Measuring logistics costs and performance
Logistics management is a flow-oriented concept with the objective of integrating resources across a pipeline which extends from suppliers to final customers. Typically, conventional accounting systems groups costs into broad, aggregated categories which do not then allow the more detailed analysis necessary to identify the true costs of serving customers with particular product mixes.
The concept of total cost analysis
conventional accounting systems do not usually assist in the identification of company wide effects of changes in the logistic management (for example minimum order value), nor are able to determine the cost of processing orders (because the involve costs from different functional areas).
Principles of logistics costing.
- A logistics costing system should mirror the material flow and identify the costs that result from providing customer service, and also it should be capable of enabling separate cost and revenue analysis to be made by customer type and by market segment or distribution channel (no to deal with averages).
- A mission cost approach can be implemented, in which a customer service goal is set within a specific product/market context, then cost associated with this mission are taken from a number of functional areas within the firm.
- Barret’s mission costing method: 1) identify activity centres associated with a distribution mission, 2) identify and isolate the incremental costs (no sunk costs) incurred as a result of undertaking that mission.
- This approach becomes particularly powerful when combined with a customer revenue analysis, because even the customers with low sales off-take may still be profitable in incremental costs terms if not on an average cost analysis.
Logistics and the bottom line
The 3 financial dimensions for decision making are the bottom line (immediate pay-back only), strong positive cash flow, and the productivity of capital (return on Investment ROI)
ROI = Profit/Capital employed
ROI = (Profit/Sales) (Sales/Capital employed)
Margin X capital turnover
- Retailers can have good ROI with low margins but high capital productivity (limited inventory, high sales per square foot, leasing instead of owning)
- Logistics management can improve the following elements that determine ROI:
1) Sales revenue
Service can improve sales and be a powerful source of differentiation.
2) Costs
Higher cost when outsourcing, inventory holding, obsolescence, and deterioration.
3) Asset deployment and utilization.
Better cash and receivables with shorter order cycle time, better order completion rate and invoice accuracy. Lower inventories, minimizing the premature purchase of materials (by using MRP and DRP –Distribution requirements planning). By converting fixed assets into continuing expenses with the use of third-party suppliers (for transport and warehousing)
Logistics and shareholder value
Shareholder value is a key performance of corporate performance (what is the company worth)
- The simplest way to determine it is by the net present value of future cash flows.
Net operating income – Taxes – Working capital investment – Fixed capital investment = After tax free cash flow
- Another method is the Ecomic Value Added (EVA), which is the difference between operating income after taxes less the true cost of capital employed to generate those profits:
EVA = Profit after tax – True cost of capital employed
- Another method is the Market Value Added (MVA) which is the net present value of expected future EVAs:
(Stock price x issued shared) – Book value of total capital employed = MVA
MVA = Net present value of expected EVA
With logistics management lengthy pipelines requiring working capital can be shortened and assets can be moved off the balance sheet through the use of third party logistics service providers.
Customer profitability analysis
- The basic principle of customer profitability analysis is the assign all cost that are specific to a individual accounts. By using the principle of ‘avoidability’ (what costs would I avoid if I didn’t do business with this customer), one can find that some customers make a negative contributions to profits. However, as long as the net contribution is positive and there are no ‘opportunity costs’ in servicing that customer, the company would be better off with the business than without it.
- Results from this analysis can be used in contract negotiations, sales and marketing strategies (to focus in profitable accounts), and in creating alternative strategies for managing customers with high service costs.
- Because customers are who make profits and no products, companies should develop accounting systems that collect and analyse data on customer profitability (instead of being product based), in addition of having cost reporting in a transactional basis rather than customer focused.
Direct product profitability
- Also know as “Total cost of ownership”, it relates to identifying al the costs that attach to a product or an order as it moves through the distribution channel (Warehousing, transportation, retail costs). Expensively used in retail, the concept is that the customer incurs in other costs other than the immediate purchase price of the product
- Here the key objective in customer service is to reduce the customers’ total cost of ownership by making changes such as changing the case size, increasing the delivery frequency, direct store deliveries Etc.
Cost drivers and activity-based costing Summary
- Conventional accounting problems when used in logistics management
There is a general ignorance of the true costs of servicing different customer types/channels/market segments.
- Costs are captured at too high a level of aggregation.
- Full cost allocation still reigns supreme.
- Conventional accounting systems are functional in their orientation rather than output oriented.
- Companies understand product costs but not customer costs - yet products don't make profits, customers do.
- The best approach would be to separate the expenses and match them to the activities that consume the resources.
- Activity-based accounting (ABC) seeks out the ‘cost drivers’ along the logistics pipeline that cause cost because they consume resources. For example invoice items costs instead of invoice costs.
- Mission costing seeks toidentify the unique costs that are generated as a result of specific logistics/customer service strategies aimed at targeted market segments.
- Stages in the implementation of an effective mission costing process:
- Define the customer service segment
Identify the different service needs of different customer types
- Identify the factors that produce variations in the cost of service
Factors that impact cost of service (product mix, delivery frequency…)
- Identify specific resources used to support customer segments
Here ABC and mission costing coincide. Identify the activities that generate cost along with their specific cost drivers (order items, people involved, inv. Support…)
- Attribute activity costs by customer type or segment
Use the principle of ‘avoidability’ o assign the incremental cost incurred. It should be cost attribution and no cost allocation.
- Because logistics management is concerned to meet customers service requirements in the most cost effective way then it is essential that to have the more accurate and meaningful data possible.
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