The Creative Cost Equation:
Here’s a Little Story
of the Lost Landed Cost

by Sharmi Duncan

cost model story.jpg When it comes to a product’s sell price, which costing method does your company employ to set the price? And is it the same for every item in your inventory? Is it the same for every customer? There are at least six different costing methods used in the food service distribution industry, and if your company hasn’t calculated the profit potential of these various methods for each and every customer, then you are leaving profit on the table. You begin by defining your cost and then determining what method(s) you utilize with each customer.

Some of the more common definitions of cost include landed, market, replacement, sales, and average. There are multiple variations on each of these methodologies, depending on the factors utilized in calculating cost. To figure out your selling price, you first have to figure out your cost.

Simply defined, landed cost is the total cost of getting a product to the distribution center. And simply put, it is. But if you consider all the variables that can affect the cost of getting a product to 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 and 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 (forty-eight cases per pallet), from their supplier, Water Guys, Inc (WGI). The cost from WGI is $2.00 per 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 on the racks. We will say that the receiving and stocking process adds another $0.20/case. So the total landed cost per case is $2.20.

The next day BWFD receives 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 in because the customer is brand new and BWFD believes in providing excellent customer service, especially for a new customer. Bob talks to WGI. 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 twenty-eight cases, it falls below their minimum order quantity (two pallets, or ninety-six cases). Because they will have to break a pallet apart, there is a small up-charge (i.e., a higher price) to place this order. The product is $2.50 per case rather than the $2.00 per 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 per shipment. WGI will deliver the goods by 4:00pm. 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) = $2.95/case. Then add the delivery cost of $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 everyday price of $4.00 per case based on his everyday landed cost of $2.20 per case because Bob never considers raising the price for his customer. Bob’s real landed cost is $9.84 per case, so rather than making $1.80 per case Bob just lost $5.84 per 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; it’s 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 excited about this plan to go above and beyond for his new customer that he never considers the costs: his warehouse manager’s wages, plus gas mileage to the supplier, from the supplier to the customer, and from the customer back to Bob’s warehouse. These are all hidden supply chain costs that directly affect the product’s landed cost. Even better, 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 it costs to pick up the product.

As long as his customer is happy, maybe making money doesn’t really matter…

One Item + Three Sourcing Methods to “Land” the Product in BWFD’s Warehouse = Three Landed Costs.

This is a simple example. Now think about how many times you’ve placed a rush order and sent your driver or an office employee scrambling to pick up a must-have item. Or think about the last time you had to airfreight a product in. What if you have multiple suppliers for the same item with different minimum order quantities? Or what about the times you run 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 and never built into the selling price of the product, which is a direct hit to the product’s profitability.

How do you get a to a single landed cost? YOU DON’T. You get somewhere close, you maintain multiple landed costs, and you 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. In upcoming articles, I will examine various creative costing methods—Market, Replacement, and my favorite, Sales Cost—and how using each of these methods can improve your profitability.

Healthcare: Cost-Checking the USA vs. the Rest of the World

The Creative Cost Equation: Which Market (Price) Is It Anyway?