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Measuring logistics costs and performance
Logistics and the bottom line 83 Logistics and shareholder value 88 Logistics cost analysis 95 The concept of total cost analysis 96 Principles of logistics costing 99 Customer profitability analysis 103 Direct product profitability 109 Cost drivers and activity-based costing 111
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LOGISTICS AND SUPPLY CHAIN MANAGEMENT
This chapter: Outlines the many ways in which logistics management can impact on overall return on investment and, ultimately, shareholder value. ●
Explains the rationale behind total cost analysis, a systematic logistics-oriented cost accounting system and the principal requirements for an effective logistics costing system. ●
Emphasizes the importance of customer profitability analysis based upon an understanding of the ‘cost-toserve’. ●
Introduces the concept of direct product profitability and underlines the need to understand the customers’ logistics costs. ●
Highlights the need to identify the cost drivers in the logistics pipeline and to replace traditional forms of cost allocation with more appropriate methods.
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3 MEASURING LOGISTICS COSTS AND PERFORMANCE
he costs of satisfying customer demand can be significant and yet, surprisingly, they are not always fully understood by organizations. One reason for this is that traditional accounting systems tend to be focused around understanding product costs rather than customer costs. Whilst logistics costs will vary by company and by industry, across the economy as a whole that total cost of logistics as a percentage of gross domestic product is estimated to be close to 10 per cent in the US1 and in other countries costs of similar magnitudes will be encountered. However, logistics activity does not just generate cost, it also generates revenue through the provision of availability – thus it is important to understand the profit impact of logistics and supply chain decisions. At the same time logistics activity requires resources in the form of fixed capital and working capital and so there are financial issues to be considered when supply chain strategies are devised.
Logistics and the bottom line
Today’s turbulent business environment has produced an ever greater awareness amongst managers of the financial dimension of decision making. ‘The bottom line’ has become the driving force which, perhaps erroneously, determines the direction of the company. In some cases this has led to a limiting, and potentially dangerous, focus on the short term. Hence we find that investment in brands, in R&D and in capacity may well be curtailed if there is no prospect of an immediate payback. Just as powerful an influence on decision making and management horizons is cash flow. Strong positive cash flow has become as much a desired goal of management as profit. The third financial dimension to decision making is resource utilization and specifically the use of fixed and working capital. The pressure in most organizations is to improve the productivity of capital – ‘to make the assets sweat’. In this regard it is usual to utilize the concept of return on investment (ROI). Return on investment is the ratio between the net profit and the capital that was employed to produce that profit, thus: 83
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LOGISTICS AND SUPPLY CHAIN MANAGEMENT
Profit ROI = –––––––––––––––– Capital employed This ratio can be further expanded: Profit Sales ROI = –––––– × –––––––––––––––– Sales Capital employed It will be seen that ROI is the product of two ratios: the first, profit/sales, being commonly referred to as the margin and the second, sales/capital employed, termed capital turnover or asset turn. Thus to gain improvement on ROI one or other, or both, of these ratios must increase. Typically many companies will focus their...
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