I interviewed Richard Wilding who discussed Cost to Serve.
( Apology for some background noise I interviewed Richard from my mountain cabin using Skype and forgot to mute, you will hear in the background some nature sounds :-) )
It's good to speak with you again, Richard. This is going to be an interesting topic on Cost to Serve. Before we start, can you provide a brief background of yourself?
Yes, of course. I'm Professor Richard Wilding. I'm professor of supply chain strategy at Cranfield School of Management in the UK. It's one of Europe's and globally one of the leading supply chain universities which is there. I'm also chairman of the Charter Institute of Logistics and Transport, and that has 18,000 member in the United Kingdom, 33,000 worldwide, and those are all professionals involved in the movement of goods and people and their associated supply chains. So that's a little bit a be me.
Thanks. So can you talk about Cost to Serve? What is it, and what's happening in this space?
One of the challenges that we have in the supply chain really is getting true transparency of costs. What we're finding is some of the traditional costing approaches don't quite work when it comes to supply chains. If you think about it, often what we do is we take a sort of an average approach. So what we will basically say is that I've got a warehouse. It costs me — I don't know; I'll make up some silly numbers here to make it simple. But it costs me $4,000 a year to run it. I have a thousand items in it, so therefore, for each item, I will allocate a cost of about $4. We go through a very simple calculation like that. The problem is that's basically saying if I'm wanting to make a small pen — if we're talking about an office furniture supply chain — in that warehouse, we're saying it costs the same to move a pen as it does to move, say, a desk and a chain. And we know, as supply chain professionals, that is totally ridiculous.
Now that then leads to some major problems in terms of how we run our supply chain. So one of the laws of logistics, which myself and a gentleman called Alan Braithwaite came up with, and this was published in the Financial Times handbook a number of years ago. Basically one of the laws is basically the total cost of sourcing, converting, and delivering product is seldom the sum of the lowest functional costs of each element of the supply chain. What that's basically saying is if you optimize each individual silo within the business, generally you're going to end up with higher costs than if you try and actually focus on the thinking about the totality of what's happening in terms of the cost. Now that proves very challenging for businesses.
One particular soft drinks that we were working with, for example, they put in a new process. This was very successful. It was going to actually give them a 2.7% reduction in costs within that supply chain. But actually that required their transport operations to increase their cost by 2.8%, their production people to increase their cost by 15.6%, but that would then mean that they could save, dramatically reduced, their finished goods by nearly 37% and their finish goods stop finance and also their raw materials. But can you, in your business, turn around to your production director and say, "Hey, we want you to increase your cost by 15.6%”? And this is all part of really truly understanding the cost to serve and what's going on.
So if we can get a savings through the supply chain of 2.7% and that's worth having. But of course, it may mean that some functions within the supply chain actually have to work differently which might increase their costs. But of course that's going to prove very challenging for performance metrics within the business and so on and so forth.
Now the thing that we really often overlook is that when you actually look at, if you like, the profitability of products, what we have is a curve which we often term a whale curve. If you can image a whale breaking out of the surface of the ocean, it creates a curve which goes up and then it comes down. And that curve is basically telling us that we're making lots of profit on, say, some of our products, but then we reach a plateau, and then we may be losing money on lots of other products, which gives us the overall profitability of the company. That is we don't make money on everything we do, and it's the same with customer.
Some of our customers are really expensive to serve, so we might make money on some customers, but then we lose lots of money on other customers. I mean, a great example I came across with basically a tire manufacturer, what they were doing was they were having this vehicle delivering tires to automotive centers. You can also buy cycle inner tubes from them as well. And what would happen is you'd fold up the organization and a small cycle shop would say, "We need four of these cycle inner tubes. Can you drop them in on your next round?" They do a [inaudible 00:05:44] round. They go around all these automotive depots delivering tires, but they also have these small other tires.
Now the example I remember was we found out that they were doing a 30-minute detour from their normal route to deliver four cycle inner tubes. Now 30 minutes to the cycle shop, 30 minutes back. Let's just have a think about that. How much money are we going to sell the cycle inner tubes for? Well typically, these might be — I don't know — five, six dollars. Right?And so we've got four of them so that's going to cost us not too much — $24. But how much is it costing us to run that particular vehicle?
Now in the United Kingdom, in Europe, there's a rule of thumb. We say it's going to cost around about, probably around about £60 an hour or €60 an hour, around that sort of ballpark figure. That's about ballpark. So it will be probably around about $60, $70 to fun that vehicle. So we've just to spend $70 delivering that item and actually the total amount of money we're going to be bringing in is going to be a very small amount. Maybe only about $24.So we've just lost loads and loads of money because of the delivery option.
Now we're not saying we shouldn’t deliver to that organization. What we should be thinking about doing is can we change the way we actually serve that customer? So it may be the best option might be put the things in the post rather than delivering to them. It will be far cheaper. You're going to lose far less money.
Now what we've done recently is we've done some work with GS1, you know, the global standards organization. And you can find this research if you just google GS1 UK cost to serve. There's some reports you can download. That's GS1 UK cost to serve. There's also a link which perhaps we can even share, Dustin, if that's appropriate. But we did this work with GS1, a specialist's consultancy which specialize in cost to serve called LCP Consulting and CranfieldUniversity. What we were looking at was apparel. This is clothing, shoes, all these types of things. Because one of the challenges they're finding is that, what we're finding is that sales are going up but the profits are falling. And we're seeing this all the time now. So if you look at Bonmarché recently, they basically said sales are up but profits are down. That was in the recent press. Vivienne Westwood, the brand profits fall. At Vivienne Westwood, sales are up, however. Uniquelos, profits continued to slide. Those sales were up. The net profits declined almost 50%.
Now part of this is because of people thinking about cost to serve because what you have to think about is you have to think about the customer. You have to think about the product or the SKU that you're delivering to them. And you have to think of the service level that you're offering to those customers as well and all those things are factored in the cost to serve.
So I guess it's worth just sharing some of the challenges that people have with this whole area. There are three key things. Network complexity is increasing in the supply chain, particularly in apparel, how things are sourced. Market volatility, critical one. Customers, they're finding demand trends are getting more volatile. But also really important, lack of visibility. That's becoming a really, really critical thing.
So what this research showed is actually two key things that we have to actually consider if we want to improve our cost to serve. First of all, think about the information flows. Think about information flows, you need to think about supply relationship management. You need to think about inventory management and centralization. Very important. Think about [inaudible 00:10:13] integrity. Think about your systems, integration, and also very much the internal structures within the business.
And the other key thing is balancing the service position. So think about how you manage peak. When we've got peak demand coming in, the big Black Friday. It could be Christmas. It could
be other times of the year. Think through that. Think about the service promise and the proposition management and also how you invested infrastructure. You have to sort of go through how do we actually deal with those particular areas there.
So really, lever one, we need a balancing the strategy proposition. So part of that is quick wins can be charging for home delivery even, avoiding Black Friday. We've got organizations in the United Kingdom now who are just not doing Black Friday. [Inaudible 00:11:08] things swiftly, and we understand that this can really detract from customer service if we don't get it right. But for long-term sustainability, you need to think through improving those information flows. So that actually leads us to think about how much of this can we do electronically. Can we use EDI? Can we use RFID? What we need to be able to do is to automate things, to drive out cost, and improve the overall flow of information within the supply chain.
So I think that critically understanding your cost to serve is a foundational to gaining competitive advantage. And from my experience, some of the big challenges are many organizations just are not set up yet to really understand cost to serve. Therefore, they're serving customers, effectively they’re just pouring money down the drain because they don't understand how much this really truly costs them.
Well thanks for sharing today, Richard.
No problem at all, Dustin.
About Richard Wilding
Professor of Supply Chain Strategy @ Cranfield School of Management | Chairman @ CILT (UK)| Supply Chain Expert |