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Your business might be in the black, but that doesn’t mean all your customers are profitable. Customer segments can vary widely in profitability, which is why cost-to-serve analysis is so important. Understanding the cost distribution for your customer base can help you optimize your supply chain to prioritize the most profitable customers and products.
What is cost-to-serve?
In supply chain management, cost-to-serve is a term that describes the average cost of fulfilling one unit of demand for any customer and product. This cost assessment strategy differs from other profitability calculations because it accounts for the supply chain’s cost not at an aggregate level but at a granular level. The final estimate shows how much profit each demand point is bringing to the overall business given all costs of sales, services, and last-mile logistics.
Cost-to-serve supply chain analysis reveals how the costs associated with certain customers and product lines vary. Supply chain managers can use this data to inform decisions about pricing, product mix, and distribution strategy.
Once service costs for a customer, product line, or distribution channel are identified, they can be compared to associated revenues to determine profitability. Organizations can then resegment customers according to their profit margins.
Related blog: 7 Benefits of Cost-to-Serve Analysis
Cost-to-serve vs. total landed cost vs. cost of goods sold
While cost-to-serve is often lumped together with cost of goods sold, these models calculate different expenses within the supply chain:
- Cost-to-serve: Accounts for goods sold, taxes, freight, insurance, and any other expenses required to make the product available to the customer. This can also be referred to as total landed cost (TLC).
- Cost of goods sold (COGS): Includes all costs associated with producing the product.
Why use a cost-to-serve model?
Cost-to-serve analysis helps quantify and monitor the breakdown and accumulation of costs throughout the supply chain required to fulfill orders and meet customer demand.
Every customer segment, distribution channel, and product is affected by variables like delivery time, target service rate, order size, frequency, product, demand, etc., all of which impact the cost-to-serve.
Identifying cost-to-serve can reveal patterns in profitability. For example, it may reveal that a specific customer segment or product is more profitable than the rest. This product-by-product, customer-by-customer understanding can then be used to improve marketing decisions, providing a blueprint for maximizing conversion value.
Below are some ways cost-to-serve analysis can increase profitability for your organization:
- Optimize marketing efforts: Prioritize increasing acquisition and retention efforts for highly profitable customer segments.
- Adjust pricing: Products with a higher cost-to-serve can be priced accordingly to avoid a drop in profit.
- Identify opportunities for expansion: Identifies products, customer segments, and distribution channels that would be the most profitable if expanded.
- Identify opportunities for reduction: Identifies products, customer segments, and distribution segments that aren’t pulling their weight and should be deprioritized.
- Inform future product-mix: Profitability data can help optimize the current product mix and inform future product development efforts.
- Optimize the network: Reveals ways the network could be restructured to lower the cost-to-serve.
How does cost-to-serve analysis fit into the supply chain management workflow?
Cost-to-serve analysis is typically implemented as part of the review process. It applies to all areas of the supply chain and can become crucial to the supply chain design process.
Here’s how it’s done:
- Start by defining your levels of segmentation, the services required to fulfill orders, and applicable supply chain cost drivers.
- Next, model cost variability for the segments according to the cost drivers.
- The results should then be used to create actionable goals that can bring the organization value both short and long-term.
Optilogic’s revolutionary cost-to-serve solution
Optilogic’s Cosmic Frog is a fast, flexible supply chain design solution. Because Cosmic Frog’s extensive data schema allows for extremely granular input from all levels of the supply chain, it can be used to calculate detailed costs for highly specific products and customer segments.
The resulting data model is flexible, allowing users to add additional costs and factors for the most comprehensive end result possible.
Cosmic Frog doesn’t just calculate the landed cost for end customers. It calculates and reports landing costs for every intermediate node, including suppliers, plants, and distribution channels. Users get a clear picture of landing costs from the product’s origin to the moment it reaches the customer, and every step in-between.
Best of all, cost-to-serve runs automatically in Cosmic Frog, meaning users can understand the cost to fulfill demand and replenish facilities across the entire supply chain—on every scenario.
Understanding the cost-to-serve of your customers at the audience segment or product level unlocks opportunities for optimization. This is just one example of how a more resilient supply chain design can increase profits for your organization.