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Improving the visibility of supply chain costs

14th December 2011 | Posted in: Supply Chain

We are witnessing dramatic changes in supply chain and its importance to the profitability of customers. 10 to 15 years ago we had Activity Based Costing (ABC), which was a painful experience for many and one never to be repeated – I still have the scars from timesheets and guessing the percentage of my time spent on filing!

I began my career as an Engineer designing components for cars before moving into finance and working out the cost of those cars and how we were going to price them. We spent all of our time caring about the price that we could charge, the discounts we would give away and the cost of materials and labour to screw it all together. The logistics of getting the pieces together at the right time and shipping the final product to a customer were never really looked into at a macro level. Back then, the suppliers were normally on the same continent at least and there were enough margins to not have to worry too much. We kept control of the costs by having groups of people looking at how we could optimise the supply chain and use wonderful things like returnable dunnage.

Time, technology and thinking moves on; Robert Kaplan1 (who invented ABC) points out that what was once an art has progressed into a science. Now we have Time-Driven ABC (TDABC) and the technology to support it; what Kaplan has done is extend the time driven approach into other areas of restrained capacity. As he said, “it’s embarrassingly simple”, but then the best ideas often are!

Well how times have changed in supply chain and its integrated nature assisted by the World Wide Web. Much has been written about the integrated nature of supply chain and the enablers of architecture, ecommerce organisation structures, processes and increased partnering and trust.  If we consider consumer goods where the gross margins are still great but the delivery model has changed. We have integrated global supply chains, Megascale distribution centres, palletised delivery, multiple services levels, timed delivery slots and value added services that internal and third party providers have to deal with.

The question is how do we understand the true cost of delivery? How useful would a waterfall be for a FMCG company to be confident in their delivered margin number, to be able to allow their team to work with their suppliers and customers to reduce the end-to end cost? Supply chain cost is not a zero sum game. The question is how do you get to delivered margin so that you can reduce the value of the sum for all and share the saving that is undoubtedly available to you?

Below is what we are aiming for; a standard waterfall that you can pull up by category, by DC by shipping route, by truck type etc.

a standard waterfall that you can pull up by category, by DC by shipping route, by truck type etc

The issue is how you get to these costs in a meaningful way that doesn’t take an army of bean counters and actually makes sense based on the operational reality that one can understand and take action on. You probably have the data for this but it will be locked away in different silos constructed without this integrated world in mind. They don’t take into account the “dance of distribution” that is undertaken everyday nor the complexity of the network, let alone what’s actually happening in each warehouse or distribution centre.

What Kaplan suggests is to try first to understand your resources, work out their cost, and discover what capacity that buys you. You can divide cost by the capacity to find out cost per unit capacity. ABC assumed all capacity was used; this just isn’t true in the real world. Time-Driven ABC enables you to work out how each activity consumes that capacity by referencing the relevant business transactions; this is much easier than working out what proportion of time you spent doing something in an average year! As Kaplan said, “ask me what proportion of time I spend analysing exam papers in a year and I’ll scratch my head and make something up. Ask me how long it takes to mark one paper and I’ll tell you….it’s 10 minutes”. Similarly, you have a good idea how long it takes to pick or pack certain items based on how “ugly” they are, their weight and where they are in a warehouse.

Once you have a view of the cost per unit of capacity at a transaction level you will be able to work out how much capacity is used and the cost to serve your customers. If you do that you may find that some are actually costing you money. If you speak to any company that has attempted customer profiling you may hear some shocking statistics. Kaplan demonstrated with his “whale bone curve” (see graph below) that your best customers may provide 180% plus of your profits but your worst customers can destroy 80% of these same profits you worked so hard to make.

whale bone curve

You then have to overcome the secrecy of providing your partners, customers and suppliers with the costs of doing business together. This is the issue with working with suppliers and partners. You will have to share your financial information to make the end-to-end view of the cost of delivery to work. This is nothing new. Outsourcers are used to open book contracts and the sharing of this detail of financial information is an extension of this philosophy. Once you have the information at an extremely granular, transaction level, it will mean provide additional pieces of information that may be useful. Such as distribution routes, load carrying type, number of drops that the wagon had, weight etc.

I once worked with a food company who everyday received an order at 9am, make the products fresh and package them and deliver to the distribution centre by 3pm, ready for the stores to receive them for the following days trading. This was a great contract driving a significant portion of their gross margin. The problem was, I believe, that it was losing them money as it used up too much of the distribution asset capacity. Ok for now in a cash strapped environment, it keeps people busy and the lights on, but it doesn’t make you money in the long term.

What can we do about it? Kaplan argues that there is “no such thing as fixed cost.” He points to the fact that costs increase as we increase capacity so why not when we reduce it? He has a point. The secret is not to go cutting based just on the numbers as you will hollow out your business before you can say “dumb decision” but to understand the reasons for the behaviour of the business and the customer which is driving this cost – how can you serve the customer’s needs more effectively?

Once you have the cost visibility with not just what it costs you but why it does, you are in a much stronger position to work with your employees, partners, suppliers and customers to identify where there is overcapacity and waste that can be removed.

1. Kaplan, Robert S. and Anderson, Steven R., Time-Driven Activity-Based Costing (November 2003)

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