Cost to Serve Part 2 - Rob O’Byrne

by Rob O’Byrne on 2012-11-02

- WARNING: Small deliveries can kill your bottom line.  - So do YOU have a problem? Here’s how to check.


So last time in Part 1, we discussed the impact of small orders and cost to serve within the distribution centre and warehouses. You can read Part 1 here. This time we'll look at customer delivery.

OK, why do I get so uptight about cost to serve? Well, the simple reason is that so many businesses are just wasting money, because they don't understand the concept or cannot be bothered to apply this type of simple analysis. So don't let that happen to you.Here's an easy way to become a 'Hero' in your business. Read on ....


OK, last time we discussed how small orders being processed through your warehouses were drivers of very high costs and also some of the benefits of incentivising customers to order less frequently and in larger quantities.Well sadly the bad news does not only reside in the warehouse. Because those small and often 'too frequent' orders also wreck havoc with your customer delivery.Imagine this. You're a company that delivers a staple or commodity product to a vast range of retail outlets. Maybe soft drinks, bread or rice. Perhaps you deliver to small corner stores, milk bars, cafes, and petrol stations. If you're lucky, you also deliver in bulk to the larger retailers, perhaps even delivering to their central warehouses, rather than their stores directly. But it's those small deliveries to the smaller customers that are killing your bottom line. I really pity companies that ONLY have those kinds of smaller customers. Because their distribution costs hurt? Why? Let's walk through some examples. I'll try to keep this non technical OK.Bulk Delivery. A great example of highly utilised transport assets and hence low 'per unit' cost delivery is bulk tankers. Picture a bulk tanker delivering flour from a flour mill to a bakery, then going back to the flour mill, collecting another load, and heading back to the bakery. This might go on 24 hours a day. Round and round, with a full load. The only way we could better utilise the tanker, would be to have a 'back load' rather than have it return to the flour mill empty.The key elements of this 'low unit cost' delivery are that: - The truck travels full.  - It makes one delivery each time. So this truck is on the move, only making one stop per run. And stopping time costs money. So this is a near perfect situation. Now contrast this next example.

Small 'Multi Drop' Deliveries. OK, this time we are out in a small truck making small deliveries. Maybe delivering to small shops, petrol stations or even homes. Now we have lots of stopping time as each delivery is made. Each time the driver has to find the delivery location, get out, check the paperwork, find someone to take the delivery, get them to sign for the delivery, unload the delivery, then get ready to make the next delivery. All of this takes time and money.

One of the issues I see frequently in this type of delivery operation is the 'we are going past there anyway' attitude. By this I mean that each new delivery is not really regarded as an extra cost, because we are going that way anyway... WRONG. There is a big cost with every delivery. Each time the driver stops, he/she has to .....OK, we don't need to repeat all that, I'm sure you get the idea.

So the easy answer here, just like reducing warehouse costs, is to encourage customers to place larger orders, less frequently. Because the cost to deliver two boxes, is almost the same as delivering one box! So the second box travels free. (almost). The fastest way to cut delivery costs is to look at all the ways you can increase order sizes and make fewer stops.

If you want a bit more of a technical explanation, have a look at this diagram. (I've put this here for the accountants. They like this kind of stuff)


The Theory of Allocation of Delivery Costs

So what does all this mean? If you are really serious about 'correctly' quantifying the cost of the delivery you might use this approach. We often do this on complex delivery operations to work out true customer profitability for example.

It works like this. You break up the cost of the delivery into fixed and variable costs. These costs include all the costs of the truck (lease or depreciation and maintenance), the fuel and the driver. You might also include some overhead costs.

A delivery route or 'run' can be thought of as taking place in two parts. The stem distance, which is the driving to and from the delivery area, and then the actually stop / start of the delivery operations. So you would allocate a part of the fixed cost and variable cost to each drop in the delivery sequence. Maybe dividing the fixed costs by the number of deliveries for example and then spreading the variable costs across all the deliveries based on the size of each order. This way you get a true cost allocation that takes into account smaller and larger orders.

Part of the costs would then also be allocated based on the distance travelled. This is where the stem distance comes in, because that cost might be allocated across all the deliveries, and then the cost of the ID or inter drop distance, might be allocated to each delivery.

This is a bit more complicated than most businesses might need to establish a rough idea of delivery costs but I just show it for interest. This approach was used for example with a company making deliveries of explosives to remote mine sites. Where the Inter Drop distance might have been 500 kilometres, and the delivery size varied enormously! They really did need an accurate view of delivery costs.....


Simple Approach

But to find out in a simple way if you have a problem with delivery costs, try this approach.

Work out the total cost of a delivery run, including all vehicle and driver costs. Let's say this is $500. Then work out how many deliveries are being made on that run. If it is 10 deliveries, then each one is costing you (simplistically) $50. Or work it out based on volume. If the truck is carrying 200 cases. It is costing you $2.50 per case for the delivery. Then work out how much margin you are making on a typical delivery or case. For example if you make $45 per delivery profit margin on average, and on average a delivery costs $50.........

We have a problem!



A very simple worked example, but I am sure you get the idea. If you think by doing this rough calculation you have a problem, then do the analysis in a more detailed way.Having gone through this exercise hundreds of times, with companies who thought that 'all was well' with their deliveries, I’ve often found that up to 36% of deliveries were losing money!!

Do yourself a favour, and check. You might become the hero who saved your company a lot of money.

I hope you find this information of value.    


All the Best

Rob O'Byrne

Logistics Bureau


P.S. You can grab some other handy information and downloads here:

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