Many articles have been written about cost-to-serve, but despite this huge amount of information, a uniform definition for cost-to-serve does not seem to exist.
As the concept of cost-to-serve originates from supply chain it is often described as ‘an analytical approach identifying the supply chain costs to service a customer’. Whilst this is partially true, it is our opinion that cost-to-serve is much broader and aims at creating visibility of product and customer profitability and using these insights to improve your service proposition whilst reducing your costs.
One might argue that cost-to-serve is not a new concept and that most companies have mapped their cost-to-serve nowadays, but reality shows differently. Due the significant changes in the way we do business - increasing service (levels), the omni-channel approach, next day delivery, free returns, further penetration of EDLP (everyday low price) players – most companies face constant increasing costs to serve their customers.
The complexity in the supply chain still plays a big role in the total cost to serve customers, but also other aspects can contribute significantly to the cost to serve.
Expensive e-selling platforms
Complex return processes
Highly customized products & services
Late order changes
Large marketing and promotional costs
Increasing quality standards
Cash collection
The above list is of course non exhaustive but shows that cost to serve can be across all parts of your value chain.
Why should you care
When talking to senior executives about cost-to-serve we often get one of below answers:
“My volume and EBIT increase year after year, so why should I care?”
“Impeccable service is embedded in our business model, we cannot change that.”
“My competitors offer the same services at the same price, so I have no choice.”
Whilst these all seem valuable reasons not to focus on cost-to-serve, none of them justify it.
Almost all companies have a whale curve, meaning around 20% of the customers generate 80% of the margin, the next 60% generates roughly 20% more, while the last 20% typically generates a negative net margin. The same logic applies to most product portfolios. Focusing on these low performing customers and products can significantly impact EBIT numbers.
We could not agree more that impeccable service is crucial in attracting and retaining customers. Our experience has shown however that not all customers require the same (level of) service. Understanding your cost-to-serve will allow you to focus better and offer the right service for the right customer segments.
A perception which is often triggered by the sales force. It is crucial to understand how you are performing versus your competitors, but that doesn’t mean you need to copy their exact behavior and service. Cost-to-serve transparency will ensure you can capture most of the value by focusing critical resources in the right way.
Cost-to-serve is not about decreasing service, but exactly the opposite. It is about creating transparency on profitability and offering the right services for the right customers. Results typically increase customer satisfaction and bring bottom line growth!
How to tackle cost-to-serve
The Chronion cost-to-serve framework consists of 3 distinct steps:
1. Generate true profitability insights
A crucial first step in every cost-to-serve exercise is to remove perception and emotions by looking at facts and figures. By combining transactional data with a fit for purpose cost allocation model we obtain true insights in customer and product profitability. These insights will allow senior management and sales executives to better steer their resources with a direct result on bottom line performance
2. Review your service proposition/grid
A common pitfall of step one is to try to remove all unprofitable customers and products from the base. Whilst this approach is not necessarily wrong, more value can often be captured by turning unprofitable products and customers into profitable ones. Creating an enhanced service proposition is the next step in achieving this.
The look and feel of a service proposition can take many different formats, but typically results in service policies, which translate the service proposition into operational guidelines. It stipulates for each service under which conditions the service is provided, for which customer segment, at which service level and whether it’s charged or not. Using the service policies will ensure resources are used in those areas where they yield the highest ROI.
3. Install a continuous improvement culture
Cost-to-serve should not be a one-time exercise, but a step-up towards a continuous improvement mindset in which customer profitability and customer satisfaction go hand in hand. Installing customized profitability dashboards for senior management which can be drilled down to detailed insights for account managers, ensure buy-in from all stakeholders in the value chain and facilitate the change towards a true customer-centric organization.
About the author
Roel Vermeulen is managing partner at Chronion. He designed and implemented true profitability models for B2B and B2C companies all over the world. He supported multiple commercial organizations to realize higher profitable growth while increasing customer satisfaction levels.
Do you want to align your service levels with your customer needs, contact us.