Cost the customer

Your report suggested a move on at least one of these two practices:

• whether cost to serve is measured by customer, segment, channel and offer;
• whether prices reflect cost to serve.

Cost to serve is what it costs to take an order, pick it, deliver it and look after the customer. This move guide measures it by activity and puts it beside each customer's price. Then you can see which customers, channels and orders make money.

If you took the consumer check, go to the consumer section. If your products reach shoppers through retailers, go to the section for brands.

1. When it applies

Use this move guide if your report placed either practice in the lowest two stages.

If both already sit at the middle stage or higher, skip this move guide.

It needs one source of pricing data first, because the costs are allocated to invoice lines.

2. What to do

Eight steps, in this order. A first model takes four to eight weeks. Book the site visits early.

1. List the cost pools. Take order processing, production, pick and pack, freight, service, rebates in and out, and overhead.
2. Write today's rule and a better driver for each pool. Today's rule is often a share of sales dollars. A driver is an activity that causes the cost: line items, drops, tonnes or claims.
3. Visit a warehouse or site to set the drivers. Time a sample of orders from receipt to delivery.
4. Allocate to each invoice, then roll up. Roll up to customer, segment, channel and offer.
5. Put each customer on a map. Plot cost to serve against the price the customer pays relative to list. Name the action for each corner. The cost-to-serve worksheet does this.
6. Write your reasons to price below cost to serve on purpose. Keep them few, and give each an approver. Table A below does this.
7. Put cost to serve beside price in the account view. Use it first in the reviews of your twenty biggest accounts.
8. Try the small-order calculator with your own numbers. It shows how small an order can be before it loses money.

The two free worksheets do the recording:

• /worksheets/pricing-b2b/cost-to-serve-data for each pool, its driver and the roll-up;
• /worksheets/pricing-b2b/cost-to-serve for the rough first pass, the map and this quarter's decisions.

3. What to produce

One table, plus the two worksheets above.

Table A. Reasons to price below cost to serve on purpose

Any customer priced below cost to serve without a reason in this table goes to the pricing forum.

4. A worked example

Illustrative. Written for this move guide. It describes no client.

A building-products maker sells to about 1,200 trade customers and three large retail chains.

Before.

• Every cost beyond the factory was spread across customers as a share of sales.
• On paper, every customer made the same margin.

The drivers.

• A week in the warehouse timed 200 orders. Picking cost followed line items, and delivery cost followed drops and distance.
• Rebates were taken from the rebate agreements, customer by customer.

What the model showed.

• One trade customer ordered small amounts almost daily, with a delivery each time. After its cost to serve, it lost money.
• A retail chain with the deepest discount took full truckloads to two sites. It made a solid margin.
• Rush orders cost three times a standard order and carried no charge.

The decisions.

• A minimum order size with a charge below it, and a rush order charge.
• Two reasons to price below cost to serve were written down: new accounts in their first year, and one customer who anchors a new region.

Two months on.

• Finance signed off the method.
• The twenty biggest account reviews showed cost to serve beside price.

On a retake, both practices could be answered at the middle stage.

What it looked like in our work

From our own work. Figures changed.

An industrial supplier ranked every customer of one product by its contribution per tonne. Three groups stood out.

Average contribution sat well below the small customers' figure. The complex accounts' full cost had never been allocated to them, so their prices were set without it.

Same sales, opposite profit

From our own work. Figures changed.

A building products business compared two customers with about the same sales. Customer A bought in 15 invoices averaging about $1,150. Customer B bought in 60 invoices averaging about $290. On material cost alone, both earned a 25% margin.

Order size drove the gap. Each small invoice carried the same handling and delivery as a large one.

Customers by price premium and cost to serve

Illustrative.

Place each customer by the price premium it pays and what it costs to serve. Each corner of the grid calls for a different response.

Service raises the cost to serve. Guaranteed delivery, short lead times and stock held for the customer all add cost. So do a full range, special specifications, technical help, special billing and long credit terms. List which of these each customer uses before you place it.

The customer profit curve

Illustrative.

Rank customers by the profit each makes, largest first. Each bar is one customer, and the line adds them up. It rises, levels off, then falls as the loss-making customers take profit back.

Each stretch of the curve calls for its own move. Add value for the best customers. Fix the mix of products and services in the middle. Cut the cost to serve the customers who lose money, and reprice or exit the last few.

5. Effort and dependencies

What you need

• Invoice lines from one source of pricing data.
• The cost ledger by pool.
• Operations records: orders, lines, drops, returns and service calls.

How long

• Four to eight weeks for a first model.
• Then a refresh when buying behaviour changes.

What gets in the way. We have seen these in our own work:

• The busy small customer. In a building-products case in our own process notes, a customer with a few large invoices made a solid margin. One with many small invoices made a loss.
• Winning the wrong work. A building-products business under-priced small orders. It attracted the work that lost money, its costs rose, and it lost the profitable orders.
• Overrides with no reason. A bank's user-pays repricing held because it named four reasons to price away from cost to serve. They were high-value customers, strategic channels, customer preferences and competitive risk.

6. How will you know it worked?

The test is whether the account reviews use the numbers. Retake the check after the first model is in use. Each of these should be true when you answer:

For consumer businesses

This section is for the B2C Consumer Pricing Health Check. Here cost to serve is by channel and order type: fulfilment, delivery, returns, payment fees and service contacts.

When it applies

Use it if your report placed this practice in the lowest two stages.

Our own notes found cost to serve mattered less in a single-channel retailer than in a multi-channel or service business. Start with channel, delivery and returns.

What to do

1. List the cost pools. Take fulfilment, delivery, returns, payment fees and the contact centre.
2. Give each pool a driver. Use orders, parcels, returns and contacts.
3. Allocate last quarter's costs by channel and order type.
4. Put cost to serve beside margin in the next channel review.
5. Try the small-order calculator to set a free-delivery threshold from your own numbers.

The free worksheet does the recording: /worksheets/pricing-b2c-direct/cost-to-serve-data, for each pool, its driver and the result by channel.

What to produce

Table B. Cost to serve by channel and order type

A worked example

Illustrative. Written for this move guide. It describes no client.

A fashion retailer sells through 25 stores and a website with free delivery and free returns.

• Costs beyond the store were one overhead line, so online and store sales showed the same margin.
• By driver, an online order cost $14 to deliver and $9 more when it came back. One online order in four came back.
• Click and collect cost less than half a home delivery.
• The next channel review set cost to serve beside margin. It led to a free-delivery threshold and a returns fee for one category.

On a retake, the practice could be answered at the middle stage.

Effort and dependencies

• Who. Finance leads. The e-commerce and logistics managers supply the drivers.
• What you need. Last quarter's costs by pool, and orders, parcels, returns and contacts by channel.
• How long. Four to six weeks for a first model.
• What gets in the way. Delivery and returns paid by the marketing budget. Bring them into cost to serve before you compare channels.

How will you know it worked?

For brands selling through retailers

This section is for the B2C via trade Brand Pricing Health Check. For a brand, cost to serve turns on how the goods reach the shelf. That means delivery to the store or a distribution centre, drop sizes, merchandising and claims.

When it applies

Use it if your report placed this practice in the lowest two stages.

What to do

1. List the cost pools. Take the distribution model, drops, order size, merchandising and claims.
2. Give each pool a driver, such as cases, drops, store visits or claims.
3. Allocate them to your twenty biggest accounts this quarter.
4. Put cost to serve in each account's profit and loss, beside net price and trade spend. Table C below lays this out.
5. Roll up by channel and have finance accept the method.

The free worksheet does the recording: /worksheets/pricing-consumer-trade/cost-to-serve-data, for the drivers, the allocation and the roll-up by channel.

What to produce

Table C. The account profit and loss

A worked example

Illustrative. Written for this move guide. It describes no client.

A frozen foods brand delivers to grocery distribution centres and direct to convenience stores.

• With costs spread by sales, a convenience account looked as profitable as a grocery account.
• By driver, small direct drops and weekly merchandising visits made convenience cost far more to serve.
• Each of the twenty biggest accounts got a profit and loss with cost to serve beside net price and trade spend.
• The convenience terms were reviewed against it at the next round.

On a retake, the practice could be answered at the middle stage.

Effort and dependencies

• Who. Finance leads. Supply chain and the field sales team supply the drivers.
• What you need. Deliveries, drops, store visits and claims by account for last quarter.
• How long. Four to eight weeks for the first model.
• What gets in the way. Merchandising time no one records. Ask the field team to log visits by account for one month.

How will you know it worked?

The worked examples are illustrative.

Think we've used your work without proper credit? Tell us and we'll fix it.