Supply Chain Costs

This is an area that is at the same time incredibly important and extremely difficult. One of the most important and also most difficult parts of supply chain management is the supply chain cost analysis. Irrespective of the kind of organization, one always needs to make sure to know about supply chain costs. Every company has a good handle on their normal production costs and perhaps even marketing and sales costs, few companies take an extra effort to really understand the costs of their supply chain.

The distribution network design affects the costs in following ways

• Inventories
• Transportation
• Facilities and handling
• Information

As the number of facilities in a supply chain increases, the inventory and resulting inventory costs also increase. As long as inbound transportation economies of scale are maintained, increasing the number of facilities decreases total transportation costs. If the number of facilities is increased to a point where there is a significant loss of economies of scale in inbound transportation, increasing the number of facilities increases total transportation cost. A distribution network with more than one warehouse allows Amazon.com to reduce transportation cost relative to a network with a single warehouse. Facility costs decrease as the number of facilities is reduced, because a consolidation of facilities allows a firm to exploit economies of scale.

Total logistics costs are the sum of inventory, transportation, and facility costs for a supply chain network. As the number of facilities is increased, total logistics costs first decrease and then increases. Each firm should have at least the number of facilities that minimize total logistics costs. As a firm wants to further reduce the response time to its customers, it may have to increase the number of facilities beyond the point that minimizes logistics costs. A firm should add facilities beyond the cost- minimizing point only if managers are confident that the increase in revenues because of better responsiveness is greater than the increase in costs because of the additional facilities.

Importance and Need for cost analyses

One might ask that if studying the supply chain costs is so difficult then why do it at all? The answer lies in the fact that in some industries and businesses the supply chain costs of a company as part of their total costs is 25-30%. There are instances where for the supply chain costs prove to be the most important consideration of business organizations like DHL and many others.

Even for normal organization where logistics and inventory management and sourcing and planning decisions are not considered so vital, the amount of supply chain costs would be surprising.  This is the reason why Supply Chain cost analysis is done. It not only will give an idea of the costs involved, but also will give another area to improve and cut costs. The supply chain cists are generally overlooked and practically not even completely optimized, since one doesn’t even have an idea of the exact costs involved. A supply chain costs analysis would help identifying which areas of a company are efficient and which ones can be worked upon for more efficiency. At certain instances companies ended up realizing the unwanted supply chain networks and even alternative cost efficient options.

Analyzing supply Chain Cost

One needs to first initially find out the accounting method which is being followed by the organization, in order to perform a supply chain cost analysis in the company. For the basic start one can choose to go with a very well-known method of Activity based costing. This method strategically divides all sorts of costs into their own proper category and you clearly chalk out the goods which are linked with the supply chain. The basic need under this method of analysis would be, gathering of product information. Gathering data becomes easier when the accounting methods include the absorption costing method or standard costing method. The product costing information is very well defined under these systems.

Activity Based Costing – This method is based on the fact that cost objects consume activities and activities consume resources. This management methodology is considered more accurate. It focuses on indirect costs (overheads).

This method points out costs which are directly related to the product. Even for the costs that does not relate directly with the product, are put under heads which clearly define the relation between the product and costs. The activities involved in resource consumption flow through a channel. Using ABC analysis method is advisable when overhead costs are high, varied product variety is there, error making can prove expensive and lot of market competition is present. This method defines the variable costs involved and importance of quality product and processes.

This method has the ability to clearly define the critical attributes of today’s business processes. In other words, Activity based costing (ABC) is an accounting technique that make use of cost attachment rather than cost allocation to determine the actual cost of products and services. The real character of an ABC model is that it compels organizations to take up a cost management model that focuses on understanding their processes well. Moment the organization accepts this plan, they soon realize that their products or services are produced through cross-functional business processes. The processes contain a wide variety of activities that not only define the process, but also more importantly, reflect how effectively the process performs.

ABC uses a more logical basis for allocating the costs. Activity based costing (ABC) brings into the emphasis the specific customer characteristics in relation to the buying behavior and distribution requirements. It depicts the cost attached at each level of activity and thus decides about the true cost. Let us take an example of a manufacturing company, which sells its products through a network of dealers to the industrial user.

The ABC can be performed in the following manner

• Realizing the product process
• Defining step wise activities involved
• Ascertaining cost for each activity
• Determining factors that affect cost
• Collecting activity data
• Calculating total product cost

The supply chain cost data, will be available in the financial department and the one who has an access to enterprise resource planning system. For instance if the company stores data in SAP software, then one has an option to access the data that is stored in SAP. It becomes very important to streamline and decide what type of costs are to be considered under the head as Supply Chain is a very wide term and may seem to be related with every activity. If the analysis has to be proven efficient initially then one will have to collect as detailed data as possible into all the different fields that are related to supply chain. It would probably be a good idea to do the analysis for the most recent completed year so you have access to a whole year’s worth of data. There should be a proper segregation of costs depending on which factory or entity of your company is being analyzed. Segregating would allow a better view of problem identification.

Classification of Supply Chain Costs

There are various kinds of costs associated with supply chain and hence it is very important to identify the right ones.

• Transportation costs incurred in getting raw material delivered at factory
• Storage costs incurred for keeping the material in warehouse
• Administrative costs incurred while handling supply chain operations e.g. sending invoices, order processing
• Taxes paid
• Shipping costs (incurred inside the country or outside)
• Packing and Packaging Costs
• Working Capital Costs
• Insurance costs
• Miscellaneous costs incurred for petty works or contingencies

These can be some of the costs which are commonly found in most of the organizations. There can be more type of costs being incurred in different kind of organizations as per the work or industry. These costs may vary as a percentage of total cost like, an anti-dumping duty imposed by a certain country for a particular product would increase the taxation costs suddenly, making it even a loss making proposition to import that raw material product.

Analysis of the Supply Chain Cost Data

At the year end when the whole annual results are available and divided neatly into different cost types this is a perfect time to do the supply chain analysis of costs. The books already have the final figures in the annual reports with all types of costs mentioned under expenditures. Comparison of supply chain costs as a component of total cost helps in finding the percentage contribution. A simple differentiation of expenditures incurred on supply chain and otherwise from the total expenditure gives the actual figure or supply chain related cost. One might feel comfortable using software to get a streamlined data.

It is better to compare between similar structured plants in the same cost areas to derive value from this analysis. The results will be helpful only if a good metric is used to compare different plants. If the company produces products according to weight, then make sure that all the costs are divided according to weight of finished goods produced in the year. Also in case there are different business segment producing different product types, it will be advisable to compare the costs of different plants only having the similar business.

This will give a fair view of the supply chain data. The comparison between specific costs across your organization will help in realizing inefficiencies, and it might also contrarily reveal the high efficiency segments with respect to supply chain. This would help in taking direct actions to reduce costs in the organization to realize savings.

This analysis of cost would help knowing the year to year difference in cost and also see the progress being made in the supply chain area. So to repeat the process for creating a supply chain cost analysis is by splitting the company’s supply chain costs into as many segregated parts as possible, take data from financial department, therein organize the data segment-wise or weight-wise and then a comparison can be done to spot irregularities which can be later on worked upon for improvement.