By Luis Rodriguez – For many business leaders, the heat is on. They face inflation, supply chain disruption, labour shortages, and pricing pressures.
Protecting margins while meeting customer needs and navigating economic uncertainty is crucial. However, many lack transparency and granularity in actual cost structures.
Advanced analytics and AI can help leaders transform cost structures in real-time, enabling them to make informed decisions and maximise profits. A robust cost-to-serve methodology can help answer critical questions and improve overall efficiency.
- Do we know our accurate margins by the customer, SKU, product lines and channel level today?
- Are our prices still valid; do they 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 actual costs and profitability
A cost-to-serve methodology offers companies visibility into accurate margins at the product, SKU, customer, and channel levels. This process combines operational and financial data with analytics and artificial intelligence (AI) tools, enabling companies to identify specific actions that can significantly improve their bottom line. It helps leaders rationalise their product portfolio, informing their “make” versus “buy” decisions, change service levels, optimise overhead, change rebate/discount structures, improve pricing strategy, and reduce design complexity.
Companies must adopt a different approach to increase or sustain margins. They must look at two costs across the value chain: traceable costs tied to a specific product line or channel and non-traceable or indirect costs unrelated to a particular plant, customer, or product. Using cost-to-serve, companies can pinpoint specific drivers of every expense and allocate them to various products/SKUs, customers, and channels. This comprehensive view allows companies to assess everything from customer and channel mix to profitability of products and SKUs, identify opportunities and make changes. Benchmark costs of plants and regions to determine where supply chain metrics and trade spending can be improved.
By mapping every cost to the activity level, companies can remove ambiguity around cost allocation and provide operating margin-level visibility. It enables companies to segment customers and rationalise their product portfolio against specific performance requirements, understand which customer segments or products are unprofitable, and take actions to improve profitability or cut underperforming product lines while driving particular interventions to reduce costs across the value chain.
Quick wins in the cost-to-serve strategy
- Enhanced Transparency: Understanding actual costs requires an in-depth look into all the direct and indirect costs associated with a product or service. This transparency can illuminate areas where resources are being wasted or misallocated.
- Better Decision Making: With a clear picture of actual costs, businesses can make more informed decisions about pricing, scaling, or discontinuing certain products or services. It helps in assessing the solid profitability of each product or service line.
- Supply Chain Optimisation: By recognising the actual costs at every supply chain step, organisations can pinpoint inefficiencies and make necessary adjustments. This can reduce waste, better supplier relationships, and cost savings.
- Improved Sustainability: Understanding actual costs often includes recognising the environmental and social impacts of business practices. By considering these factors, businesses can develop more sustainable operations suitable for the planet and appeal to eco-conscious consumers and stakeholders.
- Competitive Advantage: A firm understanding of actual costs can give businesses a competitive edge. They can offer more competitive prices, invest in more profitable ventures, and allocate resources more effectively than their competitors.
- Risk Management: Recognising hidden costs can also alert businesses to potential risks. For instance, if a critical component in the production process has a volatile price, the company can strategise to mitigate potential negative impacts.
- Customer Trust and Loyalty: By pricing products or services based on their actual costs, businesses can justify their pricing strategies to customers. Transparent pricing can increase trust and loyalty from customers who appreciate honesty.
- Encourages Innovation: When businesses fully know the costs, they are more likely to invest in research and development to find cheaper, more efficient methods or alternative materials.
- Boosts Long-term Profitability: Focusing only on direct costs might yield short-term gains, but recognising and managing actual costs can set the foundation for long-term profitability and growth.
- Stakeholder Relationships: Investors and shareholders are increasingly concerned about the entire business costs, including environmental and social impacts. Businesses can strengthen their relationships with key stakeholders by addressing these concerns and optimising actual expenses.
While it might be tempting to focus solely on visible, direct costs, the actual value can only be unlocked when businesses delve deeper into understanding the full spectrum of costs associated with their operations. It ensures economic viability and promotes sustainability, stakeholder trust, and long-term success.
Case in point: insights power retail fuel company savings – and boost margin
A retail fuel company’s cost-to-serve methodology revealed three key insights about its profitability: 50% of its unprofitable SKUs, two key product lines eroded margins, and only 25% of customers accounted for 90% of profits. The company identified 6%-8% potential cost savings and an opportunity to boost margins by 8%-10% enterprise-wide through pricing changes across customers and channels.
Key actions included ensuring prices cover variable and fixed costs, rationalising the product portfolio, and aligning servicing timelines and payment terms with customer segments. The company is now capitalising on these opportunities by improving profitability beyond cutting costs or raising prices.
Companies 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 pass-throughs 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 place itself for today’s challenges.
Luis Rodriguez is the MD for Strategy and Consulting business at Accenture in Africa