CSCMP Explores Supply Chain Costing book summary.pdf

8/9/2019 CSCMP Explores Supply Chain Costing book summary.pdf

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EXPLORES...

V o l u m e S i x 2 0 0 9 S P E C I A L I S S U E

The Worlds Leading Source for the Supply Chain Profession.

CSCMP

SUPPLY

C H A I N

COSTING

Terrance L. Pohlen, PhD, CTLUniversity of North Texas

Thomas P. Klammer, PhDUniversity of North Texas

Gary Cokins, CPIMSAS

Supply chain managers recognize that the next frontiein supply chain cost management lies in the portionof the supply chain beyontheir direct control. Thesexecutives have long understood that many of theicosts and business processeare driven by the behavioand practices of their trading partners. Yet cost information is rarely exchangedue to the perceived sensitivity of financial data anconcerns about releasinproprietary information.

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CSCMP Exploresis published by theCouncil of Supply ChainManagement Professionals333 East Butterfield Road, Suite 140Lombard, IL 60148-5617 USAPhone: +1 630.574.0985Fax: +1 630.574.0989Web Site:cscmp.org

Editor: Jessica E. DAmico

Direct Line: +1 630.645.3460E-Mail:[email protected]

2008-2009 CSCMP ResearchStrategies Committee

Susan Oaks, ChairVice PresidentA.T. Kearney

Tony BaroneDirector Global Logistics StrategyPfizer, Inc.

John DischingerProgram Director, Global Integrated SupplyChainIBM

Kathryn (Kay) DobieSchool Of Business And EconomicsNorth Carolina A&T University

Brent EdmistenDirector Strategic Sourcing & Mfg StrategyCessna Aircraft Company

Martino FernandesSupply Chain Technology ConsultantDow Chemical Company

Thomas J. GoldsbyAssociate Professor Supply ChainManagementUniversity of Kentucky

Eric PeltzDirector Logistics Program, Army ResearchDivision

RAND Corporation

TA B L E O F C O N T E N T S

EXECUTIVE SUMMARY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

NEED FOR SUPPLY CHAIN COSTING CAPABILITY . . . . . . . . . . . . . . . . . . . . . . 3

SUPPORTING RESEARCH . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

SUPPLY CHAIN COSTING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

IMPLEMENTING SUPPLY CHAIN COSTING . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Step 1: Develop a Foundation for Effective Supply Chain Costing . . . . . . . 8

Step 2: An Appropriate Structure for Capturing Costs and Supporting

Decision Making . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Step 3: Selecting the Appropriate Tools to Support Information

Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Value Chain Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Customer Profitability Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . 11

Tools Employed for Cost Reduction. . . . . . . . . . . . . . . . . . . . . . 11

Supply Chain Costing Tools for Planning. . . . . . . . . . . . . . . . . . 12

Step 4: Linking Cost Information to Performance Measurement and

Value Creation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Step 5: Employ Strategies for Overcoming the Challenges Posed

by Supply Chain Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

ENDNOTES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

TABLE OF FIGURES

FIGURE 1: KEY FINDINGS FROM SUPPLY CHAIN COSTING RESEARCH . . . . . 4

FIGURE 2: VISIBILITY OF COST INFORMATION PROVIDED BY SUPPLY

CHAIN COSTING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

FIGURE 3: COMPARISON OF TRADITIONAL AND SUPPLY CHAIN COSTING . . 7

FIGURE 4: DIMENSIONS OF SUPPLY CHAIN COST INFORMATION . . . . . . . . . 7

FIGURE 5: THE PROCESS OR JOURNEY FOR IMPLEMENTING SUPPLYCHAIN COSTING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

FIGURE 6: HOW COSTS ARE CONSUMED WITHIN THE SUPPLY CHAIN . . . . 10

FIGURE 7: SUPPLY CHAIN COSTING TOOLS EMPLOYED BY RESEARCH

FIRMS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

FIGURE 8: CHALLENGES TO IMPLEMENTING SUPPLY CHAIN COSTING . . . 14

FIGURE 9: STRATEGIES FOR OVERCOMING THE CHALLENGES CONFRONTING

FIRMS IMPLEMENTING SUPPLY CHAIN COSTING. . . . . . . . . . . . . 14

To submit a topic or suggest an authorfor CSCMP Explores,please contactthe Research Strategies Committee viae-mail at [email protected]

EXPLORES...

CSCMP

2009 Council of Supply ChainManagement Professionals

Explores...provides todays supplychain professional a good way tokeep up with the latest trends andinformation that affect your profes-sion, when you are short on time.Each issue is written by a renownedthought leader and provides in-depth coverage of an importantsupply chain topic in an easy toread and convenient publication.




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E X E C U T I V ES U M M A R YThis issue of CSCMP Explores provides aframework for gaining greater visibility, under-standing, and control over supply chain costs.The framework is part of a handbook, TheHandbook of Supply Chain Costing,publishedin 2009. The supply chain costing framework isbased on the case study findings from over 20firms recognized as supply chain costing leaders.

Executives require a much broader view of coststhan is currently provided by their firms costmanagement systems. Supply chain managersneed to improve their internal cost informa-

tion and extend their line of sight to includetheir trading partners costsboth upstreamand downstream. Without this information, sup-ply chain costs cannot be effectively managed.Many of these costs are driven by the businesspractices of trading partners. Cost visibility andinter-firm cost management can reveal new andpotentially greater opportunities for cost reduc-tion than can be achieved by a single firm.

Although most firms continue to rely on theirtraditional, inward-looking cost systems, somefirms have begun to extend their cost visibil-ity to include major segments of their exter-

nal supply chains. These firms have adoptedsimilar approaches and encountered similarchallenges along the way. However, the cost-ing techniques and strategies employed toovercome these challenges differ based on thefirms position in the supply chain, strategicobjectives, and the sophistication and level ofcost knowledge of their trading partners.

The framework, comprising a series of steps,recognizes that every supply chain poses uniquecosting requirements and challenges. The firsttwo steps build the foundation for supply chain

costing and address issues common to all sup-ply chains and costing efforts. Supply chainprofessionals must tailor the remaining stepsto their circumstances and costing needs. Theinformation contained in this Exploresandin The Handbook of Supply Chain Costing canassist them in their implementation efforts.

Cost visibility across a supply chain can open new opportunities to drive cosreductions and higher performance; however, few firms are positioned to takadvantage of these opportunities. Many of the firms internal costs are drivenby external trading partners behavior and business practices. Improved costvisibilityboth within and across firmswould enable executives to betterunderstand how their relationships with key customers or suppliers drive costhroughout the supply chain. They can take advantage of this cost informatioto make more effective cost trade-offs and to optimize their firms network otrading partners.

Despite the importance of supply chain costs, few executives possess the ability to effectively manage these costs. They frequently lack cost informationregarding their firms internal processes; the activities comprising these proc-esses; or the cost to serve different customers, marketing channels, or supplychains. Executives have even less visibility over their trading partners costs othe factors influencing these external costs. Executives that can expand theircost visibility over internal and external costs have the potential to take theirsupply chain to a much higher plateau of value creation.

Supply chain professionals are operating in a dynamic business environment.The requirements of end-user demand and the way organizations functionand interact with their trading partners have been altered by factors such asincreased globalization, product and service variety expansion, growing user

requests, rapidly changing technology, fluctuating fuel prices, and sustain-ability requirements. Measuring and managing existing and prospective suppchain costs is essential for sustaining profitability and remaining competitive this increasingly complex environment.

Supply chain costing in this dynamic environment poses a significant management dilemma. Executives require targeted, precise cost information by product, customer, or supply chain that current cost systems in use in most firmsare unable to provide. Traditional cost approaches provide detailed informa-tion regarding labor, material, freight, or other natural accounts but fail toprovide the most critical information needed by management. For example,managers seeking to improve a supply chain process, such as order fulfillmenneed to know the total cost of the process, the cost of the individual activitie

performed, and how costs will change in response to process changes. Thistype of information is not typically available within most existing cost systemDespite the importance of supply chain costs, the exchange and managementof cost information across organizational boundaries remains a largely unex-plored opportunity.

Need For Supply Chain Costing Capability




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Supply Chain Costing

Supply chain managers recognize that the next frontier insupply chain cost management lies in the portions of the sup-ply chain beyond their direct control. These executives havelong understood that many of their costs and business proc-esses are driven by the behavior and practices of their trading

partners. As a result, firms are attempting to exert greaterinfluence over their trading partners performance of activitiesand achieve better outcomes from process elements outsidetheir direct control or ownership. However, firms typicallylack the cost and performance intelligence necessary to makeinformed business decisions that affect the supply chain.

Supply chain managers have usually tackled this situation byexchanging operational performance data. Cost informationis rarely exchanged due to the perceived sensitivity of finan-cial data and concerns about releasing proprietary informa-tion. Existing cost management systems frequently precludethe exchange of the needed cost information. Traditional,

general ledger based cost systems do not possess the capa-bility to provide the type of cost information needed formanaging products, services, and information flows throughcomplex supply chains.

The adoption of supply chain management and a processview of cost result in a different perspective on cost manage-ment. The focus shifts from a single firms costs to the costsincurred by the entire supply chain in providing the finalproduct or service to the end customer. To improve the valueproposition presented to the end user, supply chain manag-ers must look across the entire supply chain for new ways toenhance product or service quality while reducing costs.

CSCMP defines supply chain management as:

Supply chain management encompasses the planning and

management of all activities involved in sourcing and pro-

curement, conversion, and all logistics management activi-ties. Importantly, it also includes coordination and col-

laboration with channel partners, which can be suppliers,

intermediaries, third party service providers, and customers

In essence, supply chain management integrates supply and

demand management within and across companies.

This definition of supply chain management suggests that a broadencompassing view is required to support effective supply chaincost management. Cost informationfrom multiple functions

within the firm and across multiple trading partners spanning thesupply chainis necessary for the effective collection, manage-ment, and control of costs.

The marketplace cost to the end user is the sum of the activitycosts performed and profits taken by all of the trading partners.Supply chain managers require the visibility obtained throughsupply chain costing to determine what causes costs from dirt-to-dirt to have the ability to control the final cost experienced by theend user (Figure 2).




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Tier 3Supplier

Product Development Process

Tier 2Supplier

Tier 1Supplier

Assembler/Manufacturer

Manufacturing Flow Process

Activities

Resources

Products

Customers

Activities

Resources

Products

Customers

Activities

Resources

Products

Customers

Activities

Resources

Products

Customers

Activities

Resources

Products

Customers

Activities

Resources

Products

Customers

6

FIGURE 2: VISIBILITY OF COSTING INFORMATION PROVIDED BY SUPPLY

CHAIN COSTING

Adapted from Cokins, Gary (2001), Activity-Based Cost Management: An Executives Guide, New York, NY: John Wiley & Sons, Inc., pp.169.

Copyright 2009, Gary Cokins. Used with permission.

Findings from the research clearly demonstrated that traditional general ledger costing systems are of limited value in providingthe types of cost information needed to support supply chain decision making. The focus of traditional costing systems is func-tional, designed to support external financial reporting, and strongly emphasizes product costing. These systems are internallyfocused, based on transactions with customers and suppliers as well as internal transactions, are historical in nature, and do notmeasure or report prospective costs. Despite these shortcomings, most companies continue to rely on traditional systems as theirprimary source of cost information. Supply chain costing differs from traditional costing in several important aspects, including:objectives, focus, cost objectives, linkages, precision, scope, and visibility (Figure 3).

Supply chain management, by its nature, is extremely complex. Firms operate in multiple supply chains with different strategies,trading partners, and end users. This complexity makes supply chain cost management very challenging. The nature of supplychain decision making requires a shift from traditional costing to supply chain costing in order to support the capturing and

analyzing of cost data across multiple firms. Supply chain costing reflects this complexity by capturing costs and cost drivers atthe activity level and by providing the capability to portray costs along the cost, product, and relationship dimensions (Figure 4).

Cost information needs to reflect this complexity to adequately support supply chain decision making. The cost dimensionaddresses not only the direct and indirect costs within the firm but expands these categories to include the transaction costs withimmediate trading partners and the process costs spanning the entire supply chain. The product dimension captures costs drivenby product characteristics throughout its entire life-cyclefrom research and design to final disposition. The relationship dimen-sion classifies costs based on external drivers ranging from trading partners behavior and business practices to the different sup-ply chains and overall network in which the firm participates. These three dimensions act as a kaleidoscope because the samedata can be viewed in many different ways. Cost information can be re-portrayed (assigned) as needed by product, process, ortrading partner/channel to support management decision making. Within the supply chain, all costs need to be identified to beeffectively analyzed and controlled.1These dimensions encompass a wider array of costs than incorporated in traditional costsystems.




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Table adapted to combine research findings with comparison previously developed by Partridge, Mike J. and Perren, Lew (1994), Cost Analysisof the Value Chain: Another Role for Strategic Management Accounting, Management Accounting, Vol. 72, No. 7 (July/August), pp. 22.

Adaptation expands on framework contained in Seuring, Stefan (2002), Supply Chain Costing, in Seuring, Stefan and Maria Goldbach, editors,Cost Management in Supply Chains, Heidelberg, Germany: Physica-Verlag, pp. 24. Used with permission of the publisher.

CostDimension

ProductionDimension

RelationshipDimension

Network designand optimization

Supply chain

Interface optimization

Trading partner

Life-cycle

Production

Product design

Product

Dire

ct

Indirect

Tran

sactio

n

costs

Proc

ess

FIGURE 4: DIMENSIONS OF SUPPLY CHAIN COST INFORMATION

Traditional costing Supply chain costing

Objective To suppor t repor ting of financial data and results To suppor t supply chain decision making

Focus Allocation of costs to responsibility (budget) centers Cost control through budget management

Determining the costs of boundary spanning processes Cost control by managing trade-offs across supply chain

Cost objects Functions Products Departments

Activities and supply chain processes Customers Suppliers Distribution channels Supply chains Products

Cost drivers Simple volume measures Multiple drivers Recognize complexity Strategic decisions

Linkages Ignored Cost allocations used to reflect interdependencies

Recognized and effect explicitly considered

Precision High apparent precision Low perceived precision Greater management insight

Scope Internal Internal and external value chain

Visibility Limited regarding factors driving costs Identifies key cost drivers in the supply chain and howprocess linkages affect cost and performance

FIGURE 3: COMPARISON OF TRADITIONAL AND SUPPLY CHAIN COSTING




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Those firms already on their supply chaincosting journey have attempted to captureexpense information and calculate costsfrom the end user to the ultimate sourceof supply. The resulting cost knowledgeallows these supply chain professionalsto report the magnitude and types of sup-ply chain costs, get senior managementsattention, and focus on key cost driversacross the supply chain. Their initial suc-cesses justified continuing the journey toobtain more complete cost informationregarding the supply chains in whichthey operate. By adopting the approachdeveloped during the research, supplychain managers in other firms can obtainsimilar benefits. The process, or journey,for implementing supply chain costing

consists of five steps (see Figure 5). Thesteps are iterative within the firm and thesupply chain.

STEP 1: Develop a Foundation for Effective Supply Chain Costing

First, executives need to ensure an appropriate foundation is in place to support supply chain costing. Essential elements of this founda-tion include a shared vision of supply chain management and determining what cost information is required to support managementdecision making. The structure of the cost system should be based on the firms strategy, production methods, and operating environ-ment.

Supply chain costing requires adopting a perspective that emphasizes the need to capture all of the costs incurred in providing a productor service to the end user. Many factors influence supply chain costs. Understanding these determinate factors is essential for managingsupply chain costs and selecting appropriate costing systems. Every organization and decision maker is positioned within a supply chainstructure, is influenced by dynamic environmental factors, makes strategic and operational product and service choices, and selects orutilizes production processes. Together these interrelated factors influence the type of cost information managers need to make decisionsthat affect supply chain costs.

Supply chain costs include selling, administrative, and product costs. Therefore there is a need for focus on both direct and indirectcosts. Without visibility to overall costs, it is easy to overlook and thus fail to monitor and manage certain types of cost. Executives inleading firms recognized the importance of documenting the magnitude of supply chain costs. Quantifying the size of the supply chaincosts an organization (or supply chain process) incurs is one approach to selling skeptical managers on the importance of measuring andmanaging these costs.

An understanding of how the firm is positioned in the supply chain and of the type of decision being made (operational, tactical, orstrategic) helps decision makers evaluate what cost information they need and what costs the decision will affect. Multiple environ-mental factors impact supply chain costs regardless of an organizations size, scope, suppliers, and customers. Strategic and productiondecisions that affect current and future supply chain costs are made at many levels. The firms position in the supply chain directly influ-ences which supply chain costs can be effectively managed with and without cost sharing across the value chain. Its strategic positioningchoices related to quality, cost, and time help draw distinctions from other firms.

Implementing Supply Chain Costing

FIGURE 5: THE PROCESS OR JOURNEY FOR

IMPLEMENTING SUPPLY CHAIN COSTING

Develop a foundation for effective supply chain costing

Create an appropriate structure for capturing costs and supportingmanagement decision making.

Select the appropriate costing tools to support informationrequirements

Link cost information to performance measurementand value creation

Iterate

withinthefirm

Iteratewith

inthesupplychain

Employ strategies for overcoming the challenges posed bysupply chain costing




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STEP 2: An Appropriate Structure for Capturing Costs and Supporting DecisionMaking

The second journey step focuses on creating an appropriate struc-ture for capturing costs and supporting management decisionmaking. Tremendous complexity exists in most supply chains.Supply chain costing needs to capture costs in a manner thatenables managers to view and portray costs in many different

ways. This step gives careful consideration to the classificationand assignment of costs.

Alternative cost classifications permit the isolation of costs byproduct, customer, or supply chain. This information supports theapplication of different supply chain costing tools (such as cus-tomer profitability analysis and target costing) as well as linkingsupply chain costs to performance and value creation through theuse of economic value-added or balanced scorecard models.

The research participants emphasized that as their firms attempt-ed to better understand supply chain costs, the need for multiplecost classifications increased. For example, one firm used multipleclassifications to better understand key cost drivers. Costs were

classified by processes (value streams) to help determine howdifferent functions affected total process costs or the cost peroutput (outcome). The classification of costs by product or familygroup (product costing and profitability) provided greater insightregarding how product differences affected activity and processcosts in the firm. Product classifications enabled the firm to moreaccurately assign costs by strategic business unit (SBU), and sup-port SBU and the division of product profitability. Classificationof costs by customer occurred where customer differences had asignificant effect on cost. Those differences often included prod-uct or packaging customization, order placement, cycle time, anddelivery.

Many firms are just beginning to explore cost classification by

distribution channel or supply chain. These firms are attemptingto better understand how external drivers and business practicesaffect internal costs, as well as how the firm affects the costs ofother trading partners. Several executives noted that the mostapparent need for this classification scheme occurs when thefirm operates in distinct supply chains that use very differentbusiness practices and thus generate large cost differences. Forexample, one of the manufacturers participating in this studyused multiple channels and sold to the end user over the Internetthrough distributors, large retailer distribution centers, and/orwith direct store delivery (DSD). The costs for each channel dif-fered markedly.

In many supply chains, indirect costs represent a significantportion of total costs. The classification of indirect costs mustsupport an appropriate assignment to activities and cost objects(products, customers, channels, or supply chains). Inaccurate orinappropriate assignments send misleading signals to manage-ment. Accurate assignments provide greater clarity regardingexactly what is driving supply chain costs and where to concen-trate managements focus. Cost assignments drive behavior, andmanagers need to ensure that the techniques and cost drivers theyuse drive the right behavior and send the right signals to uppermanagement and the firms trading partners.

Activities drive most supply chain process costs and thus man-aging activities is essential for supply chain cost management.Historically, most cost measurement systems focused on costobjects that were relevant for external reporting but not forinternal decision making. There is now a growing emphasis on

identifying activities as the cost objects of interest. This activityfocus makes it easier to obtain the type of cost information thatis more useful for managing supply chain processes.

Supply chain costing uses multiple cost drivers to deal with thecomplexity of most supply chains. Decision support hinges onthe quality of the cost information available for key tasks andprocesses. This cost is based on the resources consumed.2Figure6 provides an illustration of how this data may be obtained.Supply chain decision makers need accurate and detailed infor-mation to analyze performance within a single firm or spanningmultiple firms. This information cannot be obtained without theuse of multiple cost drivers with the ability to trace both directand indirect costs.

Since many supply chain functions are aggregated under sales,general, and administrative (SG&A) or other indirect categories,the use of cost drivers for assigning indirect costs is especiallyimportant. Without cost information and what drives these costsat the activity level, supply chain managers have no visibilityregarding costs except at a very aggregate and unmanageablelevel.




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Supply chain cost leaders were working to improve their understanding of activities; how activities are performed; the resources they use;how they are coordinated across the organization; and how these activities affect the cost, quality, and timeliness of service to customers.There is a growing realization that it is essential to manage activities. Understanding and managing costing activities is very different thanimplementing a full blown activity-based costing (ABC) system.

Activity-based management (ABM) was used to identify the activities that occur, learn why they take place, and document how they areaccomplished. The purpose of analyzing costing activities is to improve work processes. Adopting ABM principles helps supply chainmanagers develop a better understanding of work processes. Firms who participated in the research noted that the analysis required theidentification of the activities that occur, learning how they are performed, and documenting the ways they link within and across organ-izations.

Figure adapted from Cokins, Gary (2001), Activity-Based Cost Management An Executives Guide: New York: NY: John Wiley & Sons, pp. 53. Used with permission.

FIGURE 6: HOW COSTS ARE CONSUMED WITHIN THE SUPPLY CHAIN

CUSTOMER-RELATED

PRODUCT &

SERVICE LINE

RELATED

SUPPLIER-RELATED

Suppliers

CUSTOMER-RELATED

PRODUCT &

SERVICE LINE

RELATED

SUPPLIER-RELATED

Suppliers

PRODUCT &

SERVICE LINE

RELATED

SUPPLIER-RELATED

Suppliers

ACTIVITY EXAMPLES

FINAL COSTS OBJECTS

PURCHASES

RECEIPTS

MACHINES

MAKE PRODUCT,

MOVE PRODUCT,

SET-UPS

BRAND/PRODUCT

RELATED WORK

BRAND/PRODUCT ADVERTISING

FACILITIES COSTS

RELATIONSHIP

MANAGEMENT

TRADE SHOWS

IMAGE ADVERTISING

SALES CALLS

ORDER HANDLING

FREIGHT

# POS# Receipts # Sales Calls

# Orders# Shipments

# Ponds# Gallons# Meters

# Machine Hours# Material Moves# Set-Ups

BUSINESS

SUSTATINING

RELATED

SUPPLIER

SUSTAINING

UNIT &

BATCH

LEVEL

# Advertisements

BRAND

SUSTAINING

PRODUCT/SERVICE

LINE SUSTAINING

UNIT &

BATCHLEVEL

Product/SKUs

# Shows# Advertisements

ARBITRARY(forfullabsorption)

Customers

UNIT &

BATCH

LEVEL

CUSTOMER

SUSTAINING

CUSTOMER-RELATED

PRODUCT &

SERVICE LINE

RELATED

SUPPLIER-RELATED

Suppliers

PURCHASES

RECEIPTS

MACHINES

MAKE PRODUCT,

MOVE PRODUCT,

SET-UPS

BRAND/PRODUCT

RELATED WORK

BRAND/PRODUCT ADVERTISING

FACILITIES COSTS

RELATIONSHIP

MANAGEMENT

TRADE SHOWS

IMAGE ADVERTISING

SALES CALLS

ORDER HANDLING

FREIGHT


# Orders# Shipments



BUSINESS

SUSTATINING

RELATED

SUPPLIER

SUSTAINING

UNIT &

BATCH

LEVEL

# Advertisements

BRAND

SUSTAINING

PRODUCT/SERVICE

LINE SUSTAINING

UNIT &

BATCHLEVEL

Product/SKUs



UNIT &

BATCH

LEVEL

CUSTOMER

SUSTAINING

CUSTOMER-RELATED

PRODUCT &

SERVICE LINE

RELATED

SUPPLIER-RELATED

Suppliers

PURCHASES

RECEIPTS

MACHINES

MAKE PRODUCT,

MOVE PRODUCT,

SET-UPS

BRAND/PRODUCTRELATED WORK

BRAND/PRODUCT ADVERTISING FACILITIES COSTS

RELATIONSHIP

MANAGEMENT

TRADE SHOWS

IMAGE ADVERTISING

SALES CALLS

ORDER HANDLING

FREIGHT


# Orders# Shipments



BUSINESS

SUSTATINING

RELATED

SUPPLIER

SUSTAINING

UNIT &

BATCH

LEVEL

# Advertisements

BRAND

SUSTAINING

PRODUCT/SERVICE

LINE SUSTAINING

UNIT &

BATCHLEVEL

Product/SKUs



UNIT &

BATCH

LEVEL

CUSTOMER

SUSTAINING

NON-WAGE RELATED(e.g., supplies)

CAPITAL(equip related)

DIRECT MATERIALSALARY & FRINGE

BENEFITS

NON-WAGE RELATED(e.g., supplies)

CAPITAL(equip related)

DIRECT MATERIALSALARY & FRINGE

BENEFITSNON-WAGE RELATED

(e.g., supplies)CAPITAL

(equip related)DIRECT MATERIAL

SALARY & FRINGEBENEFITS

STEP 3: Selecting the Appropriate Tools to Support Information Requirements

Firms use a variety of costing methods and tools to increase cost visibility and to manage internal and external costs. As a result, supplychain costing encompasses a wide variety of tools and software technologies (Figure 7). The research found that the most appropriatecosting method often depends on the management question being asked or the position of the firm in the supply chain. Some costingtechniques work better than others in different circumstances. Certain tools are particularly useful for improving the supply chain coststructure while others are more valuable for cost planning or as part of a strategic analysis of supply chain costs. Some tools work wellin mass production environments while others better support lean production methods.




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FIGURE 7: SUPPLY CHAIN COSTING TOOLS EMPLOYED BY RESEARCHED FIRMS

Value Chain Analysis

Value chain analysis emerged as a uniquely important tool forsupply chain costing. Value chain analysis is a cost management

process that analyzes costs (such as supply chain costs) acrosslinked enterprises. This analysis helps to identify where themajority of costs are in a supply chain process, and thus, whereto focus cost management efforts, document why actions ofupstream supply chain organizations influence downstream sup-ply chain costs, and evaluate where the most or least profitablesegments of the supply chain processes arefacilitating appro-priate cost management strategies.

Both internal and extended value chains exist for an organizationand for every supply chain process. Identifying and mappingthese value chains helps supply chain executives understand howtheir organization and part of the organization is positionedwithin the value chain. Completing a value chain analysis helpsdecision makers better estimate costs within the value chain andimproves their understanding of linkages and interrelationshipsthat affect costs and profits. This analysis can improve coordina-tion, reduce waste, speed up delivery, avoid delays, and reduceerrors.

Activity-based costing (ABC)

Balanced scorecard (BSC)

Cost estimation

Cost-to-serve

Customer profitability analysis (CPA)

Economic value added (EVA)

Kaizen costing

Landed costing

Life-cycle costing

Open books costing

Standard costing

Target costing

Value chain analysis

Customer Profitability Analysis

The research identified customer profitability analysis as animportant tool within the umbrella of supply chain costing.

Upstream firms attempting to extend their visibility of supplychain costs generally were most interested in determining thecosts to serve different customers or market segments. Customerprofitability analysis is a tool that helps measure both the rev-enues generated and the resources used to serve specific custom-ers, groups of customers, or distribution channels. Because of theproduct and service variety that permeates todays business envi-ronment, not all customers are equally profitable. The analysisoften shows that a small percentage of customers generate a largeproportion of a firms profits and that many customers are actu-ally unprofitable.

Completing a customer profitability analysis requires an under-standing of how and why there are differences in the supportcosts associated with serving a customer, group of customers, ora particular distribution channel. By using this information, sup-ply chain managers can design the right product mix and supplychain strategy for various types of customers. Currently, customerdriven costs are often invisible to decision makers and thus do noreceive adequate management attention. The results of an activ-ity-based customer profitability analysis produce dramatic shiftsfrom the profitability reported by traditional cost systems.

Tools Employed for Cost Reduction

Four tools that help managers in their cost reduction efforts are standard costing, activity-based costing, landed costs, and Kaizen cost-

ing. These tools can expand managements cost visibility outside the firm and over broader segments of the supply chain. These tools helpfocus on particular types of costs, stimulate discovery of better ways to measure costs, and encourage discussion and debate about poten-tial changes that can lead to cost reductions. The information these tools provide will often indicate where there is an obvious need forchange even without deeper analysis.

Standard costing. Firms demonstrating the greatest cost knowledge expanded standard costing to incorporate non-manufacturing proc-esses. Their systems include standards for major supply chain processes such as order fulfillment, demand management, customer service,research and development, and returns management. The ability to capture cost differences by supplier, customer, or distribution channelfacilitated cost-to-serve and customer profitability analyses. Applying standard costing to a wider range of processes has positioned thesefirms to better develop, analyze, and control supply chain costs.

The development and maintenance of cost standards created a unique costing competency within firms on the leading edge of supplychain costing. Management not only knew the cost to perform activities and processes, they also recognized how their trading partnersbehavior affected activity performance and costs. Several managers indicated that they had a much better idea of their trading partners




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costs than their management counterparts in those firms. They attributed this knowledge to the work done in developing their standardcosts and in working to further reduce the time and cost required in performing these activities. They frequently worked with their cus-tomers or suppliers to reduce costs across both firms. These managers believed their cost systems and knowledge enabled them to gain acompetitive advantage over their competitors, who lacked this information.

Activity-based costing. The use of an activity-based approach to determine activity and process costs emerged as a consistent theme.Manufacturing and distribution deal with a broad range of products and stock keeping units (SKUs). Managing this diversity requires amore complex cost system, particularly since indirect and shared expenses often represent substantial portions of a firms total costs. Theprimary value of ABC stems from its capability to more directly assign these costs.

Despite the effort required for implementation, ABC appears well suited for supporting supply chain costing. The use of multiple cost

drivers enables managers to distinguish between the direct and indirect costs and to more accurately determine how product volume orother changes actually drive costs. Much of the complexity existing in supply chains is driven by the differences in products, customerrequirements, and supplier capabilities. The ability to discern how differences affect costs will require the use of multiple activities.

Landed costing. All of the firms participating in the research performed some form of landed cost analysis to study the costs of theirinbound supply chains. The analyses differed considerably in the level of detail and became considerably more complex further down-stream in the supply chain. The landed cost captures the costs of freight and other activities performed to move product from origin tofinal destination. Costs included in a landed cost analysis would include freight, quality, receiving, material handling, administration,technology, and facility costs.

Kaizen costing. Kaizen costing supports continuous improvement and cost reduction for items currently in production and processes presently in use. Internal cost reduction targets are set and then reengineering and cost reduction efforts are employed to determine wherecosts can be eliminated. ABC and landed costing are often used in conjunction with a Kaizen costing initiative. Every organization par-ticipating in our research was focused on finding ways to reduce their supply chain costs. Kaizen costing is simply a systematic approach

that is useful for achieving this objective.

Supply Chain Costing Tools for Planning

Supply chain processes are affected by the strategic decisionsmanagers make. It is easiest to manage the costs associated witha strategic decision before the decision is made because almostall costs are still variable. A carefully structured set of cost plan-ning tools is an essential element of the supply chain costing toolkit. Cost estimation is an inherent part of every supply chaincosting tool. Measures of incurred costs are useful for predict-ing future costs. Budgeting, capital budgeting, target costing andeven simple cost volume profit models are built on multiple types

of cost estimation.

Budgeting. The annual budget is the most widely used manage-ment accounting planning and control tool. Ideally, the budget-ing process requires individuals to focus on what they do (theirwork activities) and on what resources (money, time, goods) theyneed to complete these activities. The budget is where supplychain managers make their case for the resources they need. Atits core, these budgets are about resource capacity planningtheability to convert and reflect physical operational events into thelanguage of moneyexpenses and costs.

Executives participating in the research were increasinglydemanding budgets that could be readily adjusted to reflect

changed circumstances. There is growing use of rolling financialforecasts for shorter intervals where future period assumptions,especially sales forecasts, become more certain. Knowledge of theactivities that occur, what people do, what resources they use,and what these resource costs are, are essential elements of sup-ply chain costing. Building budget requests based on this type ofactivity knowledge (activity-based budgeting), is almost certainto result in more realistic supply chain resource requests andmore effective cost management.

An activity-based budgetfocuses on the work required tocomplete a process or activity (such as loading a truck). Thisinformation helps improve planning, identify areas that offer

cost improvement opportunities, and facilitates making the bud-get adjustments that are inevitable in a dynamic environment. Ithelps managers determine if adequate capacity exists to completeplanned activities and to identify areas where capacity is signifi-cantly underutilized.

Target costing.Target costing and variations of target costing aretools that companies are increasingly using to estimate and man-age the cost of a new product or service before it is introduced.

Atarget costis an estimate of the amount of cost that can beincurred while allowing the firm to earn a required profit. Themarket price is established first and the required profit marginsubtracted to get the target cost. Target costing includes all typesof costs (production, selling, and administrative), as well as alllife-cycle costs. Product and process design occur concurrently tomaximize cost reduction opportunities and the use of cross-func-tional teams that include outside entities within the value chain isessential. Typically, achieving a target cost is not feasible withoutcreating collaborative relationships with all members of the supplychain.

A major benefit firms gained from their target costing efforts wasenhanced process understanding and information relevant to the

many, ongoing organizational decisions. Target costing also makesbeing a team player and becoming more tolerant of cost ambigu-ity essential. Both are issues of concern found in the research andneither of these behavioral changes is easy.

Life-cycle costing. The importance of managing the cost of a serv-ice or process over its life is gaining broader acceptance. Firmshave to deal with a rapidly changing environment. Its now com-monly accepted that the low bid supplier wins mentality of themass production era is no longer appropriate. Leading decisionmakersespecially in firms with a cost mentalityrecognizethat considering all costs and revenues over a products life-cycleis essential when making investment or procurement decisions thatwill influence future costs for some time.This document is available from our site and provided for your personal use only and may not be retransmitted or redistributed without written permission from the



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Capital investment analysisor capital budgeting, is the processorganizations use to evaluate and select long-term investmentsin tangible or intangible assets. It helps answer questions aboutwhether the return on a proposed purchase of an asset (such asequipment or a system) is justified. A good capital investmentanalysis process helps supply chain managers analyze and planwhen and how to add long-term capacity costs in a manner con-sistent with the firms long-term strategy. It is particularly usefulin making decisions about whether to outsource supply chainprocess elements.

Capital investment decisions are important because they committhe organization to certain types of cost structures and specificsupply chain processes. Although many large organizationshave detailed procedures in place for making capital investment

decisions, research and interviews show that few firms believetheir capital investment decision process to be world class. Itsno surprise then that most firms are reluctant to benchmark inthe capital investment analysis area. This unwillingness to shareinformation makes process improvement difficult. This illustratesa problem that needs to be addressed in many parts of the supplychain costing journey.

Capacity analysis. Capacity is a measure of the quantity of goodsor services that that an organization, a process, or an individual

resource can produce. Knowledge of whether adequate or excesscapacity exists or will exist after selecting alternativesbased onlife-cycle or capital investment analysisis an important part ofsupply chain costing. There are many potential uses for capacityanalysis at the operating, tactical, and strategic level.

Step 4: Linking Cost Information to Performance Measurement and Value Creation

Performance measurement poses several unique challenges for supply chain management due to the breadth and complexity of mostsupply chains. Despite the challenges, executives need to understand how the supply chain affects performance within their firm. Supplychain costing offers the capability to translate supply chain performance into financial performance. Although cost reduction is the focusof most supply chain costing efforts, effective supply chain management can also create value by increasing sales, gaining additional mar-ket share, reducing inventory, or improving asset productivity throughout the supply chain.

Several executives emphasized that supply chain costing must be linked to the performance measurement system and not be implementedin isolation. By linking to performance measures, managers will have more interest in understanding their costs and what drives organizational cost. The integration of cost and performance information represented a major step forward in cultivating a cost conscious culturewithin the firm.

The research found that a strong emphasis on short-term performance measures still exists. Examples emerged of how this emphasisconflicted with efforts to improve supply chain management. Financial and non-financial measuresthat broaden managements focusbeyond monthly or quarterly results and support strategic supply chain decisionsare essential and will require changes in existing per-formance measurement systems. However, even when strong incentives to make changes exist, implementation is often a major challenge.Change is even more problematic if top management is not viewed as walking the talk. When performance measures do not align withan entitys objectives and strategies, they often drive the wrong type of behavior. Action can be taken to make an individual or functionalarea look good in the short run, but there will be negative long-term consequences to the firm.

Nonfinancial performance measuressuch as cycle time, on time delivery, or percent of perfect ordersprovide key indicators regard-ing the level of service provided to the customer; however, they do not indicate whether the firm or the supply chain have obtained anadequate return on investment. Supply chain costing can provide the linkage by identifying the activity costs associated with each of theperformance measures. It can identify the activities, resources consumed, and time required to achieve specific levels of customer serv-iceorder processing, order picking, delivery, inventory, sales, etc. Nonfinancial performance measures can then be translated into costsaffecting the bottom line.

The ability to translate improved process performance into value makes a compelling argument when attempting to persuade tradingpartners to align their business practices with supply chain objectives. Executives across the supply chain need to understand how chang-ing business practices will affect non-financial performance (e.g., cycle time, availability, on time delivery or obsolescence) and how align-ing their performance will create additional value for their firm. This alignment process requires that managers re-examine the nature oftheir supply chain costs and select or modify the tools used to capture cost information in useful ways supporting decision making. Asdifferent costing tools are incorporated into the supply chain cost management process, performance measures need to evolve. Likewise,as trading partners collaborate and align performance, additional insight will be required regarding how changes in the supply chain areaffecting performance, costs, and value.

The increased cost visibility made available by supply chain costing has far reaching implications for supply chain management. Valuecreation will drive strategic decisions regarding the composition and structure of the supply chain. The linking of supply chain strategy toactivity costs and to nonfinancial performance measures will change the companys evaluation of carriers, vendors, and trading partnerswhile providing a greater degree of influence over changes occurring in the supply chain. Restructuring the supply chain to exploit effi-ciencies or seize competitive advantages will further emphasize the need for a mechanism capable of equitably allocating cost benefits andburdens between trading partners.




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Step 5: Employ Strategies for Overcoming the Challenges Posed by Supply ChainCosting

Supply chain professionals will need to overcome several major challenges during the journey to supply chain costing. The challengesencountered by firms during their implementation efforts range from a lack of trust between trading partners to accounting systems thatfailed to capture needed information. Although these challenges pose significant obstacles, managers can learn from strategies employedby firms that have successfully overcome these challenges and made major strides along their journey.

Some challenges are primarily technical and can include failures to define or capture needed information, and an inability to make rea-sonable cost estimates (Figure 8). Although significant, supply chain managers can apply the costing strategies and tools that are beingsuccessfully used elsewhere to help overcome their own technical challenges. The larger challenge lies in the ability to distribute improvedtechnical skills throughout the supply chain.

The most daunting challenges to improving supply chain costing are behavioral or cultural (Figure 8). These challenges are rooted inmany firms ingrained unwillingness to share sensitive cost information, the fear of an inequitable allocation of the resulting benefits and

burdens, and a basic lack of trust in the behavior of trading partners. These attitudes may exist internally among business segments orfunctions, as well as between external trading partners.3Movement toward achieving cost transparency across trading partners can some-times be painfully difficult.

Finding ways to overcome the challenges associated with completing the supply chain costing journey remains an elusive objective. Ourresearch identified several strategies that leaders in the supply chain costing area were currently employing to cut across internal andexternal barriers and establish communication and information links across trading partners (Figure 9). These strategies focus on enablingmanagers to demonstrate how the exchange of cost information can produce a competitive advantage for the supply chain by eliminatingwaste, aligning performance, and leveraging the unique competencies within each of the participating trading partners.

FIGURE 8: CHALLENGES TO IMPLEMENTING SUPPLY CHAIN COSTING

Behavioral

Lack of trust

One-way flow or exchange of cost information

Perceptions of an inequitable sharing of benefits and burdens

Technical

Limited cost knowledge

Prevalence of traditional, general ledger cost systems

Limited cost estimation capability

Multiple definitions of cost

FIGURE 9: STRATEGIES FOR OVERCOMING THE CHALLENGES

CONFRONTING FIRMS IMPLEMENTING SUPPLY CHAIN COSTING

Developing a cost estimation capability

Leveraging information sharing requirements

Pilot projects as a catalyst for fostering collaboration and trust

Focusing on new trading partners for cost exchange

Implementing a value-based strategy




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Firms approach supply chain costing in many different ways, use a variety of costingmethods and tools, and are generally aware that there is a great deal that they still needto learn about supply chain costing. We found that a common definition of supply chainmanagement and costing does not currently exist among managers and across tradingpartners. The lack of a shared vision affects the collection, assignment, and exchange ofcost information within and between firms. Although most firms did not possess goodinformation on the costs of processes that span the internal and external supply chain,senior managers in leading-edge firms believed increased cost visibility would improvetheir decision making. As a result, these firms have embarked on a journey towardobtaining greater cost information regarding their supply chains.

Significant opportunities to improve supply chain costing and cost management exist inmost organizations. The Handbook,on which this article is based, provides numerousillustrations of practices that supply chain managers have used in their efforts to improvetheir ability to identify, measure, and use supply chain cost information. Our primarypurpose is to help supply chain managers increase their awareness of supply chain costingfundamentals and assist them in selecting appropriate costing practices for measuring and

managing supply chain costs.All of the management teams in the firms that participated in our research recognized theneed for greater cost knowledge, that many costs were driven by the behavior of theirtrading partners, and that by managing supply chain costs a competitive advantage couldbe obtained. The firms were moving in the same direction toward supply chain costing,but were at different stages in their level of cost knowledge and tools employed. The stepsthey were taking were similar, although the tools employed often differed based on theproblems being addressed or their position in the supply chain. These stages became thebasis for the segments of the supply chain journey described earlier.

Supply chain costing is still in its infancy and firms that move out aggressively towardstheir supply chain costing journey right now are at a major advantage. Leading firms havedone a number of things right and its possible to learn from their experiences. Here are

some parting observations for those taking the first steps on their journey to improve sup-ply chain costing.

The low hanging cost reduction fruit has largely been picked. Firms must look for newopportunities outside the firm. This search will require a broader vision of costs and anadditional level of effort.

Rising energy prices and further globalization will intensify the focus on managing sup-ply chain costs. Supply chain costing will become the platform for major breakthroughsin supply chain management by helping managers identify the opportunities, determinethe value created, and sell new initiatives

The value of broad cost knowledge is not understood by many managers. Thereremains a culture of not looking outside of the firm for opportunities to drive costreductions or improve performance. The true value of supply chain management is not

realized due to the inability to capture costs across trading partners. Supply chain cost management is not as well understood as many believe, especially by

smaller customers and suppliers in many supply chains.

Common definitions of the supply chain and supply chain costing are essential.Managers must also have a solid understanding of the environment, organizationalstrategies, and the types of production processes being used.

Managers need to instill a cost conscious culture in their firms. Costing is, in itself, acore competency which can yield competitive advantage. Cost information useful fordecision making takes many forms and must focus on both direct and indirect costs.

Supply chain costing is not a single costing technique. It is a broad term that encom-passes many different costing techniques for expanding cost visibility across the supplychain.

S U M M A R Y

1 Seuring, Stefan (2002), Supply Chain Costing

in Seuring, Stefan and Goldbach, Maria editoCost Management in Supply Chains, HeidelbGermany: Physica-Verlag, pp. 24.

2 McNair, C.J. (1999), Tools and Techniquesfor Implementing Integrated Supply ChainManagement, Montvale, NJ: Institute ofManagement Accountants.

3 The discussion of the challenges focuses onrelationships with external trading partnersbecause it is here that management has theleast direct ability to influence these behaviorcultural issues and even technical issues.

Supply chain costing requires a majorinvestment in time and personnelbutthis investment provides a platformto make the leap to the next plateauin supply chain management. Theinvestment for an additional analyst,software, and the management effortis a small price to pay compared to

potential cost reductions that can beachieved.

Cost knowledge within and betweenfirms is required to truly manage thesupply chain. Operational and surrogatemeasures can move the firm only sofar. Trust and dependency are critical indetermining whether cost data will beexchanged across firms.

Much of the cost data that is neededmay not be as sensitive as managerscurrently perceivecost and perfor-mance data is usually specific to theactivities, processes, and strategies beingemployed by the firm and its tradingpartners. The ability of competitors toexactly replicate these strategies andbusiness practices, especially wheninvolving multiple trading partners, isproblematic.

Supply chain costing is a strategic,competitive weapon that can also beused to support tactical and operationaldecisions once in place. To be effective,performance measures must be aligned

with supply chain costing.

Endnotes




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