Supply Chain Costing: A Key to Good Management Decisionmaking in Logistics
October 10, 2011
In the commercial world, supply chain companies need to understand both the cost of getting products to their customers and what their customers are willing to pay for the level of service they need. Understanding cost is crucial if companies are to charge their customers the right price for delivering products. If storage and delivery costs $5 for each $100 of product, that $5 needs to be recovered from the customer. Simultaneously, if a commercial company is to remain competitive, it needs to understand the cost that a customer is willing to pay for a given level of service. A $5 supply chain cost may be acceptable for a $100 product, but is it acceptable for a $20 product?
Although public health supply chains are not profit-driven, they too can improve performance by analyzing costs. The USAID | DELIVER PROJECT has developed a supply chain costing tool that enables supply chain managers to analyze activity-based costs. It has been applied in Zambia , Zimbabwe , and Nigeria, where it has helped guide supply chain management and policy decisions. With the forthcoming Supply Chain Costing Tool User Manual, supply chain costing will be more accessible as a management tool.
Supply chain costing can help define the costs of operating a supply chain. Where a supply chain involves many partners, levels, and functions, it requires an understanding of the costs incurred by each partner, at each tier, and in each function. Activity-based costing is a way of estimating the costs of undertaking a specific activity, such as warehousing commodities or transporting an order.
In public health supply chains, clients are usually not charged, so why is supply chain costing important? Supply chain managers are increasingly facing management decisions where some knowledge of the costs they incur is important. For example:
In Zimbabwe, the central medical stores, NatPharm, charges the Global Fund 6 percent of the commodity value for storage and distribution. Is this reasonable? Does it cover all of NatPharm’s costs? What about the costs incurred by other supply chain partners and tiers? Does a flat percentage fee make sense when the value and volume of products can vary greatly? For example, 6 percent of the cost of antiretrovirals and 6 percent of the cost of condoms generate substantially different revenue in relation to the volume of product handled.
In Nigeria, the USAID | DELIVER PROJECT issued a bid for local transport companies to distribute bed nets. Were the resulting price quotes reasonable? Did the companies bidding actually know what their costs would be, or whether they could deliver the level of service specified in the request for proposal for the prices quoted?
As most supply chains face manpower constraints, how do different models of delivery that shift work away from health workers compare to those where delivery teams undertake logistics functions?
A warehouse manager at the Medical Stores Department (MSD) in Tanzania is interested in understanding the cost of storage of commodities in Dar es Salaam. As the volume of products increases, would costs be lower if inventory was moved and held in an existing regional store? How do the costs of subletting private storage space compare to investing in new MSD–managed storage space?
These examples reflect a mix of strategic and tactical questions that supply chain managers face. The Supply Chain Costing Tool User Manual classifies costing questions, as follows:
Key Supply Chain Costing Questions
Decisionmaking Level
Purpose
Understanding total cost and the distribution of these across partners, functions, and tiers
Strategic
Understanding how different partners in a supply chain operate and contribute to delivered costs and how reorganization of functions and responsibilities across partners and tiers could reduce supply chain costs. Can some functions be contracted out to attain defined service levels at a lower cost?
Cost comparisons
Strategic
Tactical
Compare two or more alternative supply chains in a country to determine which one gives defined service levels for the lowest cost. Compare costs to those in comparable countries for similar commodities.
Benchmark and compare delivered costs across facilities in a country to identify factors contributing to lower costs; can practices in the lower-cost facilities be copied elsewhere?
Cost drivers
Tactical
What inputs or functions incur the most costs, and what options are there to reduce these costs? What are the most expensive inputs, how can use of these inputs be minimized, or can they be substituted with less expensive inputs? How do costs change if expensive inputs are reduced?
Source: Supply Chain Costing Tool User Manual (forthcoming).
Strategic questions typically relate to those that can influence how a supply chain is designed and implemented. For example, should a ministry of health or central medical stores be responsible for storage and distribution, or should the government contract a parallel private or nongovernmental organization third-party logistics provider? Should a vendor-managed inventory system be adopted, or should a pickup system be used? What should the central medical stores charge the Global Fund or donors for handling donated products?
Tactical supply chain questions are typically asked of a given supply chain to understand how it can run for a lower cost. Tactical questions examine the key cost drivers and what changes in operation can reduce cost. For example, in Zimbabwe the supply chain costing tool analysis found that the cost of delivery could be lowered by moving to a quarterly, rather than bimonthly, delivery schedule.
While costing analysis in the public and private sector has similarities, there are also important differences. Public health supply chains, unlike their counterparts in the private sector, are not driven by a commercial profit motive. Private supply chain cost analysis would seek to identify cost savings that can contribute to improved efficiency and shareholder value. Companies can identify where their customers are concentrated, maximizing service to those customers while focusing less on hard-to-reach clients with less purchasing power. Commercial supply chain operators may be able to trade off service levels and costs to get the right balance between what a customer will pay for a product and a given supply chain service level. There are typically fewer opportunities for such tradeoffs in public sector supply chains.
The USAID | DELIVER PROJECT is currently developing training materials to help public health supply chain managers interpret and use supply chain cost data to better understand supply chain costs in the effort to improve system performance and reliability. The project has also convened a supply chain costing experts group to help define costing methodologies and share data so that meaningful cross-country comparisons and benchmarks can be established. In collaboration with LLamasoft, a company that specializes in network optimization, the project is defining standard metrics for last mile delivery and will collate data for countries to guide performance assessments. Through this growing body of knowledge, more countries will be able to take advantage of supply chain costing and the benefits it can bring.
For more information about supply chain costing tool analysis, please see the following resources, available on the USAID | DELIVER PROJECT website.
