To clarify true supply chain costs and profitability, chief supply chain officers (CSCOs) should adopt a six-step cost-to-serve (CTS) model, according to Gartner, Inc. This model helps allocate indirect and overhead costs based on the complexity of supporting each individual customer and product.

“Many companies overlook service differentiation or product attributes when calculating the profitability of their transactions,” said Marco Sandrone, VP Analyst in Gartner's Supply Chain practice. “This oversight can result in a misleading perception of profitability at a time when leadership is leaning on the supply chain function to clarify the viability of products and customers amid growing economic uncertainty.”

Gartner’s research found that traditional accounting practices neglect to allocate the cost of supporting customers and products due to the complexity that these activities generate in corporate operations.

“Many CSCOs already suspect that some of their products and customers are unprofitable, but they lack a structured approach to define and resolve the issue,” said Sandrone. “Creating a sustainable and adaptable supply chain CTS model involves overcoming challenges related to data, modelling and technology limitations, while reorienting stakeholder objectives and corporate strategy around a clarified picture of profitability.”

To support the adoption of a supply chain CTS model, Gartner identified a multi-step framework for CSCOs to implement.

Step 1: Map Out the Cost Components

The initial step involves dissecting the organization's cost structure to pinpoint costs traditionally spread across transactions based on revenue or physical volumes. Collaborate with the finance team to gain insights and support for the initiative. Focus on identifying indirect costs like logistics, storage, handling, and value-added services.

Step 2: Agree on Scope

Successful companies often adopt a phased, pilot-based approach to CTS, starting with a defined segment like a country or product line, focusing initially on a smaller subset of direct product and supply chain costs.

Step 3: Link the Cost Components to Cost Drivers

To better align the allocation of supply chain costs with actual cost drivers requires a thorough understanding of the factors influencing each cost component. Collaboration with functional experts is crucial to effectively map these relationships. By linking cost components to their drivers, organizations can enhance their cost allocation accuracy and decision-making processes.

Step 4: Model an Approximation of Actual Costs per Activity

Quantifying the cost per activity is challenging but essential for CTS analysis. Direct spend items, such as direct-to-customer transportation fees, are easier to identify, while indirect costs require assumption-based estimates due to a lack of a direct link between the cost element and specific customer or products. Establishing the time frame for data collection, often focusing on the previous calendar year, is crucial for defining costs per activity.

Step 5: Reveal True Profitability at Transaction Level

CSCOs should collaborate with finance to gather a comprehensive list of sales transactions from the past calendar year. Aggregate the actual costs to reveal the true profitability of each invoice transaction. CTS models can offer a more nuanced approach to defining margins by considering the complexity introduced by customer behaviors and product attributes.

Step 6: Use Findings to Enhance Business Performance

With true customer and product profitability data in hand, CSCOs can:

• Aid the sales team in negotiating with new customers or renegotiating unprofitable contracts
• Use product-level data for optimizing the product portfolio
• Leverage market or channel data to guide strategic decisions
• Present cost data as percentages of gross sales for strategic discussions
• Highlight cost per unit for operational improvements (e.g. logistics and transportation)