Chapter 3 Value and logistics costs

Content Where does value come from How can logistics costs be presented Activity-based costing A balanced measurement portfolio Supply chain operations reference model

Where does value come from Key issues 1 How can shareholder value be defined? 2 What is economic value added, and how does it help in this definition?

Where does value come from Business objectives Business objective Profit Market share Shareholder value Social value

Where does value come from Concepts about shareholder value Comparable investment ROI (Return on investment) Sales Costs Working capital（营运资本） Cash and debtors（借方，债务人） Creditors（贷方，债权人） Fixed assets

Inventory＋Cash and Debtors－Creditors＋Fixed assets Sales revenue－Costs Inventory＋Cash and Debtors－Creditors＋Fixed assets ROI＝ Sales revenue Costs － Profit Capital employed Inventory Cash and debtors ＋ Creditors Fixed assets Return on capital employed Working capital ÷

Where does value come from ROI Profitability = Profit / Sales × Asset utilization = Sales / Employed investment ROI is underpinned by two main drivers: Increased profitability Increased asset utilization

Where does value come from ROI and its key drivers Level 1 Level 2 Level 3 Level 4 ROI Net Profit Sales Production costs / Sales Pay costs / sales Materials / Sales Selling costs / Sales Pay costs / Sales Administration costs / Sales Total assets Fixed assets / Sales Property / Sales Plant / Sales Vehicle / Sales Current assets / Sales Inventory / Sales Debtors / Sales Cash / Sales

Where does value come from Key time-related ratios Average inventory turnover Average settlement period for debtors Average settlement period for creditors

Case study: The Wal-Mart effect In 1987, Wal-Mart had a market share of just 9 percent but was 40 percent more productive than its competitors as measured by real sales per employee. By 1995, it commanded a market share of 27 percent and had widened its productivity edge to 48 percent. Competitors began to adopt Wal-Mart’s innovations in earnest in the mid-1990s. From 1995 to 1999, Wal-Mart improved its own productivity by an additional 22 percent.

Case study: The Wal-Mart effect Managerial innovation Wal-Mart’s productivity edge stems from managerial innovations that improve the efficiency of stores. Employees who have been cross-trained, for instance, can function effectively in more than one department at a time. Information technology investments Wal-Mart was among the first retailers to use computers to track inventory (1969), just as it was one of the first to adopt bar codes (1980), EDI for better coordination with suppliers (1985), and wireless scanning guns (late 1980s). These investments, which allowed Wal-Mart to reduce its inventory significantly and to reap savings, boosted its capital productivity and labor productivity.

Content Where does value come from How can logistics costs be presented Activity-based costing A balanced measurement portfolio Supply chain operations reference model

How can logistics costs be represented Key issues 1 What are the various ways of cutting up the total cost ‘cake’? 2 What are the relative merits of each?

How can logistics costs be represented Problems with traditional cost accounting as related to logistics (Christopher, 1998) The true costs of servicing different customer types, channels and market segments are poorly understood. Costs are captured at too high at a level of aggregation. Costing is functionally oriented at the expense of output. The emphasis on full cost allocation to products ignores customer costs

How can logistics costs be represented Three ways to cost cube

How can logistics costs be represented Fixed / Variable costs Volume of activity Fixed cost Volume of activity Variable cost

How can logistics costs be represented Fixed / Variable costs Volume of activity Cost or revenue Sales revenue Variable cost Fixed cost Total cost Break-even point

How can logistics costs be represented Fixed / Variable costs Cost or revenue Volume of activity Fixed cost High variable cost Total cost Sales revenue Break-even point Cost or revenue Volume of activity Fixed cost Low variable cost Total cost Sales revenue Break-even point

How can logistics costs be represented Direct / Indirect costs Direct costs Direct labor Direct materials Whether the cost can be directly allocated to a given product Indirect costs (overheads) Managing director’s salary Rent rates Administration expenditure

How can logistics costs be represented Direct / Indirect costs DPP (Direct product profitability) method Gross sales for product group Less product-specific discounts and rebates Net sales by product Less direct costs of product Gross product contribution Less product-based marketing expenses Product-specific direct sales support costs Less product-specific direct transportation costs Less product-attributable overheads Direct product profitability Sourcing costs Operations support Fixed-assets financing Warehousing and distribution Inventory financing Order, invoice and collection processing

How can logistics costs be represented Engineered / Discretionary costs Example Engineered costs prevention Input-output relationship Quality cost appraisal Internal and external failure Discretionary costs

Content Where does value come from How can logistics costs be presented Activity-based costing A balanced measurement portfolio Supply chain operations reference model

Activity-based costing Key issues 1 What are the shortcomings of traditional cost accounting from a logistics point of view? 2 How can costs be allocated to processes so that better decisions can be made?

Activity-based costing Today’s businesses are working in an increasingly complex environment. Use of Advanced Technology Product Life Cycle Product Complexity Channels of Distribution Quality Requirements Product Diversity

Criticisms of Traditional Cost Allocation Activity-based costing Criticisms of Traditional Cost Allocation Assumes all cost is volume-related Departmental focus, not process focus Focus on costs incurred, not cause of costs

Activity-based costing Conventional Costing Total Cost = Material + Labour+ Overheads Overheads are allocated to the products on volume based measures e.g. labour hours, machine hours, units produced Will this not distort the costing in the new environment? ABC provides an Alternative.

Activity-based costing Allocation of indirect costs based on causal activities ABC Purpose Results in better allocation Does not provide “true” cost

Activity-based costing Traditional allocation method Activity-based allocation method Costs Products Costs Activities Products First stage Second stage

Activity-based costing When is ABC Most Useful? High Overheads Product Diversity or Multiple Products Customer Diversity Service Diversity

Activity-based costing Example Production line A B C D Total Machine hours 8,000 32,000 No. of changeovers 50 30 15 5 100 Equal allocation 250,000 1000,000 Allocation by activity 500,000 300,000 150,000 50,000 Difference -100,000 -200,000

Activity-based costing Cost time profile (CTP) delivery loading sort processing storage transport

Content Where does value come from How can logistics costs be presented Activity-based costing A balanced measurement portfolio Supply chain operations reference model

A balanced measurement portfolio Financial Operation Future Past Traditional Balanced

A balanced measurement portfolio

Content Where does value come from How can logistics costs be presented Activity-based costing A balanced measurement portfolio Supply chain operations reference model

Supply chain operation reference model

Supply chain operation reference model