Weekly value-added in 5 minutes
Dear Community,
Welcome back, Procurement Professionals! Last week, we learned about the transformative benefits of digitization in procurement, how technology can streamline operations and enhance decision-making. This week, we continue our journey by focusing on "Cost-to-Serve Analysis in Procurement." Understanding your Cost-to-Serve (CtS) is crucial for managing profitability and optimizing your supply chain operations. This newsletter will guide you through its significance and practical applications in procurement and supply chain management.. Here’s how:
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SCM Takeaways
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Book Recommendations
C2B Takeaways
This Week's Topic: Cost-to-Serve Analysis in Procurement
Cost-to-Serve Analysis (CtS) is a method used to determine the total cost of servicing a customer, taking into account all the associated direct and indirect expenses. For procurement and supply chain professionals, mastering CtS analysis is vital for understanding where value is being created or lost across the supply chain. This week, we explore how CtS analysis can drive more informed decision-making, optimize processes, and contribute to profitability. Let's dive into its importance through five key points, using Unilever's supply chain transformation as our case study.
1. What is Cost-to-Serve Analysis?
Cost-to-Serve (CTS) analysis is a detailed examination of the total cost incurred by a company to serve a customer, segment, or channel. This includes all direct and indirect costs from production to delivery (Kaplan & Anderson, 2007).
The significance of CTS analysis lies in its ability to highlight hidden costs and profit drains within the supply chain, enabling companies to make informed decisions about customer relationships, pricing, and service levels. For instance, Procter & Gamble (P&G), a global consumer goods company, utilized CTS analysis to optimize its distribution strategy. By identifying high-cost service routes and customers, P&G was able to restructure its logistics and procurement processes, leading to substantial cost savings and improved profitability (Hope & Fraser, 2003).
Examples:
Logistics Costs: A company might discover that certain delivery routes are disproportionately expensive due to fuel, time, or tolls. By re-evaluating these routes, they can reduce overall logistics costs.
Packaging and Handling: Some customers might require special packaging, which increases the cost. Identifying these cases allows companies to either adjust pricing or find more cost-effective packaging solutions.
Inventory Holding: Holding inventory for certain customers might incur higher costs due to storage fees or spoilage. CTS analysis helps in making decisions about inventory levels based on actual cost data (Anderson & Narus, 2004).
2. Identifying Cost Drivers in Procurement
Cost drivers are the factors that generate costs within a business. In procurement, these can range from raw material prices to supplier terms and logistics expenses (Kaplan & Anderson, 2007).
Understanding cost drivers is essential for optimizing procurement strategies. By focusing on the right drivers, companies can reduce unnecessary expenses. For instance, in the automotive industry, Toyota used CTS analysis to identify cost drivers related to supplier inefficiencies and logistics. By addressing these issues, Toyota significantly reduced its procurement costs and improved its supply chain responsiveness (Hope & Fraser, 2003).
Examples:
Supplier Performance: Poor supplier performance can increase costs through delays or quality issues.
Procurement Processes: Inefficient procurement processes can lead to higher transaction costs.
Logistics and Freight: Unoptimized logistics routes can be major cost drivers, especially for global companies (Anderson & Narus, 2004).
3. Segmenting Customers Based on Profitability
Customer segmentation based on profitability involves categorizing customers according to the profit they generate after accounting for the costs of serving them (Kaplan & Anderson, 2007).
By segmenting customers, companies can focus their resources on the most profitable segments. For example, Unilever implemented CTS analysis to segment its customer base and identified that a small percentage of its customers were driving the majority of profits. This allowed Unilever to tailor its procurement and supply chain strategies to prioritize these key customers, thereby maximizing profitability (Hope & Fraser, 2003).
Examples:
High-Profit Customers: These customers generate substantial revenue with minimal cost-to-serve, making them ideal for premium services.
Low-Profit Customers: These customers require more resources and may need re-evaluation of service levels or pricing.
Strategic Customers: Some customers, while not highly profitable, might be strategically important and require tailored procurement strategies (Anderson & Narus, 2004).
4. Enhancing Supplier Relationships
Enhancing supplier relationships involves working closely with suppliers to improve collaboration, reduce costs, and ensure a reliable supply chain (Kaplan & Anderson, 2007).
CTS analysis can reveal which suppliers are most cost-effective and which may require renegotiation or replacement. An example from the retail sector is Walmart, which uses CTS analysis to collaborate closely with suppliers, sharing cost data to identify inefficiencies. This collaboration has helped Walmart and its suppliers reduce costs and improve service levels, benefiting both parties (Hope & Fraser, 2003).
Examples:
Collaborative Planning: Working with suppliers to plan and optimize production schedules can reduce costs.
Supplier Consolidation: Reducing the number of suppliers can lead to economies of scale and better pricing.
Joint Cost Reduction Initiatives: Partnering with suppliers on cost reduction initiatives can benefit both parties (Anderson & Narus, 2004).
5. Applying Cost-to-Serve Insights to Pricing Strategies
Using CTS analysis in pricing strategies involves adjusting prices based on the true cost of serving different customers or segments (Kaplan & Anderson, 2007).
By incorporating CTS data into pricing strategies, companies can ensure that prices reflect the actual costs of service. An example from the telecommunications industry is Vodafone, which used CTS analysis to adjust its pricing models for different customer segments. This allowed Vodafone to improve profitability by aligning prices with the cost-to-serve, ensuring that less profitable customers were charged appropriately, or service levels were adjusted (Hope & Fraser, 2003).
Examples:
Differential Pricing: Adjusting prices based on customer segments ensures that high-cost customers do not erode profit margins.
Volume Discounts: Offering discounts to high-volume customers who are cheaper to serve.
Service Level Adjustments: Modifying service levels for less profitable customers to reduce costs (Anderson & Narus, 2004).
Sources:
Anderson, J.C., & Narus, J.A. (2004). Business Market Management: Understanding, Creating, and Delivering Value. Pearson Prentice Hall.
Kaplan, R.S., & Anderson, S.R. (2007). Time-Driven Activity-Based Costing: A Simpler and More Powerful Path to Higher Profits. Harvard Business Review Press.
Hope, J., & Fraser, R. (2003). Beyond Budgeting: How Managers Can Break Free from the Annual Performance Trap. Harvard Business Review Press.
SCM Takeaways
Understanding Cost-to-Serve is vital for procurement and supply chain management. By breaking down and analyzing costs at each stage of the supply chain, professionals can identify inefficiencies, optimize processes, and make informed strategic decisions. For instance, Unilever’s integration of CtS analysis with digital tools resulted in substantial cost savings and improved efficiency. This case highlights the importance of not only conducting CtS analysis but also ensuring that it is an integral part of the digital transformation process within SCM.
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Book Recommendations
"Supply Chain Management: Strategy, Planning, and Operation" by Sunil Chopra.
A comprehensive guide to modern SCM practices, this book offers deep insights into strategic decision-making, including a section on CtS analysis. It’s perfect for professionals looking to optimize their supply chains."Supply Chain Metrics That Matter" by Lora Cecere.
This book bridges the gap between supply chain strategy and execution, emphasizing the importance of metrics like Cost-to-Serve in driving business success. It's ideal for those who want to understand how to measure and improve supply chain performance effectively."The Digital Supply Chain" by Bart L. MacCarthy.
A deep dive into how digital tools can enhance SCM, this book connects well with this week's topic by showing how CtS analysis can be integrated into a broader digital strategy.
C2B Takeaways
Understanding Cost-to-Serve isn't just for large corporations; individuals can apply these principles in everyday life to better manage their personal finances and consumer habits.
Budgeting: Just as companies use CtS analysis to manage costs, individuals can analyze their spending to optimize their budget.
Example: Tracking all monthly expenses to identify areas where you can cut back or find more cost-effective alternatives.
Efficient Shopping: Understanding the total cost of a purchase, including time and effort, can lead to smarter shopping decisions.
Example: Opting for online shopping with free delivery vs. driving to a store, saving both money and time.
Investment Decisions: Just like businesses, individuals can use CtS principles to make better investment choices.
Example: Considering all fees and potential returns before making an investment, ensuring it aligns with long-term goals.
We Learned Today
Key takeaways from this week's newsletter:
Cost-to-Serve (CtS) Analysis is crucial for understanding the total cost of servicing a customer.
Unilever's use of CtS analysis led to significant cost savings and operational improvements.
Integrating CtS with digital tools enhances its effectiveness in supply chain management.
Optimize Costs: Regularly conduct CtS analysis to identify and reduce inefficiencies in your supply chain.
Leverage Technology: Use digital tools to streamline CtS processes and make data-driven decisions.
Continuous Improvement: Overcome challenges in CtS implementation by fostering a culture of transparency and continuous learning.
Thank you for reading this week's edition of ProcWee! We look forward to sharing more insights with you next week. Have a great week ahead!
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