Evaluating and allocating outbound logistics cost in the fast moving consumer goods (FMCG) industry

Abstract

Logistics costs constituted 11.7%, 11.1% and 11.2% of South Africa’s total GDP during 2012, 2013 and 2014 respectively. The risk of high transport cost (compared to global averages), a depressed South African economy and more competitive market conditions resulted in a renewed focus on logistics services and associated cost. For most Fast-Moving Consumer Goods (FMCG) manufacturers in South Africa, outbound logistics cost amounts to between 5% and 15% of sales value. This percentage range hides the reality that logistics efficiency (and therefore cost) vary significantly between products (or categories), customers (or channels) and regions (or markets). In this complex FMCG trading environment, many companies are experimenting with various ways to increase profit. Several programs are launched looking at ways to reduce cost, improve service levels and a significant amount of time is spent thinking about new products and logistics solutions to service more customers. The reality, however, is that in most instances companies do not understand the outbound logistics cost drivers and hence profitability of current (let alone new) channels, regions, products and customers. This is simply as a result of insufficient information available from traditional accounting statements. Customer profitability is usually calculated on a Gross Profit level (net sales contribution less cost of goods) and therefore excludes all other activity costs, including logistics. Defining cost drivers for each outbound logistics process, namely (i) primary distribution, (ii) warehousing/storage, and (iii) secondary distribution, and related activities can be used to determine the true cost-to-serve (CTS) on a customer and product level. This is a critical understanding for making integrated product and customer network decisions and is a very necessary building block for achieving optimised supply chains. It can also support what-if scenarios of the logistics network and the resultant impact on cost, service levels and resultant profit, assisting businesses to focus on the true cost drivers before they become costs. The research posed three conjectures: 1. Current accounting systems provide insufficient insight into the outbound logistics cost-to-serve (CTS) on a product and customer level. The development of an alternative CTS allocation framework, underpinned by cost drivers, is required to translate and assign cost logically to customer transactions to determine the true CTS. 2. The cost drivers of outbound logistics in the South African FMCG industry are not well defined or understood. This is a key component to develop cost allocation logic for each cost driver on a customer transactional level. 3. An outbound logistics CTS allocation framework is a critical component of supply chain optimisation as (i) cost is linked to actual activity, (ii) it leads to business understanding of costs and cost drivers, (iii) it acts as a tool to identify customer servicing strategies to improve service and profit. The research led to the following conclusions: • Conjecture 1: Current accounting systems are lacking the insights to understand the outbound logistics CTS on a product and customer level. Being able to evaluate the CTS on a more detailed level is a key requirement to ensure that informed and appropriate business decisions are taken. The market interviews within the FMCG industry supported the notion that a CTS allocation framework, based on defined cost drivers, could be a critical input to supply chain optimisation and overall business profitability. • Conjecture 2: The market interviews indicated that cost drivers for outbound logistics in the FMCG industry are not well defined. However, the literature study and structured interview questions evinced that standard cost driver(s) for each outbound logistics process and related activities can indeed be defined, albeit slight variations might exist due to different supply chain intricacies. However, the principle of using the cost driver(s) to develop a CTS allocation framework on a customer and product level holds true. • Conjecture 3: The study established that it’s probable that costs can be ringfenced for the respective outbound logistics processes. Evaluating the cost drivers for the activities associated to the processes will lead to a better understanding of the logistics costs and the drivers thereof. The suggested CTS allocation framework determines the true CTS on customer and product level and is therefore a valuable decision-support tool to identify improvement initiatives and optimisation. Applying the tool to shape customer servicing strategies whilst reducing the outbound logistics CTS (and hence increase profit) is a significant competitive advantage.