Cost of serving: an analysis to leverage the profitability of supply chains

Recognizing and responding to customer needs is becoming increasingly important to thriving supply chains. But not at any cost. As well as delivering a high-value customer experience, profitability is also an important success factor.

Although historically it was common to calculate customer profitability considering only the gross margin (sales revenue minus the cost of goods sold), nowadays service costs are very representative and cannot be ignored. By service costs, we mean the costs of all marketing, sales and logistics activities related to customer service, from the sale and promotion stage of the product to its delivery, and eventual provision of after-sales services. As examples, we can mention the customization of products, storage and dispatch, commercial actions, order billing, routing, distribution, monitoring, payment method and post-sales. 

Companies, in general, manage to raise these costs correctly, but have difficulties when trying to allocate them to those who really should pay them. In traditional practice, service costs were apportioned proportionally to the sales volume of each customer. If a customer accounted for 15% of sales, 15% of service costs were charged to him. Thus, customers were only differentiated by the volume purchased, without considering the different levels of demand, such as sales effort, the number of orders that each customer placed, the frequency of delivery and the need for after-sales services, among many others. variables. In this way, services could be charged to customers who did not demand them and, at the same time, customers who demanded a lot of services could be paying very low prices. 

More detailed approaches, such as activity-based costing (ABC – Activity Based Costing), allow for a fairer allocation of costs, considering how much each client actually demanded from each analyzed activity. By deducting the cost of goods sold and the cost of service from sales revenue, it is possible to calculate the profitability per customer. The main result of this analysis is a graph known as Curva da Baleia, which allows you to visualize which customers have positive profitability, zero profitability and negative profitability (consume part of the profit), as shown in Figure 1.

Figure 1: Whale Curve. Source: ILOS

Among the strategic opportunities provided by customer profitability analysis, we can highlight:

• Identify opportunities for simplification, standardization and optimization of processes: To calculate the cost of fulfillment, all activities in the order cycle must be analyzed in detail, which generally allows identifying important opportunities for improvement, reducing costs and increasing profitability;
• Adjust service policies: Based on the profitability analysis, it is possible to adjust service policies seeking to be profitable in all customer segments;
• Renegotiate commercial policies: Information on costs and profitability is essential to base price definitions, bonuses, promotions, etc., that allow you to achieve your objectives (eg: increase in volume, customer development) and bring the expected return.

In an increasingly competitive environment, with greater demands in terms of differentiated services, expansion of the product portfolio and service channels, the analysis of the cost of serving is of great value to support the definition of action plans (eg. customized service, process optimization) that allow leveraging the chain's profits.

References:

• Guerreiro et al., 2008. Cost-to-serve measurement and customer profitability analysis. The International Journal of Logistics Management.
•  The Whale Curve and Customer Profitability Calculation
•  Customer profitability and service level
•  Cost of serving: a methodology for calculating customer profitability