Chapter 3 Value and logistics costs

Content
Where does value come from How can logistics costs be presented

Activity-based costing

A balanced measurement portfolio

Supply chain operations reference model

Where does value come from

Key issues
How can shareholder value be defined?

What is economic value added, and how does it help in this definition?

Where does value come from

Business objectives
Business objective

Profit

Market share

Shareholde r value

Social value

Where does value come from

Concepts about shareholder value
Comparable investment ROI (Return on investment) Sales Costs Working capital Cash and debtors Creditors Fixed assets

ROI

Sales revenueCosts InventoryCash and DebtorsCreditorsFixed assets Sales revenue

Costs

Profit

Inventory

Return on capital employed

Working capital Cash and debtors

Creditors

Capital employed

Fixed assets

Where does value come from

ROI

Profitability = Profit / Sales

Asset utilization = Sales / Employed investment

ROI is underpinned by two main drivers: Increased profitability Increased asset utilization

Where does value come from

ROI and its key drivers Level 1 Level 2
Net Profit Sales

Level 3
Production costs / Sales Selling costs / Sales Administration costs / Sales

Level 4
Pay costs / sales

Materials / Sales
Pay costs / Sales Pay costs / Sales Property / Sales

ROI Sales Total assets

Fixed assets / Sales

Plant / Sales

Vehicle / Sales
Inventory / Sales Current assets / Sales Debtors / Sales Cash / Sales

Where does value come from

Average inventory turnover

Key timerelated ratios

Average settlement period for debtors

Average settlement period for creditors

Case study: The Wal-Mart effect

In 1987, Wal-Mart had a market share of just 9 percent but was 40 percent more productive than its competitors as measured by real sales per employee.

By 1995, it commanded a market share of 27 percent and had widened its productivity edge to 48 percent.
Competitors began to adopt Wal-Marts innovations in earnest in the mid-1990s. From 1995 to 1999, Wal-Mart improved its own productivity by an additional 22 percent.

Case study: The Wal-Mart effect

Managerial innovation
Wal-Marts productivity edge stems from managerial innovations that improve the efficiency of stores. Employees who have been cross-trained, for instance, can function effectively in more than one department at a time.

Information technology investments

Wal-Mart was among the first retailers to use computers to track inventory (1969), just as it was one of the first to adopt bar codes (1980), EDI for better coordination with suppliers (1985), and wireless scanning guns (late 1980s). These investments, which allowed Wal-Mart to reduce its inventory significantly and to reap savings, boosted its capital productivity and labor productivity.

Content
Where does value come from How can logistics costs be presented

Activity-based costing

A balanced measurement portfolio

Supply chain operations reference model

How can logistics costs be represented

Key issues
What are the various ways of cutting up the total cost cake? What are the relative merits of each?

How can logistics costs be represented

Problems with traditional cost accounting as related to logistics (Christopher, 1998)
The true costs of servicing different customer types, channels and market segments are poorly understood. Costs are captured at too high at a level of aggregation. Costing is functionally oriented at the expense of output. The emphasis on full cost allocation to products ignores customer costs

How can logistics costs be represented

Fixed Variable Engineered

Direct

Indirect Discretionary

Three ways to cost cube

How can logistics costs be represented

Fixed / Variable costs

Fixed cost

Variable cost

Volume of activity

Volume of activity

How can logistics costs be represented

Fixed / Variable costs
Cost or revenue Sales revenue Break-even point Total cost Variable cost

Fixed cost

Volume of activity

How can logistics costs be represented

Fixed / Variable costs

Cost or revenue

Sales revenue Total cost

Cost or revenue Break-even point

Sales revenue Total cost

Break-even point High variable cost Fixed cost

Fixed cost Volume of activity

Low variable cost Volume of activity

How can logistics costs be represented

Direct / Indirect costs

Direct labor Direct costs Direct materials Whether the cost can be directly allocated to a given product

Managing directors salary

Indirect costs (overheads)

Administration expenditure Rent rates

How can logistics costs be represented

Direct / Indirect costs

DPP (Direct product profitability) method

Gross sales for product group
Less product-specific discounts and rebates

Net sales by product

Less direct costs of product

Gross product contribution

Less product-based marketing expenses

Product-specific direct sales support costs

Less product-specific direct transportation costs Less product-attributable overheads Direct product profitability

Sourcing costs Operations support Fixed-assets financing Warehousing and distribution Inventory financing Order, invoice and collection processing

How can logistics costs be represented

Engineered / Discretionary costs

Example

Engineered costs

prevention

Input-output relationship

Quality cost

appraisal

Discretionary costs

Internal and external failure

Content
Where does value come from How can logistics costs be presented

Activity-based costing

A balanced measurement portfolio

Supply chain operations reference model

Activity-based costing
Key issues
What are the shortcomings of traditional cost accounting from a logistics point of view? How can costs be allocated to processes so that better decisions can be made?

Activity-based costing
Todays businesses are working in an increasingly complex environment.
Use of Advanced Technology Product Life Cycle Product Complexity Channels of Distribution Quality Requirements Product Diversity

Activity-based costing
Criticisms of Traditional Cost Allocation
Assumes all cost is volume-related Departmental focus, not process focus Focus on costs incurred, not cause of costs

Activity-based costing
Conventional Costing
Total Cost = Material + Labour+ Overheads
Overheads are allocated to the products on volume based measures e.g. labour hours, machine hours, units produced

Will this not distort the costing in the new environment?

ABC provides an Alternative.

Activity-based costing

Allocation of indirect costs based on causal activities

Results in better allocation

ABC Purpose

Does not provide true cost

Activity-based costing
Traditional allocation method
Costs Products

Activity-based allocation method

Costs
First stage

Activities

Products
Second stage

Activity-based costing When is ABC Most Useful?

High Overheads Product Diversity or Multiple Products Customer Diversity Service Diversity

Activity-based costing
Example

Production line Machine hours No. of changeovers Equal allocation

A 8,000 50 250,000

B 8,000 30 250,000

C 8,000 15 250,000

D 8,000 5 250,000

Total 32,000 100 1000,000

Allocation by activity
Difference

500,000
250,000

300,000
50,000

150,000

50,000

1000,000
0

-100,000 -200,000

Activity-based costing
Cost time profile (CTP)
Cost-time profile
120

Cumulative cost (%)

100 80 60

delivery

loading
sort processing storage

40

20 transport 0 15 45 60 70 75 85

Cumulative time (hours)

Content
Where does value come from How can logistics costs be presented

Activity-based costing

A balanced measurement portfolio

Supply chain operations reference model

A balanced measurement portfolio

Financial Financial

Past

Future

Past

Future

Operation

Operation

Traditional

Balanced

A balanced measurement portfolio

Content
Where does value come from How can logistics costs be presented

Activity-based costing

A balanced measurement portfolio

Supply chain operations reference model

Supply chain operation reference model

Supply chain operation reference model