Cost to Serve Analysis—And the Costs of Neglecting It

I’ll start this post off with a straightforward question.

Have you conducted a cost-to-serve (CTS) analysis for your enterprise?

If you can answer with a “Yes”, I applaud you.

If you can only say “No”, I will not be surprised, because many companies have never drilled down into the costs involved in selling specific SKU categories, individual SKUs, or providing particular services connected with those sales, to specific customers or customer categories. And that is the sole purpose of cost-to-serve analysis.

If you were going to say, “What is a cost-to-serve analysis?” I would be no more surprised than if you were in the “no” camp (which I guess you are), but hopefully, I’ve enlightened you somewhat with the explanation above.

With that question answered, I’m giving the rest of this article over to highlighting several business and supply chain issues, which, if you are experiencing them in your enterprise, are potent indications that CTS analysis should be on your agenda—for execution at the soonest.

Oh! And, of course, I will also share how knowing your cost-to-serve will help you to solve those all-too-familiar performance gremlins.

Are Your Profit Margins Declining?

If your business is experiencing a persistent reduction in profit margins, analysing your cost to serve is an advisable step in diagnosing the causes. When costs begin to spiral out of control, the result is usually a loss of revenue in proportion to sales.

Potential Factors in Declining Margins

To get to the root of the problem, understanding the costs of production or purchasing will be a necessary starting point, but typically, more information will be needed. Excessive costs can hide anywhere in your company’s service provision or supply chain functions, including manufacturing, logistics, distribution, and customer service.

Let’s examine several possible issues that can lead to profit margin erosion.

Customer/Product Profitability

Inevitably, the profitability of some products, customers, and combinations of the two will be lower than others. Indeed, during our CTS work with clients, we’ve encountered many cases where products or customers drive losses rather than profits—always an eye-opener, but more common than you might ever expect.

Under/Overpricing

You might be underpricing some of your products, which, of course, eats directly into your profit margins, or overpricing, which curtails profits by driving customers into the arms of your competitors.

Process Performance

What if the problem isn’t connected to products, customers, or pricing but lies instead with process performance? Some of your processes or activities may erode your margins through excessive resource consumption. You may have process bottlenecks, inefficiencies, or suboptimal workflows collectively eating into your profits while negatively impacting service.

Supply/Inventory Management

Inventory management problems and supplier relationship issues, too, can creep in over time and eat away at your profit margins. Lengthy lead times and high transportation costs can increase the cost to serve for some customers and products while staying hidden amid the bigger picture. Only a complete cost-to-serve analysis will expose these underlying issues unless they happen to be discovered incidentally.

Customer Service Policies and Practice

Could your company’s customer service interactions be impacting margins more than necessary? We have seen cases where customer service departments waive delivery or other fees far more often than policy dictates, especially in response to customer pressure and complaints.

Some customers are very good at finding loopholes to reduce their purchasing costs. It might not be palatable to think that such a thing is happening to your organisation, but can you be sure?

In summary, there are many ways in which your business and supply chain costs can increase significantly in proportion to revenue and nibble away at your profit margins. Without proper insight into cost-to-serve, the erosion may continue, holding back your enterprise and making it increasingly harder to compete in your market.

So, let’s get more specific about some of these issues now, because even if you are not seeing any margin erosion currently, it doesn’t mean that some of the problems I’ve mentioned don’t exist in your business.

We’ll begin with a look at pricing strategy.

Do You Lack Confidence in Your Pricing Strategies?

Without a firm grasp of its cost to serve, your company may not have all the intelligence it needs for accuracy in pricing.

For instance, are you confident that your enterprise is not overpricing or underpricing its products or services? If not, your pricing strategies could inadvertently limit your profit margins, either by throttling revenue or gifting sales to your competitors.

If you follow the more traditional pricing approach of calculating direct production, manufacturing, or purchasing costs and adding a markup, consider what other costs might remain undetected, like those associated with distribution, customer service, and returns management.

Of course, it’s always possible to factor estimates of those costs into your product or service pricing, but then you can find yourself overpricing them.

It’s unlikely, however, that the effects of your pricing strategies are quite that simple. It’s more likely that you are inadvertently over-serving some customers or customer categories (hence exposing them to overpricing) and underserving others.

Are You Missing Opportunities in Pricing Strategy?

Is yours an enterprise that could differentiate pricing based on your customers’ service requirements? Are you taking advantage of that ability? If not, you’re missing a golden opportunity to set prices in a way that improves customer perception and protects your margins.

Even if differentiated pricing is not an option for your business, what about discounts? How can you be sure that your discounted offerings are not resulting in losses?

Discounting prices for a known loss as part of a deliberate strategy to gain customers and increase sales is one thing, but unwittingly selling products at a loss is simply a waste. How can you assess the effect of price discounts without understanding your service costs? In short, you can’t.

What other pricing opportunities might you be missing if you have not analysed your cost to serve? I can think of a few more.

Bundling/Upselling Opportunities

For example, some of your products and/or services might have price structures that complement one another, creating opportunities for bundling or upselling. After a CTS analysis for each product/service you supply, identifying those possibilities can become far more straightforward.

Pricing Agility

How often does your company review and adjust prices, and on what basis do you make those adjustments?

In an era of rapid changes to market conditions, competition, and costs, pricing agility is essential—and agile pricing requires knowledge of the changes and differences inherent in the cost to serve each of your customers.

Negotiation in B2B Pricing

The points I’ve raised here are valid for all businesses. However, if you operate in the B2B sphere, where you are much more likely to negotiate prices than set them according to policy, it’s often necessary to explain your reasoning. That’s far easier to do with solid data to inform you and your customer. Cost-to-serve analysis arms you with that data, strengthening your position in price discussions.

In all cases, your pricing strategy is instrumental in maintaining realistic profit margins, ensuring your business remains competitive without incurring unsustainable losses. If you’d like to feel more confident that your pricing strategies are serving you as they should, a CTS study will help you either gain the assurance you need or highlight how and where you can improve pricing.

Are You Missing Insight Into Customer Profitability and Value?

Even if your profit margins are not noticeably declining, would you be happy to know that orders are leaving your warehouse without making you a penny in profit? I’d wager not.

Would you knowingly sell your products or services to customers whose behaviours or service requirements result in a loss on your sales? Again, I assume you wouldn’t. But unless you have analysed your cost to serve, I’ll bet you have a degree of unprofitable or even loss-making sales you don’t know about.

Imagine if that is the case. Imagine if you could stop those losses with a few strategic changes and turn those orders and customers into profit generators. Well, you can!

But before I reveal more about how cost-to-serve could be affecting your customer profitability right now, even as you read this, I want to dispel any doubts you might hold about the reality of loss-making orders and customers. Not only is it a genuine issue, but it is not unusual to see, when somebody digs deep enough to reveal it.

To that end, I recommend that you take a look at a short case study video that I published on YouTube around a year ago, in which I discuss just such a scenario and how it shocked our client, the Managing Director of a large and successful company, to learn that orders were leaving his warehouse with all potential for profit exhausted—even before the costs of transportation and delivery.

View case study

Learn more about cost-to-serve benefits.

The Path to Transparency in Customer Profitability

So what is it that impacts customer profitability in ways that you might not notice? Typical factors include purchasing behaviour, order frequency, order size, and service requirements. If you have segmented your customers into groups based on these characteristics, you will have some idea of their impact on your profits.

A cost-to-serve analysis based on these groupings will provide a more accurate picture, enabling you to appropriately manage customers with low profitability for your enterprise.

If you haven’t done a segmentation exercise, that would be a positive first step towards understanding customer profitability. However, the real gains will come only after a holistic assessment of the costs of individual customers within the various segments, based on their activities, orders, or other appropriate metrics.

That’s one of the advantages of a comprehensive cost-to-serve analysis, which ensures the attribution of direct and indirect costs. That level of investigation will show you which of your customers is covering the costs of serving them and which are not.

Beyond Segmentation: Understanding Customer Value

Segmentation alone can’t highlight how different customers offer different levels of value to your business. Some of those in the high-profitability segment will provide more long-term value than others, and pricing and service strategies that target an entire segment may not represent the best use of your resources or maximise the likelihood of retaining your best customers—those that offer the most significant long-term value.

When you understand your customers’ individual profit and value contributions—an achievement requiring detailed knowledge of their associated costs—you can begin to implement precise measures to nurture those that bring value and take meaningful steps to increase the value of the rest.

Are You Frustrated by Process Inefficiencies?

I wouldn’t want you to think I’m suggesting cost-to-serve is all about your customers. Earlier, I mentioned that CTS relates to customers, products, and processes. So, now, let’s look at how analysing your service costs can help you resolve process challenges.

Because CTS analysis covers all aspects of the customer journey, it will help you to see patterns in the cost of specific processes. For example, as the analysis takes place, pictures will emerge highlighting specific activities or workflows that stand out more than others as cost drivers, regardless of the customer or product segments to which they cater.

As you drill down into the costs of these activities, the analysis can often throw up indications about which specific steps in a process or workflow harm your operational efficiency. These will typically be tasks that consistently require high resource levels or create bottlenecks or delays in the process.

That insight can make the difference between knowing you have an issue with operational efficiency and determining the precise points at which the problems lie.

Targeting Processes with CTS Analysis

A detailed analysis of your cost to serve requires appropriate skills, tools, and, ideally, a high degree of experience, but there are ways to lighten the burden.

If you determine that a detailed CTS analysis makes sense for your company, remember that you don’t have to analyse your entire business from end to end in one fell swoop, particularly if you wish to focus on processes.

For instance, it is possible to initially target a specific function or division of your enterprise, such as your warehouses or the logistics function, and then move through the rest of the supply chain or customer journey in later stages.

Alternatively, you can engage a team of specialists, such as those here at Logistics Bureau, to support you or even to carry out an entire cost-to-serve analysis on your behalf. To learn more about how we can help you, why not contact us to arrange an initial consultation call free of charge?

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Considering a cost-to-serve analysis for your enterprise? Schedule your consultation call now.

Are You Perplexed by SKU Proliferation

As we reported in our previous blog post on ecommerce inventory management, SKU proliferation has become a challenging supply chain trend associated with the growth of online sales, and one that has no simple solution.

As such, even small measures that can help an enterprise review and, when necessary, rationalise a product portfolio are to be welcomed by inventory teams frustrated with ballooning inventory dollars and executives concerned about falling profit margins.

Have you looked closely at comparisons between the cost of supplying each of your SKUs and the revenue that it generates? If not, it won’t be easy to make objective decisions about which SKUs to prioritise and which to discontinue.

Just as some customers are more profitable than others, so are some of your products. Therefore, when trying to prevent SKU proliferation from getting out of control, it’s sometimes necessary to be ruthless—but that’s a big ask when you don’t have a cost-versus-revenue profile of each product.

The Hidden Potential of Low-profit SKUs

Of course, managing proliferation is not just about which SKUs you keep and which you choose to delist. With a complete picture of your cost to serve, you can also identify products that are yielding only small profits now, but can potentially improve profitability with a few adjustments to strategy.

Even if you diligently apply ABC classification to your inventory, that merely gives you an idea of each SKU’s value and throughput volume. But a complete cost-to-serve analysis adds the cost implications, so you can make more accurate decisions about which SKUs to nurture, which to delist, and to which you can invest resources and effort into developing profitability.

Is SKU Proliferation Increasing Complexity in Your Supply Chain?

As a result of SKU proliferation, your inventory management and, indeed, the management of your entire supply chain can become increasingly complex. In turn, such a development can start to drive up the costs associated with the products you manufacture or supply.

However, increased complexity is likely to impact some SKUs more than others, so again, it will take a CTS analysis to help you understand the effects at a granular level.

The cost-to-serve knowledge you gain may increase your ability to balance the costs of managing an extensive SKU portfolio with the benefits of product variety.

SKU Proliferation: A Challenge for Product Lifecycle Management

Then, there is the issue of lifecycle management. As the number of SKUs in your portfolio grows, it can become harder to assess the value of each item as its lifecycle progresses from introduction to decline.

Understanding this rise and fall is a crucial element of SKU rationalisation, without which your company might overspend on products that already cost more to supply than they are worth as profit generators, or abandon others before they rise to their full potential.

Cost-to-serve analysis can highlight data trends showing how products in specific categories affect profit during the various stages of their lifecycle. You can then exploit that information when deciding which SKUs to discontinue, revamp, or promote.

Cost to Serve as an Aid to SKU Management

SKU proliferation will not go away now. Nor will it become a less significant issue as markets increasingly demand more comprehensive ranges of products, packaging configurations, and forms of presentation.

While CTS analysis will not solve the problem or even make any concrete impact on it, per se, it will give you a clearer picture of the costs, value, and potential of each SKU that you can use to make more accurate decisions about your product portfolio.

How to Reap the Benefits of CTS Data

In this article, I have covered five distinct business and supply chain management elements that often cause fear and frustration among company executives and managers.

In each case, I have learned enough, across some three decades of studying, consulting on, and completing analyses of cost-to-serve, many of them for large companies with complex product ranges and diverse customer cohorts, that CTS data can significantly improve insight supporting the resolution of problems, and support better decision-making.

Of course, it’s not a panacea. Like any management tool (and CTS is just that—an addition to the supply chain management toolbox), its impact depends on how broadly you apply it, the level of detail to which you wish to take it, and, of course, the accuracy of the raw data with which you supply it.

Want to Know More About Cost-to-Serve Analysis?

You’ll find many other articles about cost-to-serve in our blog, some of which will help with the practicalities if you wish to start exploring CTS within your organisation. And, of course, our team is always ready and willing to provide you with support or hands-on help with cost-to-serve projects.

So, for now, I will leave you with a final reminder of the case study I mentioned earlier in this article. It will take just three or four minutes to view the video (it’s that short), and it genuinely highlights just how revealing a cost-to-serve analysis can be.

SPOILER: The word “shocked” features several times in the video!

Please—enjoy the video and, perhaps more importantly, think about the value a cost-to-serve study might bring to your enterprise, especially if you’re experiencing any of the issues we’ve featured in this article.