Says Its Six-Step Model will Bring More Rigor into the Process

“Cost-to-serve” is a supply chain concept that has been around for decades, especially in the consumer package goods sector:

The basic idea: that it’s smart to track the profitability of individual customers, and that to do so requires more than simply calculating the sales price minus cost of goods sold.

There are a wide array of other costs that are often involved in processing and fulfilling an order.

Supply Chain Digest Says... Gartner believes that to better align the allocation of supply chain costs with actual cost drivers requires a thorough understanding of the factors influencing each cost component. What do you say? Click here to send us your comments

An easy example: if one customer orders only in full pallet quantities, while another has a heavy share of carton-level orders, for order picking processes the first customer will be less expensive than the second.

Depending on the sector a company operates in and its customer mix, these variable costs can can include transportation, customer “chargebacks,” many kinds of services (labeling, kitting, etc.), returns, payment terms, and more.

The goals of calculating true cost-to-serve can include better determining pricing for each customer and identifying opportunities to change processes and reduce costs.

In a recent blog post, Gartner analyst Marco Sandrone says there are opportunities for many companies to start using cost-to-serve, and for some current users to get more rigorous in the process.

“Many companies overlook service differentiation or product attributes when calculating the profitability of their transactions,” said Sandrone, adding that “This oversight can result in a misleading perception of profitability at a time when leadership is leaning on the supply chain function to clarify the viability of products and customers amid growing economic uncertainty.”

Sandrone notes that recent Gartner research showed that traditional accounting practices often neglect to allocate the cost of supporting customers and products due to the complexity that these activities generate in corporate operations.

To that end, Gartner has developed a multi-step framework for companies to better implement cost-to-serve initiatives.

Those steps are:

Step 1: Map Out the Cost Components

Gartner says the initial step involves dissecting the organization's cost structure to pinpoint costs traditionally spread across transactions based on revenue or physical volumes. Collaborate with the finance team to gain insights and support for the initiative. Focus on identifying indirect costs like logistics, storage, handling, and value-added services.

Step 2: Agree on Scope

Successful companies often adopt a phased, pilot-based approach to CTS, Gartner says, starting with a defined segment like a country or product line, focusing initially on a smaller subset of direct product and supply chain costs.

(See More Below)

Step 3: Link the Cost Components to Cost Drivers

Gartner believes that to better align the allocation of supply chain costs with actual cost drivers requires a thorough understanding of the factors influencing each cost component. Collaboration with functional experts is crucial to effectively map these relationships. By linking cost components to their drivers, organizations can enhance their cost allocation accuracy and decision-making processes.

Step 4: Model an Approximation of Actual Costs per Activity

Quantifying the cost per activity is challenging but essential for CTS analysis, Garter notes. Direct spend items, such as direct-to-customer transportation fees, are easier to identify, while indirect costs require assumption-based estimates due to a lack of a direct link between the cost element and specific customer or products. Establishing the time frame for data collection, often focusing on the previous calendar year, is crucial for defining costs per activity.

Step 5: Reveal True Profitability at Transaction Level

Gartner adds that CSCOs should collaborate with finance to gather a comprehensive list of sales transactions from the past calendar year. Aggregate the actual costs to reveal the true profitability of each invoice transaction. CTS models can offer a more nuanced approach to defining margins by considering the complexity introduced by customer behaviors and product attributes.

Step 6: Use Findings to Enhance Business Performance

With true customer and product profitability data in hand, Gartner says, CSCOs can:

• Aid the sales team in negotiating with new customers or renegotiating unprofitable contracts

• Use product-level data for optimizing the product portfolio

• Leverage market or channel data to guide strategic decisions

• Present cost data as percentages of gross sales for strategic discussions

• Highlight cost per unit for operational improvements (e.g. logistics and transportation)

Good advice from Gartner on this one.

Any comments on Gartner’s comments on CTS? Let us know your thoughts at the Feedback section below.