Logistics and Supply Chain Management, 4th Edition

LOGISTIC S & SUPPLY CHAIN MANAGEMENT

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Danger zone

These customers should be looked at very carefully. Is there any medium- to

long-term prospect either of improving net sales value or of reducing the costs of

service? Is there a strategic reason for keeping them? Do we need them for their

volume even if their profit contribution is low?

Cost engineer

These customers could be more profitable if the costs of servicing them could

be reduced. Is there any scope for increasing drop sizes? Can deliveries be con-

solidated? If new accounts in the same geographic area were developed would it

make delivery more economic? Is there a cheaper way of gathering orders from

these customers, e.g. the Internet?

Protect

The high net sales value customers who are relatively cheap to service are worth

their weight in gold. The strategy for these customers should be to seek relation-

ships which make the customer less likely to want to look for alternative suppliers.

At the same time we should constantly seek opportunities to develop the volume of

business that we do with them whilst keeping strict control of costs.

Ideally the organisation should seek to develop an accounting system that would

routinely collect and analyse data on customer profitability. Unfortunately most

accounting systems are product focused rather than customer focused. Likewise

cost reporting is traditionally on a functional basis rather than a customer basis.

So, for example, we know the costs of the transport function as a whole or the

costs of making a particular product but what we do not know are the costs of

delivering a specific mix of products to a particular customer.

There is a pressing need for companies to move towards a system of account-

ing for customers and market segments as well as accounting for products. As

has often been observed, it is customers who make profits, not products!

Direct product profitability

An application of logistics cost analysis that has gained widespread acceptance,

particularly in the retail industry, is a technique known as direct product profitability

– or more simply ‘DPP’. In essence it is somewhat analogous to customer profit-

ability analysis in that it attempts to identify all the costs that attach to a product or

an order as it moves through the distribution channel.

The idea behind DPP is that in many transactions the customer will incur costs

other than the immediate purchase price of the product. Often this is termed the

total cost of ownership. Sometimes these costs will be hidden and often they can

be substantial – certainly big enough to reduce or even eliminate net profit on a

particular item.

MEASURIN G LOGISTICS COSTS AND P ERFORMANCE

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For the supplier it is important to understand DPP inasmuch as his/her ability

to be a low-cost supplier is clearly influenced by the costs that are incurred as that

product moves through their logistics system. Similarly, as distributors and retailers

are now very much more conscious of an item’s DPP, it is to the advantage of the

supplier equally to understand the cost drivers that impact upon DPP so as to seek

to influence it favourably.

Table 3.3 describes the steps to be followed in moving from a crude gross

margin measure to a more precise DPP.

Table 3.3 Direct product profit (DPP)

The net profit contribution from the sales of a product after allowances

are added and all costs that can be rationally allocated or assigned to an

individual product are subtracted = direct product profit

Sales

− Cost of goods sold

= Gross margin

+ Allowances and discounts

= Adjusted gross margin

– Warehouse costs

Labour (labour model – case, cube, weight)

Occupancy (space and cube)

Inventory (average inventory)

– Transportation costs (cube)

– Retail costs

Stocking labour

Front end labour

Occupancy

Inventory

= Direct product profit

The importance to the supplier of DPP is based on the proposition that a key

objective of customer service strategy is ‘to reduce the customer’s costs of owner-

ship’. In other words the supplier should be looking at his products and asking the

question: ‘How can I favourably influence the DPP of my customers by changing

either the characteristics of the products I sell, or the way I distribute them?’

From pack design onwards there are a number of elements that the manufac-

turer or supplier may be able to vary in order to influence DPP/square metre in

a positive way, for example, changing the case size, increasing the delivery fre-

quency, direct store deliveries, etc.