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The “Cost to Serve” Customer Fulfillment

Most manufacturing firms are actually manufacturers and distributors. Although a majority of the work performed involves manufacturing products for customers, a significant amount is also performed after products are produced and before they are shipped to the customer. In cases where the company ships manufactured products immediately upon completion, these post-manufacturing activities may be minor. But as customers demand more and more from their suppliers, post-manufacturing “costs to serve” the customer begin to grow and become important factors in measuring and managing customer profitability.

Warehousing finished goods, processing orders, picking orders and preparing them for shipment are common activities at most manufacturers. When the costs of these activities are significant, their measurement and assignment to the individual customers being served can provide a manufacturer with critical insights that enable its management to both accurately measure customer profitability and to manage customers to improve their profitability.

Consider two identical manufacturers—Alpha Corporation and Beta Corporation—each with $12 million in manufacturing costs, $3 million in post-manufacturing costs and $3 million in selling, general and administrative (SG&A) costs. Beta Corporation treats post-manufacturing costs as “overhead” and assigns them to customers as a percentage (25 percent: $3 million to $12 million) of the manufacturing cost of the products they produce. Alpha Corporation, on the other hand, segregates these costs into four activities—warehousing, order processing, order picking and order shipment—and assigns them to customers based on their demand for those four activities.

Exhibit 1 details the types of costs and activities that Alpha considers in accumulating the cost of their four customer service activities. Warehousing includes the capital cost required to finance finished goods, occupancy costs, insurance and property taxes, as well as the physical work performed by material handling and warehousing personnel and the administrative efforts of material management and accounting. Order processing costs include the administrative efforts of materials management, customer service and accounting. Order picking costs include the physical efforts of warehousing, material handling and shipping and receiving as well as the administrative work of materials management. Shipment includes the occupancy costs for the shipping area, the physical work of material handling and shipping and receiving and the administrative efforts of materials management, accounting and logistics.

Exhibit 1: Alpha Corporation’s Post-Manufacturing “Costs to Serve”

Exhibit 1_WEB
To assign these costs to customers, Alpha selects an appropriate “driver” (a factor that causes a change in the cost of an activity) to link each of these activity’s costs to specific customers and calculates a cost per unit of driver that it then uses to assign each activity’s cost to individual customers. Warehousing costs are assigned at $1.25 per inventory item sold; order costs are assigned at $20 per order processed; picking costs are assigned at $5 per line item picked and shipment costs are assigned at $30 per shipment.

Exhibit 2 compares the profitability measure of Customer One that buys $2 million in products that cost $1.2 million to manufacture using both Alpha’s and Beta’s costing methods.

Exhibit 2: Customer One’s Profitability Comparison

Exhibit 2_WEB