total Cost analysis

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4//1155//22000044 IItthhaaccaa 11

Total Cost Analysis

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Learning Objectives

• Understand the total cost concept

• Appreciate how organizational structure and IT systems help / hinder the application of total cost analysis

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Logistics

Logistics –

– Activities Drive Total Cost

Activities Drive Total Cost

Place/Customer Service Levels Place/Customer Service Levels ••Customer ServiceCustomer Service

••Parts & Service SupportParts & Service Support ••Return Goods HandlingReturn Goods Handling

Transportation Costs Transportation Costs ••Traffic &Traffic &

Transportation Transportation

Warehousing Costs Warehousing Costs ••Warehousing & StorageWarehousing & Storage ••Plant & WarehousePlant & Warehouse

Site Selection Site Selection Inventory Carrying Costs

Inventory Carrying Costs ••Inventory ManagementInventory Management ••PackagingPackaging

••Reverse LogisticsReverse Logistics

Lot Quantity Costs Lot Quantity Costs ••Material HandlingMaterial Handling ••ProcurementProcurement Order Processing & Information Costs

Order Processing & Information Costs ••Order processingOrder processing

••Logistics CommunicationsLogistics Communications ••Demand Forecasting/PlanningDemand Forecasting/Planning

The cost trade-off associated with customer service is that of lost sales and potential future sales

Transport costs, as we have already seen, vary with the weight, value and volume of the items being shipped

Lot quantity costs include setup costs – time, scrap & operating inefficiencies plus the opportunity cost of lost capacity

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Logistics Trade

Logistics Trade--Off Decisions

Off Decisions

LOW LOW COSTS COSTS Optimise Optimise material material costs, capital costs, capital costs & costs & overhead overhead expenses expenses HIGH SERVICE HIGH SERVICE LEVELS LEVELS Optimise Optimise reponse reponse toward toward production & production & markets markets QUALITY QUALITY ASSURANCE ASSURANCE Maintain & Maintain & improve improve quality of quality of material material LOW LEVEL LOW LEVEL OF TIED OF TIED--UPUP CAPITAL CAPITAL Optimise Optimise capital capital tied tied--up inup in inventories inventories SUPPORT SUPPORT OTHER OTHER FUNCTIONS FUNCTIONS Support sales, Support sales, design & design & development development

Objectives

Objectives…

…

Source: Yunus Kathawala & Heino H. Nano, “Integrated Logistics Management: A Conceptual Approach, ” International Journal of Physical Distribution and Materials Management 19, no. 8, p. 10

In every logistics activity we must make trade-off choices that reflect our understanding of our markets.

In purchasing, inventory transportation and warehousing we are determining the balance required to meet the marketing needs – of the right product or service in the right place at the right time at a price the consumer is willing to pay.

If we buy too large a quantity of a product because the unit price is low, what is the trade-off cost of holding greater levels of inventory; if we buy in

accordance with customer demand, what are the chances of a surge in demand that will cause out-of-stock and therefore lost sale situations? Materials flow is about providing customer service at every point within the supply chain – not only to the final, end-user customers – but to internal customers. There are five key objectives – often we find that these are in conflict with each other and we need to make trade-off choices.

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Controlling Logistics Activities

Control over logistics can be accomplished by: Activity Based Costing Statistical Process Control Productivity Standards Budgets Standard Costs

You cannot manage what you cannot measure – therefore the old style of cost reporting is inadequate for managing the logistics and supply chain task. The challenge is less to create new data – but to tailor the existing data in the accounting system to meet the requirements of the logistics function. These are the core elements that enable the control of logistics activities through understanding and application of cost data.

•Standard cost involves determining a benchmark or norm for measuring performance and managing exceptions to that standard

•Budgets can be developed using standard costs – but also to control capital expenditures, and for non-activity related costs

•The use of productivity standards is similar to standard cost control –

exceptions to the benchmark standard can be managed on a case-by-case basis

Statistical process control is primarily used in the manufacturing process and requires an understanding of the variability of the process itself prior to

making any management decisions

Activity Based Costing examines the demands made by particular products or customers on indirect resources

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6 4/15/2004 Ithaca 6 Shareholder Value Invested Capital

Revenue Costs Working

Capital Fixed Capital Profitability Greater Customer Service Greater Product Availability

Lower Cost of Goods Sold (transportation, warehousing, materials handling, distribution, management costs) Lower raw materials & finished goods inventory Shorter ‘order to cash’ cycles Fewer physical assets (trucks, warehouses, materials handing equipment)

Competitive Advantage of Integrated Cost

Management & Total Cost Analysis

The impact of integrated cost management and total cost analysis has considerable potential to provide the following sources of competitive advantage:

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Overhead Pool

Supervision Supplies Utilities Office Support Equipment Product Division A Product Division D Product Division C Product Division B

Typical Full Costing Model

Accounting systems are designed to report the aggregate effects of a firm’s operation to its shareholders, creditors and government

They provide a historical record of the company’s operations. All of the firm’s costs are allocated to various business segments – but on average rather than reflecting the actual cost of the business service to that segment Accounting systems typically record marketing and logistics costs in

aggregated accounts and seldom attempt to attach the costs to functional responsibilities and to individual products and customers

Profitability reports do not show a segment’s contribution to profitability but include fixed costs, joint product or service costs and corporate overhead costs

In many standard cost systems fixed costs are often treated the same as variable costs, masking the true behaviour of fixed costs

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8 4/15/2004 Ithaca 8 Supervision Product Division A Product Division D Product Division C Product Division B Receiving

Supplies Utilities Office Support

Equipment

Put-Away Set-Ups Packing Shipping

Activity Based Costing (ABC) Model

This slide demonstrates how activity based costing may be used to apportion activity costs in a warehouse

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9 4/15/2004 Ithaca 9 Narvik Hammersley Rotterdam Bremen

Total Cost Analysis

Consider two options facing a Bremen steelworks: Scenario 1

•1,400,000 tonnes of iron ore is bought each year from a company in the Hammersley region of Western Australia at a low price per tonne

(US$23.12/tonne) – or US$32.4 million per annum.

•The ore is shipped from Hammersley to Rotterdam, Holland in large bulk carriers – seven shipments are required each year, each shipment taking 45 days including loading and unloading. The cost per day for the bulk carrier is US$39,252 – or US$12.4 million per annum.

•Once in Rotterdam the iron ore is transferred to trains for the final journey to the steelworks in Bremen, Germany. This is necessary as Bremen’s port cannot accommodate large bulk carriers. This takes a further six days and costs US$5.8 million per annum.

•Due to the infrequent receipt of iron ore shipments from Hammersley the Bremen steelworks maintains a maximum inventory holding capacity for 300,000 tonnes of iron ore. This costs a further US$1.56 million per annum. Scenario 2

•1,400,000 tonnes of iron ore is bought each year from a company in

central Sweden. Because the mine is underground costs associated are high and the cost of this iron ore is US$28.39/tonne) – or US$41 million per

annum.

•The ore is shipped by slurry pipeline from Malmberget to the port at

Narvik, Norway where it is loaded on small bulk carriers that take three days to reach Bremen. 48 shipments are required each year. The total cost per annum for the pipeline and small bulk carrier is US$4.9 million per annum. •Due to the frequent receipt of iron ore shipments from Narvik the Bremen steelworks maintains a maximum inventory holding capacity of only 45,000 tonnes of iron ore. This costs US$234K per annum.

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total Cost analysis