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Most successful wholesale distributors have a firm handle on revenue sources and direct costs. But many lack sufficient understanding of how the products they distribute and the customers they serve consume support services and contribute to other indirect costs. Without detailed visibility into sales, logistics, fulfillment and administrative expenses, it is difficult to measure the financial performance of individual products and customers or make informed decisions that reduce overall costs and optimize profitability.
Activity-Based Costing (ABC) is a methodology for accurately determining the true cost of products and services. It is a way to assign costs based on services performed by distributor resources. ABC is a valuable tool for managing costs and improving performance. When conducted effectively, ABC can provide rich insight into a distributor’s business processes that helps managers plan, test and execute business practice change. ABC helps distributors uncover and adjust the drivers of cost and profitability and get real-time feedback on business change impact.
Optimizing profitability is a top-of-mind issue for many industry leaders. In fact, Dr. Barry Lawrence, Director of the Industrial Distribution Program and the Supply Chain Systems Lab at Texas A&M University, discusses the power of ABC in stratifying customers and items as one method of optimizing distributor profitability in the book, Optimizing Distributor Profitability: Best Practices to a Stronger Bottom Line.
To manage profitability effectively, distributors need to use the right costing method and have the right information and analytical tools. Most distributors use some method of apportioning costs that lacks rigor and prevents them from understanding the real profitability of products and customers. Unfortunately, when it comes to optimizing profitability many distributors use an array of desktop spreadsheets rather than a dedicated application as a method of capturing costs.
Spreadsheets can be extremely difficult to use for repetitive, collaborative tasks, and especially for analyses that involve complex sets of cost data. Relying on desktop spreadsheets can keep distributors from doing the kind of ABC needed to optimize profitability.
Technology is now available to assist distributors in applying ABC to drive improved financial performance. With profitability and cost management (PCM) applications, distributors can increase visibility into enterprise costs. PCM applications can help automate and enable the alignment of operational resources to increase revenues by focusing on the products and customers that are most profitable, and reduce costs on those that are not.
PCM applications enable improved visibility into the drivers of cost and profitability with activity-centric, multidimensional modeling and analysis. Distributors can quickly build simple or complex ABC models that can truly reflect operational costs.
Having the right cost information when you need it is critical to making smart, timely business decisions. PCM puts valuable data at the fingertips of users across the enterprise, enabling distributors to operate with agility and flexibility. It can help identify areas for cost improvements, such as instances of waste or high cost activities, and facilitate proactive decision making to rectify problems. For example, a seemingly profitable high-volume customer can turn out to be unprofitable, when all of the costs of all value-added services are considered. Better understanding of customer profitability enables a distributor to improve the structure of its sales terms and to align sales commissions to focus on sales that are more profitable.
With PCM applications, distributors can become more agile, gaining organizational alignment, visibility, and greater confidence to give them optimal control and competitive advantage in a low margin industry.
With PCM applications, wholesale distributors can gain a deep understanding of the levers affecting organizational costs and profitability. It allows for the identification of underlying causes of underperformance, testing of potential impacts of change, and incisive actions to reduce costs and optimize profitability of products and customers.
Applying a modern profitability costing methodology effectively means a distributor has current information technology to ensure accuracy, efficiency and agility. Doing so enables distributors to model what-if decisions they make every day. The first step in enabling actionable insight to improve financial performance is a candid assessment of current capabilities and needs.
Paul Pretko is an Industry Principal for Wholesale Distribution at SAP America. He focuses on enabling efficient distributor operations with SAP for Wholesale Distribution solutions. For more information, contact him at email@example.com or visit www.sap.com/usa/industries/wholesaledistribution.