March 21, 2012
This is the third entry in a six-part series focused on exploring five of the key areas of opportunity for better pricing in the chemicals industry.
When thinking about how to improve margins, many companies first look at improving variable costs and/or fixed costs. That’s fine, but many companies – especially in the Chemical industry – would do well to look also at Costs-to-Serve. Costs-to-Serve are costs that the organization incurs in servicing a specific customer. The most common examples are the various costs associated with freight / transportation, logistics (e.g. inventory consignment), engineering services, and payment terms costs.
This area often is comprised of several seemingly small costs, but when considered together these costs typically sum up to be in the range of 10% of revenue and in some instances we’ve even seen freight costs alone be as high as 30% of a “delivered price.” So focusing on better costs-to-serve recovery can yield a chemical manufacturer millions a year in additional profit.
First of all, most companies need to improve their visibility into these costs. And the best-practice for visualizing these important areas of margin leakage is the pocket price waterfall (I’ll refer to it as the price waterfall or waterfall for short). The price waterfall is not new, but it’s surprising how many companies are still unfamiliar with the concept. And for those who are familiar with it, their use of it is limited to a highly manual effort to wrestle the data needed into an Access or Excel file for a point-in-time analysis. Here is an example of a chemicals price waterfall that has a few illustrative cost-to-serve components:
Actual waterfalls typically end up with several more elements, depending on the availability of data and the degree to which the subject is manageable or controllable. So the first step for many companies in improving cost-to-serve recovery is to define their price waterfall – in sufficient detail that is needed to analyze root causes of margin leakage. The waterfall can also be used to easily implement insightful metrics like Freight Cost Recovery Ratio (Freight Charges / Freight Costs). These metrics are normalizing metrics that can be used across many dimensions like customer, product, region, etc.
Once you’ve built your waterfall, you can begin to analyze specifically where you’re not recovering your costs-to-serve. This can be challenging because to do this well, you need to be able to analyze this at the product / ship-to level, but, as many of Vendavo’s customers have discovered, there are often millions of dollars of profit to be recaptured.
Once you’ve identified cost-to-serve recovery improvement opportunities in your business, it’s time to start capturing that value. There are a variety of ways to do this and the appropriate action is highly dependent on the details of the situation. But here are some sample best practices around capturing value:
Use pricing to encourage cost-efficient behavior (e.g. price in a way that encourages full truckloads or rail cars)
Use specific charges and surcharges to discourage cost-inefficient behavior – or at least re-capture the costs (e.g. Demurrage Charges, LTL Surcharges, Rush Charges, etc.)
Specifically identify the variances in costs-to-serve recovery by product/customer combinations
Set targets and/or floors for costs-to-serve like freight, requiring approval for non-compliance with policy
With large customers where price or charge adjustments are unlikely, consider working to adjust ship-to volume mix within a sold-to to improve your margins without necessarily raising any prices. In other words, work to capture a higher percentage of the volume from ship-to locations with lower costs-to-serve.
Costs-to-serve recovery can be a huge profit opportunity for chemicals companies, and with the right approaches and with the help of better tools, you can identify and realize millions a year in additional profit for your organization.
– Michael Lucaccioni