not Be So Drastic

Supply Chain By Design: Three Ways to Handle the Lag Time from Modeling to Implementation

Supply Chain By Design: Three Quick Steps for Analyzing Big Data

Supply Chain by Design: What is Big Data?

Supply Chain By Design: Using Optimization to Compare Facilities or Internal Benchmarking

Supply Chain By Design: Four Steps for Thinking About An Optimization Problem

Supply Chain By Design: Don't Let the Term "Optimization" Become a Buzzword

Supply Chain By Design: Supply Chain Models Can Go Wrong - A Different Perspective

Supply Chain By The Numbers: Top Three Ways Supply Chain Models Can Go Wrong

Supply Chain By Design: Supply- and Demand-Centered Modeling: A Follow Up to 2013 Priorities

Supply Chain By Design: Three SCDigest Predictions You Should Be Modeling

Supply Chain by Design: Cost to Serve Modeling

Supply Chain By Design: Top Five Models You Should Build in 2013

Supply Chain By Design: Should You Source from China or the US? Why Not Both?

Supply Chain By Design: Same Day Delivery and Network Design

Supply Chain By Design: Political Supply Chain and Network Design

Advanced Analytics in Supply Chain - What is it and is it better than Non-Advanced Analytics?

Network design modeling software can complete the analysis by allocating those cost that simply cannot be allocated with Excel.  For example, it is not trivial to allocate your inbound transportation costs or costs of raw materials to your customers.  When using your network modeling software for this, you may want to model every customer and every product, but limit the amount of optimization (you don’t want to consider opening and closing facilities with this use of the tool.).  Then, when you run, the tool returns details on the cost to get each product to each customer.  In effect, this tool allocates all your transportation costs, your production costs, and your warehousing costs to a customer and product combination.  You get all this information as part of a standard network optimization run—it requires no special features.

Again, according to Mike Hegedus, “When we modeled our logistics costs, we found the obvious—customers who ordered products directly from the plant had much lower transportation, warehousing, and inventory costs.  But, now we knew exactly how much lower.  Using a modeling tool can help you correctly allocate these costs.  Without a modeling tool, the allocation is not nearly as accurate.”


Final Thoughts

Determining your cost-to-serve provides you with valuable insights.  But, don’t think of it as a single exercise or that it can be done with a single tool.  Instead, think of it as a series of steps, each providing value, that all add up to the total cost-to-serve.

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