This paper discusses the five steps B2B suppliers should implement to optimize their cost-to-serve. Sudipto Banerjee is a Principal in the Munich office of The Boston Consulting Group. He is a core member of BCG’s Marketing, Sales, and Pricing Practice and one of the founding leaders of the Pricing Enablement Center (PEC) initiated in Atlanta. He is currently helping launch the PEC in Europe. He can be reached at Banerjee.sudipto@bcg.com. Steven Greene is a Project Leader in the BCG Chicago office. He has done extensive work with BCG’s Pricing Enablement Center (PEC), is part of BCG’s Big Data and Analytics Experts Cadre, and built digital pricing solutions in collaboration with software developers. He can be reached at greene.steven@bcg.com.

The Pricing Advisor, March 2016

Mature pricing professionals conduct a range of analyses to understand customer profitability. In doing so, they attempt to understand the Total Cost-to-Serve (TCS), or the cost of serving their customers, and thereby optimize their spend depending upon the strategic importance and their objective for customers. Conversely, mature procurement professionals also conduct analyses to understand their cost of owning a product or service. The term procurement professionals use to define these analyses in the strategic sourcing approach is Total Cost of Ownership (TCO). This approach may be used to bring all suppliers monetarily at par in order to make the best supplier selection and retention decisions.

Often these analyses are conducted disparately with little shared insight between the supplier and customer during negotiations. Both parties may obscure this information to avoid giving up any “bargaining power” that they assume to have. The result is a less optimal negotiation that discourages value protection. Furthermore, in many cases, these negotiations are held for extended periods of time, thus prolonging the value leakage for both parties.

This paper discusses the strategies that companies should adopt to minimize this value leakage and maximize the win-win outcome. The perspective used in this paper is primarily from the eyes of a business-to-business (B2B) supplier such that they may succeed in their goal to maximize customer profitability.

Understanding Total Cost-to-Serve (TCS)

TCS is an analytical approach that uses activity-based costing techniques to identify and understand the costs of producing, marketing, selling, fulfilling, and providing after-sales support to customers. TCS provides the facts required to work collaboratively with customers to improve profitability and strengthen relations. TCS can be typically understood across the various elements of the Plan-to-Return cycle (P2R) for an organization. The 12 major process steps across the P2R cycle provide a comprehensive understanding of TCS. These include planning, quotation and order generation, commissions, manufacturing, storage and packaging, shipping and freight, billing and deductions, warranty and after-sales services, and returns. While the applicability of the service elements across the P2R cycle changes from one industry to the other, in general, many of them remain pertinent.

Understanding Total Cost of Ownership (TCO)

The Total Cost of Ownership (TCO) captures the total cost of acquiring, implementing, using, and maintaining the product or solution. A new kind of procurement professional is emerging – one who seeks to understand the “value received” from the product or service.

This is often understood from the following equation:

Value received = Benefits – TCO

Procurement professionals are seeking to increase the value received by minimizing their TCO and maximizing the benefits received. Oftentimes, in their pursuit to decrease TCO, buyers overlook imperative business requirements. For example, a buyer may decide on a monthly shipment to decrease TCO while the business requirement might require a weekly shipment. By opting for the monthly shipment, the buyer may jeopardize production schedules, which could eventually impact customer satisfaction.

Five steps for B2B suppliers to optimize cost-to-serve

1. Comprehensively identify and prioritize TCS: Organizations should rapidly develop the applicability, understanding, quantification, and variability of service elements across their customer segments and the Plan-to-Return cycle and eventually be able to distinguish the profitable ones from the unprofitable (Figure 1). An effective first step in TCS analysis, especially where data is limited, is to lay out the P2R elements to understand which of these services the supplier provides and what they charge their customers for. Start with identifying which TCS elements the supplier is offering to its customers.

In one diversified industrial company, a rapid analysis revealed that while two customers were at par in sales, they had

very different cost-to-serve patterns. One of the customers was served more orders, had more out of sphere shipments, had a higher weight per order, and larger cash discount. All of these, consequently, contributed to lower realized margin for that customer, something that managers were not aware of.

2. Gain cost transparency: Ideally, before moving into a customer strategy or price-setting exercise for the TCS elements, suppliers will benefit from gaining an accurate, customer-level picture of costs of each of the TCS elements. This provides an accurate view of customer level profitability to fuel annual commercial strategy and account planning processes as well as a reference point in the price setting process.

Suppliers often use simple allocation schemes for logistics costs and selling costs. As an example, a power cable producer with multi-country operations in Europe allocated its logistics costs based on sales, but would give the same weight to Buyer A with 1 warehouse and “x” logistics costs and another Buyer B with 300 branches and “2x” logistics costs, so long as they have equivalent sales. This simple allocation is not only misleading but dangerous. If, for instance, Buyer A has a marginally worse mix, it may show as worse from a profitability standpoint than Buyer B, despite a 2x logistics cost difference, and could steer volume in the wrong direction during the annual sales processes.

To gain better cost transparency, heavy lifting analytics or client surveys are usually required. At a Medtech company producing laboratory products, logistics costs were allocated to product groups with 90% accuracy using geo-spatial data, INCO terms for the client’s buyers to determine who paid shipping, and standard shipping rates, weights, and volume. The SG&A costs within a country were allocated with a workshop-based approach: the sales force broke down time spent across all customer and product groups and applied the appropriate percentages to the total SG&A costs.

3. Fine tune analysis with consensus workshops: A common issue facing suppliers is low data transparency pertaining to services provided to buyers. Often it is unclear whether the services provided are charged or not. At the same power cable company, no markets consistently invoiced services other than basic freight to the customer, meaning that few TCS elements appeared in the client’s SAP data and therefore could not be traced. The implication was that the commercial leadership could only anecdotally determine if certain services were charged to the customer, e.g. cutting or expedited freight. For this supplier, 4-hour workshops were held in 5 markets with the Sales Directors, Pricing Managers, and Local Finance representation to lay out which services were provided to customers, which were charged, and where there was willingness to pay from the market (Figure 2). TCS elements to charge through to the customer, or leakages to shore up, were prioritized based on where services were provided but not charged, and where there was customer willingness to pay. Immediate opportunities on several technical services provided at the point of delivery were identified as quick win opportunities and were “live” in the market within 1-2 months.

4. Set customer strategy and prices of service elements: Fundamentally, there are two tactics for setting prices for these services – leakages and surcharges. When addressing leakages, evaluate for which customers to reduce or eliminate leakages and by how much. This could be established by considering several customer dimensions such as overall deal economics, historical customer profitability, growth potential of the customer, customer share of wallet, or customer lifetime value. For example, a large Technology company reduced the returns quota from 2% to 1% for their smaller, less strategic customers leading to an immediate margin uplift of 50 basis points at these accounts – a big number considering the low margins in their Industry!

When evaluating surcharges, a cost-plus strategy (if the cost of the service element is known) is a good first step, but more value can be extracted by using a value based pricing strategy. As an example, the customer service center, sales force, or dedicated technical staff will respond to inquiries from buyers related to their purchasing patterns. Some big customers require as much as 1 day per week from an employee in the finance department to monitor purchased volumes, sales, forecasts, and product offering.

These costs are often considered as part of the offering by the buyer, but a better approach for the supplier is to standardize the data, technical support, and customer service support offering

then add surcharges for any buyer requirements above and beyond the standard.

5. Embed TCS in the sales process: Several projects in consumer and industrial goods industries have revealed that many TCS elements often surface as hidden pockets of value. During price negotiations with buyers, these elements

can frequently be a lever to build into the offer, or even into standard terms and conditions of frame contracts, to shore up gaps in target product prices. In negotiations, leverage these as a trade-off or balancing tool: “If you really want us to give you a discount, you have to pay extra for expedited shipment since last year 20% of your shipments were expedited and it cost us $15,000.” Very importantly, communicate with confidence: don’t apologize! Many times, the discomfort arising from putting strain on old sales relationships between buyer and supplier gets in the way of taking tough, but valuable, discussions on TCS and TCO. Also, build a robust tool that embeds the standardized treatment of TCS into the quoting engine. This would provide the transparency required for your sales force to know, communicate, and negotiate in real time. Train your sales force around the logic behind the tool and the tool itself. Prepare them to win in these negotiations by coaching them through robust use cases (both real and hypothetical) to hone their capabilities. Finally, roll it out with pilot markets or customer subsets and expand from there. To test and learn, a good practice is to start with the long-tail of customers and work your way up from there.

Closing and summary

There is a compelling reason to establish an end to end view of TCS. Doing so affords suppliers two clear benefits:

1. Developing an accurate picture of customer profitability, which feeds into annual commercial strategy setting and account planning processes, and
2. Equipping the sales force and customer service center with a seemingly endless menu of service elements to use in price negotiations

Experience has shown that companies that can articulate the TCS elements for their business work more collaboratively with customers, have a sales force that more aggressively negotiates on price, and are better at continually finding improvement levers in the sales process. By producing the end to end view of TCS, laying out the largest elements from a cost perspective, identifying gaps on what can be measured with today’s data and capability, fine tuning the analysis with a cross-functional team, and developing a TCS systematic solution along with robust sales training, tomorrow’s pricing professionals can systematically incorporate TCS elements, one by one, into their negotiation tactics. Doing so leads to an incremental 50 – 100 basis points of margin enhancement within 12 months, and more in the long term.

Knowledge of true profitability empowers managers to make the right decision for their customers. By controlling their investment on service elements, customer-centric companies can take their profit destiny into their own hands.