Want to unlock more value? Focus on true costs

For many business leaders, the heat is on. They continue to face record inflation, supply chain disruption, labor shortages and increasing pressure on pricing. And particularly challenging now is protecting margins while meeting changing customer needs and navigating economic uncertainty. However, many miss out on unlocking value because they lack transparency and granularity into true cost. If you don’t know your full cost structure, how can you determine your true margins — and make the right decisions to maximize profits?

Fortunately, with advanced analytics and AI, leaders can get granular in real time to successfully transform costs structures. Start with a robust cost-to-serve methodology to answer the following critical questions:

• Do we really know our true margins by customer, SKU, product lines and channel level today?
• Are our prices still valid; do they really cover what it takes to serve our customers?
• Is our product portfolio right-sized to meet changing customer needs?
• Do we have the right channel mix?

A new approach to identifying true costs and profitability

A cost-to-serve methodology provides visibility into true margins at the product, SKU, customer and channel level (see figure below). The methodology combines the right operational and financial data with powerful analytics and artificial intelligence (AI) tools. With this visibility, companies gain insight to identify specific actions that can significantly improve their bottom-line. For example, it helps leaders to rationalize their product portfolio, inform make vs. buy decisions, change service levels, optimize overhead, change rebate/discount structures, improve pricing strategy and reduce design complexity.

We look at two types of cost across the value chain. The first are traceable costs directly tied to a particular product line or channel, such as direct materials and labor. The second are non-traceable or indirect costs that aren’t tied to a particular plant, customer or product. Using cost-to serve enables a company to pinpoint specific drivers of every cost. From there, they can allocate the drivers to various products/SKUs, customers and channels.

The goal is to get a complete view that enables companies to assess everything from the customer and channel mix to the profitability of products and SKUs. It also enables visibility into complex operations at the activity level to identify opportunities and make changes. And it helps benchmark costs of plants and regions to identify where supply chain metrics and trade spends can be improved.

Using this approach, a company can map every cost down to the activity level, which removes the ambiguity around cost allocation. Each product and customer is mapped to provide visibility at the operating margin level. The resulting visibility enables the company to then segment its customers and rationalize its product portfolio against specific performance requirements. Companies can understand which customer segments or products are unprofitable and why. Then they can take actions to improve profitability or cut underperforming product lines while driving specific interventions to reduce costs across the value chain. 

Case in point: insights power retail fuel company savings — and boost margin

For one retail fuel company, the cost-to-serve methodology uncovered three insights about the business’s profitability:

• 50% of the company’s SKUs were un-profitable, while two key product lines were eroding margins.
• Just 25% of the company’s customers accounted for 90% of its profits, while 20% were profit-neutral and 55% were costing the company money.
• For some customer segments, a combination of small order sizes, high order processing costs, and corresponding high overhead was eating into margins.

Digging deeper, we were able to identify 6%-8% in potential cost savings. And an opportunity to boost margins by 8%-10% enterprise-wide with a mix of pricing change across customers and channels.

The company is now capitalizing on these upside opportunities with several key actions:

• Ensuring prices cover variable and fixed costs
• Rationalizing the product portfolio and reviewing logistics networks to improve primary logistics costs
• Aligning servicing timelines and payment terms with customer segments to improve profitability through order and load consolidation.

Beyond cutting costs or raising prices

Companies that are serious about increasing or sustaining margins can’t take the same approach as they did in the past or rely solely on price increases or cost passthroughs in the current inflationary environment. Instead, leaders will see real value in identifying specific, insight-based interventions to reduce costs and position their company for growth.

A cost-to-serve approach is fundamental to how a holistic, forensic view of all costs can enable a company to position itself for today’s challenges. Contact me to learn how cost transformation can help your company reimagine its business, reset its cost base and free up funds to invest in the future.