total Cost analysis

Total Cost Analysis

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Learning Objectives • Understand the total cost concept • Appreciate how organizational structure and IT systems help / hinder the application of total cost analysis

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Logistics – Activities Drive Total Cost Place/Customer Service Levels •Customer Service •Parts & Service Support •Return Goods Handling

Inventory Carrying Costs •Inventory Management •Packaging •Reverse Logistics

Transportation Costs •Traffic & Transportation

Warehousing Costs •Warehousing & Storage •Plant & Warehouse Site Selection

Order Processing & Information Costs •Order processing •Logistics Communications •Demand Forecasting/Planning 4/15/2004

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Lot Quantity Costs •Material Handling •Procurement

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The cost trade-off associated with customer service is that of lost sales and potential future sales Transport costs, as we have already seen, vary with the weight, value and volume of the items being shipped Lot quantity costs include setup costs – time, scrap & operating inefficiencies plus the opportunity cost of lost capacity

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Logistics Trade-Off Decisions Objectives… LOW COSTS Optimise material costs, capital costs & overhead expenses

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HIGH SERVICE LEVELS Optimise reponse toward production & markets

QUALITY LOW LEVEL ASSURANCE OF TIEDTIED-UP CAPITAL Maintain & improve quality of  material

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Optimise capital tiedtied-up in inventories

SUPPORT OTHER FUNCTIONS Support sales, design & development 4

Source: Yunus Kathawala & Heino H. Nano, “Integrated Logistics Management: A Conceptual Approach, ” International Journal of Physical Distribution and Materials Management 19, no. 8, p. 10

In every logistics activity we must make trade-off choices that reflect our understanding of our markets. In purchasing, inventory transportation and warehousing we are determining the balance required to meet the marketing needs – of the right product or service in the right place at the right time at a price the consumer is willing to pay. If we buy too large a quantity of a product because the unit price is low, what is the trade-off cost of holding greater levels of inventory; if we buy in accordance with customer demand, what are the chances of a surge in demand that will cause out-of-stock and therefore lost sale situations? Materials flow is about providing customer service at every point within the supply chain – not only to the final, end-user customers – but to internal customers. There are five key objectives – often we find that these are in conflict with each other and we need to make trade-off choices.

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Controlling Logistics Activities Standard Costs Budgets Control over  logistics can be accomplished by:

Productivity Standards Statistical Process Control Activity Based Costing

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You cannot manage what you cannot measure – therefore the old style of cost reporting is inadequate for managing the logistics and supply chain task. The challenge is less to create new data – but to tailor the existing data in the accounting system to meet the requirements of the logistics function. These are the core elements that enable the control of logistics activities through understanding and application of cost data. •Standard cost involves determining a benchmark or norm for measuring performance and managing exceptions to that standard •Budgets can be developed using standard costs – but also to control capital expenditures, and for non-activity related costs •The use of productivity standards is similar to standard cost control – exceptions to the benchmark standard can be managed on a case-by-case basis Statistical process control is primarily used in the manufacturing process and requires an understanding of the variability of the process itself prior to making any management decisions  Activity Based Costing examines the demands made by particular products or customers on indirect resources

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Competitive Advantage of Integrated Cost Management & Total Cost Analysis Shareholder Value

Profitability

Revenue Greater Customer Service Greater Product  Availability

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Invested Capital

Costs

Working Capital

Fixed Capital

Lower Cost of Goods Sold (transportation, warehousing, materials handling, distribution, Ithaca management costs)

Lower raw materials & finished goods inventory Shorter ‘order to cash’ cycles

Fewer physical assets (trucks, warehouses, materials handing equipment) 6

The impact of integrated cost management and total cost analysis has considerable potential to provide the following sources of competitive advantage:

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Typical Full Costing Model Supervision

Supplies

Utilities

Office Support

Equipment

Overhead Pool

Product Division A

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Product Division B

Product Division C

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Product Division D

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 Accounting systems are designed to report the aggregate effects of a firm’s operation to its shareholders, creditors and government They provide a historical record of the company’s operations. All of the firm’s costs are allocated to various business segments – but on average rather than reflecting the actual cost of the business service to that segment  Accounting systems typically record marketing and logistics costs in aggregated accounts and seldom attempt to attach the costs to functional responsibilities and to individual products and customers Profitability reports do not show a segment’s contribution to profitability but include fixed costs, joint product or service costs and corporate overhead costs In many standard cost systems fixed costs are often treated the same as variable costs, masking the true behaviour of fixed costs

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Activity Based Costing (ABC) Model Supervision

Receiving

Supplies

Put-Away

Product Division A

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Utilities

Set-Ups

Product Division B

Office Support

Packing

Product Division C

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Equipment

Shipping

Product Division D

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This slide demonstrates how activity based costing may be used to apportion activity costs in a warehouse

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Total Cost Analysis Narvik

Bremen Rotterdam

Hammersley

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Consider two options facing a Bremen steelworks: Scenario 1 •1,400,000 tonnes of iron ore is bought each year from a company in the Hammersley region of Western Australia at a low price per tonne (US$23.12/tonne) – or US$32.4 million per annum. •The ore is shipped from Hammersley to Rotterdam, Holland in large bulk carriers – seven shipments are required each year, each shipment taking 45 days including loading and unloading. The cost per day for the bulk carrier is US$39,252 – or US$12.4 million per annum. •Once in Rotterdam the iron ore is transferred to trains for the final journey to the steelworks in Bremen, Germany. This is necessary as Bremen’s port cannot accommodate large bulk carriers. This takes a further six days and costs US$5.8 million per annum. •Due to the infrequent receipt of iron ore shipments from Hammersley the Bremen steelworks maintains a maximum inventory holding capacity for 300,000 tonnes of iron ore. This costs a further US$1.56 million per annum. Scenario 2 •1,400,000 tonnes of iron ore is bought each year from a company in central Sweden. Because the mine is underground costs associated are high and the cost of this iron ore is US$28.39/tonne) – or US$41 million per annum. •The ore is shipped by slurry pipeline from Malmberget to the port at Narvik, Norway where it is loaded on small bulk carriers that take three days to reach Bremen. 48 shipments are required each year. The total cost per annum for the pipeline and small bulk carrier is US$4.9 million per annum. •Due to the frequent receipt of iron ore shipments from Narvik the Bremen steelworks maintains a maximum inventory holding capacity of only 45,000 tonnes of iron ore. This costs US$234K per annum.

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Suggested Reading / Research • www.clm1.org • http://www.optimizemag.com/issue/001/strategies.htm • Journal of Supply Chain Management http://www.ism.ws/Pubs - various articles

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