How Cost to Serve analysis is transforming supply chain profitability in a challenging economic climate

As supply chains grow more complex amid economic pressures, businesses are turning to Cost to Serve analysis to uncover hidden costs, optimise operations, and boost profits in an increasingly competitive landscape.

Supply chains today are intricate systems shaped by diverse customers, products, and service expectations, making profitability measurement a formidable challenge. While customer satisfaction remains paramount, supply chain profitability demands the same leve...

l of scrutiny. Traditional approaches can either oversimplify costs, masking profit-draining activities, or become so complex that decision-making stalls. Cost to Serve (CTS) analysis offers a pragmatic middle ground, enabling businesses to assess the true cost of delivering goods or services to each customer and product combination, thereby identifying actionable opportunities to enhance profitability without compromising service levels.

At its core, Cost to Serve quantifies all expenses involved in fulfilling a customer order—from production to transportation, storage, and customer-specific services—and compares these against the revenue invoiced. Many companies are surprised to find that certain customers, or even products, are actually loss-making once logistics and other indirect costs are accounted for. For instance, investing in an expensive courier service to deliver a low-margin product will erode profits, a fact often hidden without CTS analysis.

CTS also stands out by striking a balance between simplicity and depth. Unlike highly detailed activity-based costing (ABC) systems, which can become overwhelming, CTS typically utilises existing cost data and focuses on cost drivers linked to activities along the supply chain. Spreadsheet models or network design software can support the calculation, and the approach allows incremental adoption—starting with major cost contributors like logistics before expanding to end-to-end supply chain activities.

The process involves six logical steps: agreeing on clear objectives, mapping relevant activities, linking activities to cost drivers, calculating actual costs, implementing changes based on insights, and post-implementation evaluation. This systematic approach ensures not only that data collection is purposeful but also that subsequent decisions are evidence-driven and aligned with strategic goals.

Enterprises adopting CTS have found it invaluable for revealing a “whale curve” of profitability—a graphic illustration showing that a small percentage of customers typically generates the bulk of profits, a large segment breaks even, and a small portion actually causes losses. Such insights enable businesses to differentiate their strategies, such as adjusting pricing, tailoring service levels, and reconsidering SKUs to optimise margins.

Real-world examples underscore CTS’s impact. A hospital group in Thailand identified inefficiencies and streamlined supplier management without impacting patient care. A company confronting frequent order changes managed to recoup an estimated $5 million through appropriate customer charges and behavioural changes. A manufacturing firm in Sweden found that its largest-volume customers were least profitable, leading to adjusted pricing and supply decisions that boosted profits while maintaining relationships. Meanwhile, an Australian and Thai consumer goods distributor each realised significant cost savings and margin improvements by addressing logistics inefficiencies highlighted by CTS.

Industry experts endorse CTS as a vital management tool amid economic uncertainty. Gartner, for instance, urges chief supply chain officers to implement a six-step CTS model that properly allocates indirect and overhead costs based on the distinct complexities of supporting each customer and product. This counters common miscalculations that overlook service differentiation or product attributes, thereby providing clearer insight into true profitability.

Market analysis projects the supply chain CTS analytics sector to grow substantially, reaching billions by the mid-2020s, driven by the rising need to navigate complex supply networks and escalating operational costs. Research indicates that 20–40% of customers may be unprofitable once hidden logistics, labour, and fulfilment costs are factored in, underscoring the urgency for accurate cost visibility.

Logistics Bureau, a consultancy specialising in supply chains, further offers a “Profitability Checker” service that leverages CTS to identify unprofitable orders and customers at multiple cost levels—from cost of goods sold through warehousing and freight—targeting a potential reversal of 40–50% of unprofitable transactions. According to the consultancy’s experience, even large organisations with seasoned finance teams often underestimate their true cost to serve, yet all benefit from profit increases once costly customers and products are identified and addressed.

However, the real power of CTS lies not in merely cutting unprofitable customers loose, but in uncovering opportunities to enhance profitability by adjusting service levels or pricing. For example, customers over-served beyond their expectations can be offered leaner, cost-effective alternatives that preserve satisfaction while lowering costs. Alternatively, higher-cost serving customers might warrant premium pricing aligned with the service level.

Broader economic and operational trends also amplify the importance of CTS. Grant Thornton highlights rising logistics costs, constrained warehouse space, and labour shortages that erode distribution profitability, even as revenues grow. Companies like Amazon have seen significant jumps in logistics expenses as a share of sales, a pattern echoed across the industry. These factors make understanding and controlling the cost to serve crucial to sustaining margins.

CTS benefits extend beyond addressing current challenges. With robust data and modelling, organisations can undertake scenario planning, exploring “what-if” analyses on service modes, order acceptance criteria, or potential mergers and acquisitions to unlock latent value. This dynamic capability supports agile decision-making in an increasingly volatile global market.

In summary, Cost to Serve analysis equips companies with a nuanced, actionable understanding of profitability embedded within their supply chains. By illuminating hidden costs and profit leakages, CTS empowers businesses to make informed commercial decisions, optimise operations, and foster stronger, more profitable customer relationships. Firms that integrate CTS into their strategic planning not only safeguard their bottom line but position themselves to thrive amid complexity and change.

Source: Noah Wire Services