Wholesalers, distributors and e-commerce companies are facing increasingly tough competition. It can be from completely new players, or an established player like Amazon. New players often have different and far more efficient ways of serving their customers than the existing ones. They choose markets and segments where they have the greatest potential for margin improvement. So how do you avoid them attacking your market – and your company?

When existing companies face new competition, it is crucial that they understand their own costs associated with customers and products. Simply looking at the financial statements will not give the correct picture of the situation. Unfortunately, the crucial cost drivers in the value chain can rarely be read from the financial statements.

The solution in this situation is to identify all the cost drivers. You need to become as efficient and profitable as possible – and quickly. If your company serves the market in a very efficient way, you will reduce the chance that troublesome competitors will enter the area. In this article, we will give you information on what it takes to identify and eliminate your cost drivers.

 

 

Get all the facts

When you're trying to identify cost drivers, you need to look beyond the ordinary financial reports. They don't show the real picture when it comes to the profitability of products and customers. You need to get the facts so you can take targeted action. You need to get to the bottom of the following questions:

How does your company use its resources?

How effective are the processes related to customers and products? 

Some typical cost drivers

Fortunately, most cost drivers are generic, but some are company and industry specific. Our methodology for analysis and implementation is specifically tailored for wholesalers, distributors and e-commerce businesses, but we believe that more than just these industries will benefit from acquiring this knowledge. Also note that in addition to identifying cost drivers, it is important to find actions to improve the top line. Here are some of the most common cost drivers to look for:

Customer behavior

This is the most important cost driver for a wholesaler. It affects the entire value chain at the wholesaler, both positively and negatively. The solution for you is to have in-depth knowledge of the profitability of your different customers for you. This will help you prioritize customers in an otherwise hectic everyday life.

• Which customers can be served with few resources and at the same time provide good profitability? These will be the customers you should prioritize.  
• Which customers require a lot of resources from you? They can be characterized by having many low-value orders or many complaints. You should not prioritize these unless you can increase their profitability by helping them behave rationally. 

Too often we see wholesalers offering the same prices and terms to both profitable and unprofitable customers. It's not profitable for you!

Conditions and characteristics of products and product groups

This can create a lot of resource consumption in goods receipt and storage, as well as in picking and packing. But this cost is rarely captured in the accounts. The reality may be that products with a very high contribution margin are actually loss-making products when you consider their use of the company's resources.

Poor and inadequate documentation from the supplier

Such deficiencies can result in additional resource use for you in both goods receipt and purchasing departments, thereby increasing costs for the product.

Procurement policy with unintended consequences

This can be a cost driver for many. An example would be when small orders are encouraged. This can create backorder situations with multiple partial deliveries. For example, we have seen one customer increase the shipping percentage from 4.85 to 6.60 percent, which instead of strengthening the bottom line actually reduced the company's profit by as much as 23 percent.

Customer bonuses

These often have a negative and unintended effect and negatively affect your bottom line.

 

Activity-based costing (ABC method)

Our method for identifying cost drivers is based on the ABC method (Activity Based Costing) developed at Harvard in 1989. An important distinction is that our approach is based on transaction costs and processes. This opens up insights and opportunities that are difficult to achieve with an accounting perspective.

Considium started with the ABC method in the 90s and decided early on that we should adapt it to wholesalers and distributors. We have later expanded it to also apply to online retailers.

 

6 steps to successfully identify cost drivers

1. Start with the important activity mapping

This activity mapping is central to the ABC analysis. We at Considium have developed and use a specific mapping methodology adapted to wholesalers and distributors in these four central areas of the business. This way, the mapping of activities and work processes can be done quickly and precisely, and it is in this process that you can identify cost drivers. To get to the bottom of it, you should use different forms of interviews and data collection, depending on which areas you want to map. You should review these four central areas of your company with a magnifying glass:

• Sales organization, purchasing and administration
• The warehouse and logistics organization
• Stores/service centers
• "Data center", especially related to online shopping activities.

2. Link the accounts with the activity analysis

This step gives you the company's activity accounts, where you will see the real costs of the various activities in the company (not just the accounting costs).

Let's take an example:

Your company's sales activities cost 28 MNOK (department accounts sales). To your great surprise, several people in the sales departments also work with purchasing activities. This corresponds to a cost of 4 MNOK. The company's purchasing costs were therefore not the 8 MNOK that you assumed (department accounts purchasing), but actually 12 MNOK when you take into account the purchasing activities in your sales units. This shows how the picture changes when information from the accounts and the activity analysis is linked. When it becomes visible in this way, it is easier to assess whether this is desirable behavior for the future, or whether measures should be taken to change course.

3. Allocate activity costs to customers and product

You distribute activity costs to customers or products using distribution keys. This gives a picture of how customers and products consume the company's resources. Example: The activity account states that processing returns in the sales department costs 0.8 MNOK. The company then charges these costs to customers who have had returns. The number of returns is used as the distribution key. Customers without returns are not charged these costs. In this way, a correct picture emerges of what each customer actually costs with regard to returns.

Typical distribution keys to use may be the following:

• Order
• Order lines
• Returns
• Backorder
• Invoice
• Invoice lines

4. Calculate the operating profit for each customer and product

Here you should also take into account any customer and supplier bonuses, as well as shipping costs associated with deliveries to customers. If you sum up the operating results for each customer or product, this should be able to be reconciled with the operating result in the accounts.

By doing this, you will get an accurate picture of your customer and product profitability. This information will be valuable when choosing between different market segments and marketing channels, and for evaluating product assortment and pricing of products.

The final analysis will provide you with support for strategic and operational decisions in the company and be a good basis for increased profitability.

Realize your potential! 

Once the facts are in place, it is time to realize the potential you have identified. In this phase, it is important to “dare to make it simple”. Based on the facts from the mapping, you specify which measures are to be implemented. Here you must make the necessary priorities and decide on effective progress, as well as specify who will hold the responsible roles along the way.

6. Put in place a simple and affective method for follow-up 

The follow-up should ensure that identified measures are implemented and the benefits are realized. Also remember to repeat the analysis at regular intervals. Our advice is to use the ABC method as a supplement to traditional accounting, and that you conduct this type of analysis at intervals of two to four years, depending on size, industry and, not least, needs.

Considium has almost 30 years of experience with the ABC concept. We ensure that you receive quality delivery and a quick completion of the analysis.  

For further information, you are welcome to contact us.