How to make better decision for your entire Supply Chain – calculate | implement| decide
How to make better decision for your entire Supply Chain
Saving money is great, but in a supply chain, cutting costs in one place can increase costs in another. So we need to take a broader view to make sure we’re having a positive impact on the bottom line. We get that broad impact by calculating the total cost to serve. We’ll walk through an example to show you how you can use a spreadsheet to calculate the total cost here.
Let’s say our company buys 1,000 widgets per week from a supplier, and we operate for 50 weeks out of the year. We’ll analyze the total cost for these widgets by looking at three categories, purchasing costs, transportation costs, and inventory costs.
Purchasing costs are easy. The supplier charges $5 for each widget, and it costs us $50 to process the paperwork for each order.
Since we place 50 orders per year, our total purchasing cost is $252,500. It costs $500 to ship each order, so the total transportation cost for 50 shipments, is $25,000.
We’ll assume our average inventory level is one-half of the order size. We order 1,000 widgets at a time, so the average inventory level is 500. We also estimate that our inventory holding cost rate is 20%. So the total inventory cost is 20%, times the cost of each widget, times the average inventory level, that’s $500 per year.
Now we add the purchasing cost, plus the transportation cost, plus the inventory cost, and we get a total cost to serve of $278,000. If we divide that by the total number of widgets, our cost per widget is $5.56. Now, the supplier reaches out with a proposal. Rather than buying 1,000 widgets at a time, why not buy all 50,000 widgets at once? If we do, they’ll drop the price per widget from $5 to just $4. Should we take the deal? Let’s use our total cost calculator to decide.
Our new total cost to serve would $221,050, or $4.42 per widget. In other words, ordering all of our widgets at once could save us over $56,000 per year, and reduce our cost per widget by 20%. So from a cost perspective, this looks like a pretty good deal. Of course, we’d still need to figure out if we have room to store 50,000 widgets, and whether we have the money to buy them all at once. But if we were only concerned with reducing inventory levels then this savings opportunity would have been dismissed immediately. The power of supply chain management comes from looking across the functions in your business and working with your customers and suppliers to make sure you’re delivering the most value at the lowest cost. By using a total cost to serve approach, you can see the impact of changes on all of the steps in your process, and make better decisions for your entire supply chain