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How to Build a Cost-to-Serve Model

Companies typically spread supply chain costs evenly across customers and products, but that results in some products and services subsidizing others, says Stan Aronow, director of supply chain research at Gartner. Aronow explains how cost-to-serve modeling can provide insights that lead to smarter and more profitable operating decisions.

Cost-to-serve models basically enable companies to use activity-based accounting to better understand which products and customers cost more to produce or to serve so that smarter decisions can be made about managing those costs and/or associated pricing, says Aronow. "It is a yardstick that allows you to come in and ask whether you are doing business in a profitable way."

Companies typically begin building cost-to-serve models by setting targets that reflect their supply chain priorities, Aronow says. For some, this might be cost efficiency and for others customer responsiveness. "If you think about these two strategies and the metrics they would use, it is easy to see that costs would vary quite significantly, so having a model that gets into the details is a great way to set those targets."

A consumer packaged goods company, for example, might come up with a customer profit and loss model that looks at the complexity of different service requirements, he says. "In some cases, the CPG company will actually go to more complex customers and say, if we could deliver to you less frequently or perhaps with fewer pallet combinations and less custom work in the warehouse, we could give you some money back, either in trade promotions or discount pricing. There are a lot of opportunities for win/win negotiations, within the four walls and also with trading partners."

The end goal is to shift behaviors through insights into what true costs are, he says, and change management is as important to this process as building the model. "You need to start with a project manager who is experienced in change management and you also want finance people and subject matter experts involved. You absolutely want to have your head of supply chain and someone at the executive level stepping up to sponsor the program."

In addition to the right people, you have to have the right tools, Aronow says. "One of the problems companies have in building these models is getting their hands on the data to make a clean set of analytics." He notes that most companies start modeling in Microsoft Excel but eventually move to a best-of-breed solution to accelerate time to value. "These solutions can help companies get the data they need and also have built in logic around how to allocate costs in different areas to customers and products," he says. 

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