Executive Briefings

Customer, Hand Over the Wheel

We keep hearing the mantra, over and over: To be successful in business today, you have to be customer-driven. There are times, though when you might need to take away his car keys.

Wouldn't it be great if you could meet the demands of every buyer, large and small? Is there anything more painful than telling a customer "no"? I can think of one thing: going out of business because your cost to serve was greater than the profits you made from a good portion of your account base.

Juan Rubio, managing partner of Logistics Resources International, has a dream. He wonders what it would be like to exist in a world without warehouses. Wouldn't it be great, he asks, if your production lead times were equal to your quoted delivery times, and you could simply ship all finished product directly to buyers? Aircraft manufacturers manage to do that; when was the last time you saw a showroom for Boeing 747s?

All right, so we can't all be aircraft manufacturers. (And, given the recent tales of woe from Boeing and EADS, who would want to?) For most businesses, the humble warehouse lives on - and with it, the need for an inventory policy that's tied directly to your customer-service policy.

Assuming you've got a customer-service policy - the kind that's written down in clear language, and is followed to the letter by both sales and supply chain. The problem with many companies, according to Rubio, is that the customer with the highest cost to serve tends to drive what's done with all inventory. That's the case even if a customer doesn't care whether a product ships on the day of the order. Suppliers often lack a pricing structure that would provide incentives for buyers to accept a lower level of service.

You can break that cycle by taking a realistic approach to the needs of your customer base. The trick lies in segmenting both products and customers, based on the true cost of making the first and serving the second. Speaking at the Aberdeen Group's Supply Chain Summit in San Francisco last week, Rubio laid out a road map.

A good approach, he said, is to divide all products and customers into traditional "A," "B" and "C" designations, based on their return to the company. A typical profile will find those categories representing around 80 percent, 15 percent and 5 percent of profitability, respectively. A natural impulse might be to dump the "Cs," but who can afford to lose even 5 percent of profits today? Not in a time of depressed demand, when a quarter of a percentage point is seen as critical.

So Rubio has another suggestion: create a fourth category - call it "C-minus," so you don't insult anybody - and make that represent 1 percent of your profits. Now it's not so tough to imagine cutting some of those customers loose, or at least asking them to accept higher prices or lower service levels in line with their value to the seller. Analysis often shows that the 1-percenters account for between 3 percent and 4 percent of costs, Rubio said. "It's kind of a no-brainer, when you get down to that level."

Don't base your calculations entirely on revenue, he warned. Other factors to consider include volume, margins, and earnings before tax; they all go into the total cost to serve. Yet another criterion is the ability to forecast demand for a given segment. What percent of your SKUs do you put through a forecast engine? Which are subject to extreme highs and lows, seasonality and chronic uncertainty? The unpredictable portions "are the most expensive services of all," said Rubio. And the last thing you want to do is lump all your inventory together and come up with an average figure for forecast accuracy. The number is bound to be useless at best.

Once you've figured all that out, start treating your customers accordingly. Draw up a matrix, with the four customer segments along one axis and product segments along the other. (It's really just an expanded version of the "Magic Quadrant" developed by Gartner Inc. to analyze market and company maturity.) Products and companies that fall into the "A-A" box get the highest level of service, including any concessions you need to make in order to keep their business. Customers in the double C-minus group get a reality check about the true cost of serving them.

Companies flying the "customer-driven" flag will naturally want to treat everybody with a "A" level of service. What happens in reality, said Rubio, "is you treat everybody like a 'B.' That's great for 'C' customers, but terrible for 'As.'"

Rule number one is to track inventory and customer-service policies closely together, and tie them to economic reality. "It is eye-opening," said Rubio, "when you start looking at cost to serve from that standpoint."

By the way, be on the lookout for the executive video interviews that I conducted with Rubio and many others, at this year's Aberdeen Supply Chain Summit in San Francisco. We'll have those on the site soon.

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We keep hearing the mantra, over and over: To be successful in business today, you have to be customer-driven. There are times, though when you might need to take away his car keys.

Wouldn't it be great if you could meet the demands of every buyer, large and small? Is there anything more painful than telling a customer "no"? I can think of one thing: going out of business because your cost to serve was greater than the profits you made from a good portion of your account base.

Juan Rubio, managing partner of Logistics Resources International, has a dream. He wonders what it would be like to exist in a world without warehouses. Wouldn't it be great, he asks, if your production lead times were equal to your quoted delivery times, and you could simply ship all finished product directly to buyers? Aircraft manufacturers manage to do that; when was the last time you saw a showroom for Boeing 747s?

All right, so we can't all be aircraft manufacturers. (And, given the recent tales of woe from Boeing and EADS, who would want to?) For most businesses, the humble warehouse lives on - and with it, the need for an inventory policy that's tied directly to your customer-service policy.

Assuming you've got a customer-service policy - the kind that's written down in clear language, and is followed to the letter by both sales and supply chain. The problem with many companies, according to Rubio, is that the customer with the highest cost to serve tends to drive what's done with all inventory. That's the case even if a customer doesn't care whether a product ships on the day of the order. Suppliers often lack a pricing structure that would provide incentives for buyers to accept a lower level of service.

You can break that cycle by taking a realistic approach to the needs of your customer base. The trick lies in segmenting both products and customers, based on the true cost of making the first and serving the second. Speaking at the Aberdeen Group's Supply Chain Summit in San Francisco last week, Rubio laid out a road map.

A good approach, he said, is to divide all products and customers into traditional "A," "B" and "C" designations, based on their return to the company. A typical profile will find those categories representing around 80 percent, 15 percent and 5 percent of profitability, respectively. A natural impulse might be to dump the "Cs," but who can afford to lose even 5 percent of profits today? Not in a time of depressed demand, when a quarter of a percentage point is seen as critical.

So Rubio has another suggestion: create a fourth category - call it "C-minus," so you don't insult anybody - and make that represent 1 percent of your profits. Now it's not so tough to imagine cutting some of those customers loose, or at least asking them to accept higher prices or lower service levels in line with their value to the seller. Analysis often shows that the 1-percenters account for between 3 percent and 4 percent of costs, Rubio said. "It's kind of a no-brainer, when you get down to that level."

Don't base your calculations entirely on revenue, he warned. Other factors to consider include volume, margins, and earnings before tax; they all go into the total cost to serve. Yet another criterion is the ability to forecast demand for a given segment. What percent of your SKUs do you put through a forecast engine? Which are subject to extreme highs and lows, seasonality and chronic uncertainty? The unpredictable portions "are the most expensive services of all," said Rubio. And the last thing you want to do is lump all your inventory together and come up with an average figure for forecast accuracy. The number is bound to be useless at best.

Once you've figured all that out, start treating your customers accordingly. Draw up a matrix, with the four customer segments along one axis and product segments along the other. (It's really just an expanded version of the "Magic Quadrant" developed by Gartner Inc. to analyze market and company maturity.) Products and companies that fall into the "A-A" box get the highest level of service, including any concessions you need to make in order to keep their business. Customers in the double C-minus group get a reality check about the true cost of serving them.

Companies flying the "customer-driven" flag will naturally want to treat everybody with a "A" level of service. What happens in reality, said Rubio, "is you treat everybody like a 'B.' That's great for 'C' customers, but terrible for 'As.'"

Rule number one is to track inventory and customer-service policies closely together, and tie them to economic reality. "It is eye-opening," said Rubio, "when you start looking at cost to serve from that standpoint."

By the way, be on the lookout for the executive video interviews that I conducted with Rubio and many others, at this year's Aberdeen Supply Chain Summit in San Francisco. We'll have those on the site soon.

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