Eenie, Meanie, Miney, Mo. How Will We Make Our Dough?
by Sharmi Duncan
How does the company you work for set the price for the products it sells? Do you know? Is it consistent for every item? For every customer? There are at least six different costing methods that can be used, and if your company hasn’t considered or calculated the profit potential of each of these methods for every customer, then revenue is probably being left on the table. First, you define your cost, then you determine what method(s) should be used with each customer.
Common definitions of cost include landed, market, replacement, sales, and average. Within each of these methodologies there are multiple variations, depending on how cost is calculated. To figure out your selling price, you first have to figure out your cost.
Simply defined, landed cost is the total cost for getting a product into the distribution center. But if you consider all the variables that can affect the cost of getting a product into the distribution center, things become a little more complex. Let’s take the example of Bob’s Wholesale Food Distribution (BWFD)to illustrate why distributors don’t have a clear, accurate picture of a product’s true landed cost.
Once a week, Bob’s Wholesale Food Distribution purchases cases of water; a minimum of two pallets (48 cases per pallet), from their supplier,Water Guys, Inc. (WGI). The cost from WGI is $2.00/case, including delivery and unloading. When WGI arrives, it’s an easy delivery for BWFD’s warehouse. All they have to do is check the driver in, receive the product into their warehouse management system, and put it away in the racks. We will say that the receiving and put-away process adds another $0.20/case. So the total landed cost per case is $2.20.
The next day, BWFD receives a call for a rush order from a customer, so Bob calls WGI to see about getting more product. Bob’s willing to do whatever it takes to get this water, because the customer is brand new and BWFD believes in providing excellent customer service, especially for a new customer. WGI says they are glad to help Bob out—he’s one of their BEST customers. They confirm that the product is in stock and the order can be filled today—once they go over a few details with Bob.
First, because this new order is for only 28 cases, it falls below their minimum order quantity (two pallets/96 cases). Because they will have to break a pallet apart, there is a small up-charge to place this order. So the product is $2.50/case, rather than $2.00/case. WGI does everything they can to accommodate special orders for their customers.
Second, per their contract, Bob receives deliveries once a week, on Tuesdays. But that’s not a problem because WGI wants to help Bob out. Since the delivery is on a Wednesday and is the second delivery this week, it’s considered a special delivery. After all, Bob is a special customer. The cost for special deliveries is $200/shipment. WGI will deliver the goods by 4:00 pm. If Bob places this order, what is the new landed cost?
Here’s the math: $2.50/case + $0.20/case put-away (same as before) = $2.70/case. Then add the delivery cost $200/28 cases = $7.14/case. Total Landed Cost: $9.84/case.
Let’s assume that a 4:00 delivery is okay. Let’s also assume that Bob charges his customer their regular price of $4.00/case based on his usual landed cost of $2.20/case because Bob never considers raising the price on his customer. Bob’s real landed cost is $10.09/case, so rather than making $1.80/case Bob just lost $6.09/case. But his customer is happy.
Bob’s customer calls back; they need the product sooner than 4:00 pm. Bob thinks about it for a minute and comes up with a brilliant idea. Rather than disappoint the customer, he decides to send his warehouse manager out to WGI to get the product. Problem solved! His warehouse manager (the highest-paid person in the DC) will use his personal truck, hop on the interstate, and cruise up to WGI’s warehouse. It’ll probably take him an hour to get there.
Then, to show this new customer how important his business is to BWFD, Bob’s going to have the warehouse manager personally deliver the product to the customer. All he has to do is jump back on the interstate and head south—no more than two hours from WGI to the customer. This will be a testament to Bob’s excellent customer service. No doubt his customer will be impressed, and his warehouse manager can enjoy a day out of the office.
Bob’s so impressed with this plan to go above and beyond for his new customer that he never considers the costs—his warehouse manager’s wages; gas mileage to the supplier, from the supplier to the customer and from the customer back to Bob’s warehouse—which are all hidden supply chain costs that directly impact the product’s landed cost. Even worse, Bob forgets that this is the fourth time this month that he’s run into similar situations.
Bob has failed. Because Bob’s not capturing the hidden costs, he’s not making any money. He never considered telling the customer no, or that he could fill the order but the price would have to be higher. Bob doesn’t even know what the cost is for picking up the product.
But as long as his customer is happy, maybe making money doesn’t really matter…
One product – two sourcing methods to “land” the product in BWFD’s warehouse = two landed costs.
This is a simple example. Now think about how many times you’ve placed a rush order and sent your driver or office employee scrambling to pick up a must-have item, or think about the last time you had to airfreight a product in. Do you have multiple suppliers for the same item with different minimum order quantities? Or what about the times you ran to the local Sam’s Club or Costco for a fill-in order? There are a multitude of factors that affect landed cost, and often they are never captured, which leads to inaccurate profitability reporting.
How do you get a to a single landed cost? YOU DON’T.
You can get somewhere close, you can maintain multiple landed costs, and you can capture the hidden costs in your supply chain. You can get to a number that is probably more realistic than what you have today.
And this is only landed cost. Soon, I will talk about other creative costing methods—market, replacement, and my favorite, sales cost—and how these methods can improve your profitability.
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