SCM Part 2

Reasons why some customer are less profitable than others

• Customers make frequent order changes

• Needs special attention

• Difficult to please

Primary objectives of customer profitability analysis

• Measure customer profitability

• Identify effective and ineffective customer related activities

• Total cost of category / Total units of category= per unit cost

Possible reasons to retain unprofitable customers

• Customer prestige

• Potential future profitability

• Loss leader to enter market

• Nonmonetary benefits such as knowledge or expertise

Selling cost analysis ex

• 40,000 grocery orders * .85 by telephone= 34,000 grocery telephone orders

• 34,000 / 80,000 total telephone orders= 42.5% telephone orders

• 42.5% of $130,000 total telephone costs= 55,250 telephone marketing cost for groceries

Distribution cost analysis ex.

• Pharmacy delivers 286,000, 87.66%

• Grocery delivers 40,248, 12.34%

• Total distribution cost: 8,080,000

• Pharmacy distribution cost: .8766*8,080,000= 7,083,201

• Grocery distribution cost: .1234×8,080,000= 996,799

G&A cost analysis ex.

• Allocate customer service based on revenues

  • Pharmacy traced revenue: 25,514,800, 28.04%

  • Customer service and general business total: $5,789,000

  • Pharmacy customer service and general business: .2804*5,789,000= 1,623,134

• Allocate manufacturing support based on variable COGS

  • Pharmacy variable COGS: 13,755,008, 25.16%

  • Manufacturing support total: 2,481,000

  • Pharmacy manufacturing support: .2516*2,481,000

Customer Income

Traced revenues - all costs

Return on sales

Customer income / revenue

If customer has highest margin but negative return on sales

• Do nothing: generally unacceptable given magnitude of loss

• Dropping the customer: should only be considered if cost savings are greater than contribution that would be given up

• Decreasing operating costs and increasing efficiency of serving the customers are the best options

Target profit and Target cost

• Determine target selling price: price comes from contract sales price, estimate based on market analysis, competitor’s pricing

• Determine target cost: target selling price - target profit (return on sales)= target cost

• Compare target cost to currently feasible total cost: currently feasible total cost - target cost= cost reduction target, how much cost must be cut to earn target profit at target price

• Redesign products and processes to achieve cost reduction target

Relevant costs

Cost relevant only if it’s an expected future cost (not sunk cost) and costs are different between alternatives, focus on avoidable costs when identifying relevant costs

Avoidable costs

• Cost that goes away if you choose particular option

• Includes direct labor and material, variable MOH, other avoidable fixed costs and opportunity costs

• If part is outsourced and cost goes away, the avoidable goes under Make only since it’s only paid to make the part, if the cost doesn’t go away after buying part then the unavoidable will stay either way and appear under both Make and Buy so it cancels out

Irrelevant costs

• Cross it out

• Includes sunk costs, unavoidable fixed costs that stay no matter what, allocated common costs which are shared costs across products

Outsourcing (make or buy decision)

• When company needs goods or services should they be made internally or bought externally

• Is it cheaper to make or buy, what are relevant costs, how dependable is the supplier

• Identify variable costs that would disappear if we outsource, identify new variable costs that would incur if outsource, identify fixed costs that could be avoided if outsource

Pitfalls of outsourcing

• Freed up resources not used as planned

• Customers may object

• Supplier tech and knowledge base may not be as anticipated

• Supplier quality not as high as anticipated

• Customer contact may be reduced

• Loss of sensitive info to supplier

Decision to add or drop product service

• By dropping segment, CM will be lost and avoidable fixed costs that disappear with it will be saved

• If avoidable fixed costs saved is greater than the CM lost then drop the product, you’ll save more than you give up

Opportunity cost

• Profit given up by not choosing next best alternative

• Keep segment only if it earns more than the opportunity cost, if segment line’s benefit is smaller then drop it and use facilities for better product

Pricing decisions

• Market forces (customers and competitors) pull price toward what buyers will pay and what rivals will charge setting the price ceiling

• Costs set floor where in long run the price has to cover costs or company will lose money

Special order price decisions

• Compare special price to variable cost of order, ignore fixed costs that stay same

• If there’s no spare capacity then add the opportunity cost of the lost business

• If price is higher than total relevant cost then accept, if not reject