Cost-to-serve analysis: To determine a customer’s actual value to your business, you first must understand your cost of serving that customer

Analyzing a company’s true “cost to serve” at the customer level provides valuable insight into key accounts, customer segmentation and profitability, and, ultimately, overall business value. Pre-deal diligence for mergers and acquisitions typically overlooks cost to serve; however, this should be a key consideration during this process as it often highlights unlocked value in a company’s operations—usually in the form of underpricing or over-servicing customers.

This article offers a definition of cost to serve, explains the bottom-line impact, provides a practical illustration, and shares insight for the parties involved in preparing to perform a cost-to-serve project, whether internally or on an acquisition target.

Defining cost-to-serve

Cost-to-serve analysis yields information about the true cost of servicing individual customers by quantifying specific business activities and overhead consumption on a customer and/or product level. The result provides powerful insight before a deal—enabling the parties to define value and develop long-term strategic plans for the Target Company. It also provides useful insight for post-close operations and short-term decision making around customer service levels, pricing, incentives, promotional spend, and internal resource/organization structure and allocation.

Impact on profitability

A cost-to-serve analysis quantifies the value of negotiated service levels (e.g., the cost of managed fill rates or customer-specific inventory levels), shipment exceptions (e.g., expedites), customer service resource time and/or other broad overhead costs across the organization’s entire customer set. This analysis enables re-segmentation of the organization’s customers based on newly understood margin insights. Ultimately, it enables decisions that reduce services offered to “over-served” customers or that adjust pricing for those customers to improve profitability.

 

Bottom line impact comes in one of two forms:

  • Cost savings from service reductions and more efficient internal resourcing
  • Revenue growth resulting from pricing increases—either as a total number or in line-item surcharges, such as those often associated with rush shipments


One analysis generated $5 million in bottom-line value

There are numerous examples of potential benefits from a cost-to-serve analysis—the simplest perhaps being the benefit of selectively charging for or disallowing expedites for customers in lower-value segments.

A less obvious instance with a significant potential impact involves customer-driven order changes. For example, we helped one customer analyze customer-driven order changes to better understand its customer-level margins and make appropriate changes. Here’s how that worked:

  • Analyzed total order changes in the order-entry system
  • Broke that data down into specific activity costs—such as logistics costs, customer service time, return freight, etc.—for the different types of order changes
  • Applied those costs to customers
  • Identified “repeat offenders” with high costs for order changes that affected their customer profitability
  • Raised prices or applied surcharges for these customers’ high-dollar order changes


This change, alone, generated $5 million in bottom-line value for the organization, and it subsequently resulted in a change in customer behavior that proved beneficial for both parties.

Sales/marketing or supply chain opportunity—or both?

While supply chain executives often lead cost-to-serve analyses (commonly supported by the controller), this effort often proves to be a company-wide one with a great breadth of organizational coverage. Despite the fact that most primary costs tie to the supply chain, the core analysis drives customer profitability, which falls within the oversight of the marketing function. Accordingly, these projects may be viewed and managed either as sales and marketing opportunities or supply chain opportunities.

Many organizations value and segment their customers according to tenure and revenue volume. Far fewer use profitability as a means of segmenting customers. To determine a customer’s actual value to the business, understanding the cost of serving that customer is paramount. Whether you are looking for ways to improve current operations or to facilitate a successful merger or acquisition, a cost-to-serve analysis can be a powerful tool for improving the bottom line.

If your company or target could benefit from a more detailed view of customer-level margin data, we can help. Contact Tom Racciatti.

West Monroe Insights
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