Understand cost-to-serve in order to maximize customer profitability
Many supply chain technology blog posts open with an introduction to an abstract concept and then support the hypothesis with real-world examples. This post turns that model on its head and begins with a short television commercial that succinctly illustrates the meaning of cost-to-serve and the decisions that cost-to-serve analyses demand. It doesn’t get more authentic than this! Click here to watch.
The heroine of this story (Sheila) obviously understands cost-to-serve. She knows a customer with a severe critter problem will be unprofitable and therefore she quickly, coolly and calmly resigns the account.
In contrast, the foil in this ad (Tom) blindly assumes that a customer stolen from Sheila must be good for him and bad for her. He too understands cost-to-serve, at least superficially, but wasn’t willing to assess the new customer’s profit potential before accepting the business.
On a more conceptual level, what type of organization can benefit from an ongoing cost-to-serve initiative? Answer: all, big and small. The need is clear for a company struggling with profitability, but the more interesting and less conspicuous case is the company enjoying consistent rapid revenue growth and healthy profits.
At any rate, as the industrial economy matures, businesses are being forced to adapt their products to individual customers’ requirements and to provide more and more services in the package they sell their customers. In short, everyone wants it their way, problems tend to flow downhill, and the cost implications are plain to see. Better to understand your profit picture before it’s a survival issue.
The point of cost-to-serve, then, is to understand profit-by-customer at a granular level in order to maximize Total profit, Revenue and Retention.
Halo Customer Scorecard is a comprehensive set of dashboards loaded with intuitive, highly visual tools to help you explore margins and analyze the key factors influencing total profit, including cost (of product), sell price, sales volume, mix, and cost-to-serve (e.g. transportation costs, warehousing, special requests, trade spending, customer service policies, sales expenses, etc.).
The image above shows the Margin Explorer dashboard in Halo Customer Scorecard. It provides easy visualization of revenue and profit dynamics at the customer, product and channel level. It answers questions such as, "Which of your customers have the highest margins?", "What are they buying?" and "What product groups provide the most margin?"
Let’s pivot now and assume that, regardless of current and projected profitability, your VP of Operations and VP of Sales have been directed to make your company more money. Will a cost-to-serve initiative be worthwhile? What does it take to start one and sustain it?
In terms of value, studies show a large gap between the importance of cost-to-serve initiatives and the effectiveness of measurement efforts. In other words, they’re very valuable but difficult to implement. This finding is bolstered by research that shows a high correlation between successful cost-to-serve programs and companies that outperform their peers in managing costs.
As for implementing cost-to-serve, you will likely face structural and political barriers, such as:
- Lack of data/difficulty aggregating data (an average company has to extract and normalize data from 17 separate systems)
- Lack of ownership. Cost-to-serve is often perceived as residing outside the S&OP process
- Fear. Of losing a customer. Of exposure -- “Let us get the data whipped into shape first.”
- Poor alignment. Sales is compensated on topline performance only
- Definition difficulty. Building consensus around the elements of cost-to-serve that should be analyzed, and how to allocate costs.
What are you likely to find once Halo Customer Scorecard is implemented and providing insights? Many companies discover their customer base will look something like this:
- Cash Hogs: low profit, high cost
- Lean and Mean: low profit, low cost
- Fat Cats: highly profitable, but high cost
- Good Citizens: High profits, few assets tied up
Based on this data and a full understanding of where margins are in jeopardy, you’ll need to make some decisions:
- Which customers are Good Citizens, and appreciate the value you provide? How many are there? (probably between 5% and 25%.) How will you retain them, grow them, replicate them?
- Who are the Potentials, AKA the budding Good Citizens? This group must drive substantial future growth
- Who are the demanding, the ungrateful and the deal-conscious? Should they be fired, or is the root cause something you can fix? Perhaps you’re selling this customer the wrong product mix through the wrong channel.
Here’s a final recommendation. Don’t allow a cost-to-serve analysis to devolve into just an IT project or just a Finance project. It’s a journey the whole company needs to undertake together. There’s much to be learned, and alignment will suffer if the entire effort resides in a silo.