High-Tech's Total Cost Quandary

As the complexity of customer needs continues to evolve rapidly, everyone must create solutions matching those needs. Understanding total costs involved in delivering these solutions is necessary to evaluate cost-service tradeoffs and ensure that customer requirements are addressed in a profitable manner.

The analysis and quantification of all activities and associated costs incurred in order to fulfill customer demand for a product is referred to as cost-to-serve analysis (CTSA). Since the combination of every customer category (channel, product) would have a disparate set of activities and associated costs, CTSA must account for multiple supply chains that exist in the business.

Interest in cost-to-serve capabilities has increased over the years, though many organizations in the high-tech industry have struggled to model all supply chain activities in their networks, identify associated costs, and then properly allocate those costs. At the other end of the spectrum, companies with mature CTSA capabilities are actively engaged in cost-to-serve optimization (CTSO), which involves "what-if" analyses to optimize manufacturing, transportation, inventory, and pricing strategies.

Avnet Inc. (NYSE: AVT) leverages its CTSA and CTSO capabilities to assist customers move up the CTSA maturity curve through a three-step process. The process validates costs associated with each supply chain in the customer's business and allows customers to analyze the cost impact by changing performance attributes of individual supply chains. Customers can then optimize their supply chains to specific performance levels and cost, while ensuring competitiveness in their markets.

Here is a brief overview of the process.

1. Identifying the data requirements, data sources, and data collection: In most cases, there are seven types of data elements that must be identified. These are:

• Product-related, such as part number, description, cost, price, and unit weight.
• Bill of Materials-related, such as mapping raw materials, intermediate materials, and packaging materials to final product.
• Site-related, such as demand locations, manufacturing locations, and supply locations.
• Demand-related, such as customer, product, quantity, and shipment frequency.
• Supply-related, such as product, supplier, and production site
• Inventory-related, such as product, safety stock, obsolescence rate, and handling costs.
• Transportation-related, such as origin and destination, mode, transit time, shipping weight, and shipping cost.

These data elements reside in ERP, off-ERP databases, Excel files, and service providers' systems. The role of the finance team is critical to ensuring that cost allocations are done correctly and any assumptions are documented.

2. Creating a supply chain matrix: This phase defines the number of supply chains in relation to its customers and products. Columns in the matrix represent Demand, Channel, and Customers, while the rows represent Supply (Business and Product categories). A probable supply chain matrix for a storage products manufacturer is shown below.

If done right, columns would add up to total revenue (demand), and rows would add up to total cost (supply).

3. Supply chain prioritization and performance prioritization: The supply chains identified in the prior step are ranked based on pre-selected criteria and weight. A higher number denotes a higher ranking. The resultant matrix is depicted below. With this matrix, the supply chains within project scope can be finalized. Supply chains with a higher overall rating are more critical to the company.

As the final step, the objective is to prioritize supply chain performance based on competitive requirements in the industry or market. For each supply chain attribute, the company must determine whether it needs to perform at a superior level (90th percentile), advantage level (between superior and parity), or at parity to most competitors (50th percentile).

The resulting unique combination of ratings defines the overall strategy for each supply chain that the company has. Called the Performance Prioritization matrix, this ensures that optimization of cost-service tradeoffs is aligned with competitive requirements of the specific supply chain.

If cost-to-serve analysis and optimization in your business is a key initiative for you, I invite you to share your methodology, experiences, and insights.