What is Cost-To-Serve (CTS)?
What is the “operating profit” that you make on every – line, order, customer, customer-niche and territory – OR – SKU, product group or supplier line? You know the Gross Margin Dollars (GM dollars) and Gross Margin Percent (GM%) in every line event. But, what is the estimated, service-activity costs for processing each line item event? Call this the “Cost-To-Serve Dollars” (CTS dollars).
How to create a good-enough, CTS model is another-day topic. But, have this vision: be able to calculate a Value Exchange Equation (VEE) for every line event in your fiscal year. Shorthand for a VEE is:
GM Dollars(less) CTS Dollars = Profit Dollars.
Once you have Line-Item VEEs, they can be summed up to give VEE’s for: orders, customers, SKUs, etc. All of the line-item VEEs for the year should total to the same numbers on your final financials for: GM dollars, Total Operating Expense dollars and Operating Profit dollars.
GM% Obsession is Misplaced.
Note that GM% is not included in the VEE. What matters is if the line’s GM dollar content exceeds the CTS dollars for good Profit dollars. All things being equal, selling the same lines/orders at a higher GM% is better. But, this does not mean that a naturally occurring high GM% – line, order or customer – with small GM dollar content is profitable. In fact, the great majority of high GM% elements in your business have losing VEEs.
By example: wouldn’t you guess that some low GM% orders (a $100,000 direct ship at 12%) are very profitable? And, a $2 line pick in the warehouse with a gaudy 50% retail margin won’t have enough GM dollars to cover the average cost of a warehouse pick. There is no minimum, must-have GM% target for a warehouse line. Such a target ignores the size of the GM dollar content in the line v. the CTS dollars.
We Can Do One More Small Order for Free: FALSE!
When a typical distributor calculates VEEs for every line item, they discover 70% of all line items are losers. The profitable 30% may generate about 300-500% of the operating profit to then pay for the 70% losers with 100% of the financial-statement, profit remaining. Assume: “take one more small order to keep idle people busy” for years. Then, you have accumulated enough losing lines to keep a number of full-time-equivalent people 100%-busy losing money. Chronic, losing busi-ness prevents proactive, next-level service improvements for a small percent of high-profit (potential) customers.
Next: Profit Ranking Reports and Whale Curves.
CTS Math makes profit rankings for all elements possible. Customer or SKU profitability Whale Curves illustrate startling cross-subsidies (Google Image: “Whale curve”). But, the CTS-Math facts of super-profit winners and losers are only “symptoms” of what underlying “root-causes”? With a Line-Item, VEE database, what new CTS-Math Insights do you discover?
- All customers don’t have equally effective buying: logic, processes and habits.
- Super-winners often decided to give your firm 100% of their needs. Combined with their good, forecasted-demand and disciplined replenishment systems, their orders have larger GM dollars per line and per order with great annual volume too. Smart customers choose better, total supply-chain savings over just “Price savings”.
- Super-losers create high CTS dollars for you and high, unmeasured Purchasing Activity Cost dollars for themselves. Their small-dollar (emergency) orders on the same repeat SKUs also costs their folks unmeasured Downtime Costs for lack of product.
- The Law of Reciprocal Costs emerges. A distributor’s service activity costs are mirrored more or less by the customer’s purchasing activity costs and inefficiencies. Be the first to prove to super-losers – with their own buying statistics – how a re-tuning of their buying activity will save you both on formerly, hidden, activity costs. Many will be so pleased, they will want to give you more volume, but now on a profitable basis.
- Re-tuning hidden buy-sell activity costs with CTS Math is a one-time, big win for all four stakeholder groups. Customers save and buy more from you. Profits for shareholders and compensation for all employees both grow. And, suppliers love your faster growth and fast pay from free cash-flow dollars.
Turn Data into è Information è Knowledge è Actionable Wisdom.
- VEEs for every line item is “Quantum (smallest indivisible unit) Profit DATA”.
- Summing up line-item VEEs for an SKU or a customer and plotting those points on Whale Curves yields cross-subsidy
- Finding what buying patterns cause big profit and loss customers is
- Identifying hidden, high-activity, low-dollar buying that costs both parties unnecessarily and offering buy-sell-process retuning solutions is ACTIONABLE WISDOM with big payoffs.
For More Actionable Wisdom…
- I’ll be presenting on “CTS Math, Actionable Insights” at the Advanced Profit Innovation Conference on Sept. 29-30 in Phoenix. Consider attending! (apicconference.com)
- And/or: contact me about a new video-based CTS Math course for every distributor employee. We are looking for beta-testing volunteers.