Chapter 3

Value and
logistics costs
 Content

Where does value come from

How can logistics costs be presented

Activity-based costing

A balanced measurement portfolio

Supply chain operations reference model

 Where does value come from

• Key issues

How can shareholder value

1 be defined?

What is economic value

2 added, and how does it help
in this definition?
 Where does value come from

• Business objectives

Business objective

Shareholde
Profit Market share Social value
r value
 Where does value come from

• Concepts about shareholder value

– Comparable investment
– ROI (Return on investment)
– Sales
– Costs
– Working capital （营运资本）
– Cash and debtors （借方，债务人）
– Creditors （贷方，债权人）
– Fixed assets
 ROI ＝ Sales revenue － Costs
Inventory ＋ Cash and Debtors － Creditors ＋ Fixed assets

Sales
revenue
－ Profit

Costs

Return on
Inventory ÷ capital
employed
＋
Working Cash and
capital debtors
Capital
－ employed
Creditors

＋
Fixed
assets
Where does value come from
ROI

Profitability = Profit / Sales

×

Asset utilization = Sales / Employed investment

ROI is underpinned by two main drivers:

Increased profitability
Increased asset utilization
 Where does value come from

ROI and its key drivers

Level 1 Level 2 Level 3 Level 4
Pay costs / sales
Production costs / Sales
Net Profit Materials / Sales
Sales Selling costs / Sales Pay costs / Sales
Administration costs / Sales Pay costs / Sales
Property / Sales
ROI
Fixed assets / Sales Plant / Sales
Sales Vehicle / Sales
Total assets Inventory / Sales
Current assets / Sales Debtors / Sales
Cash / Sales
 Where does value come from

Average inventory turnover

Key time-
Average settlement period for debtors
related ratios

Average settlement period for creditors

Case study: The Wal-Mart effect

In 1987, Wal-Mart had a market share

of just 9 percent but was 40 percent
more productive than its competitors as
measured by real sales per employee.

By 1995, it commanded a market share

of 27 percent and had widened its
productivity edge to 48 percent.

Competitors began to adopt Wal-Mart’s

innovations in earnest in the mid-
1990s.

From 1995 to 1999, Wal-Mart improved

its own productivity by an additional 22
percent.
 Case study: The Wal-Mart effect

Managerial innovation

Wal-Mart’s productivity edge stems from

managerial innovations that improve the
efficiency of stores. Employees who have been
cross-trained, for instance, can function
effectively in more than one department at a
time.

Information technology investments

Wal-Mart was among the first retailers to use computers to track inventory
(1969), just as it was one of the first to adopt bar codes (1980), EDI for better
coordination with suppliers (1985), and wireless scanning guns (late 1980s).
These investments, which allowed Wal-Mart to reduce its inventory significantly
and to reap savings, boosted its capital productivity and labor productivity.
 Content

Where does value come from

How can logistics costs be presented

Activity-based costing

A balanced measurement portfolio

Supply chain operations reference model

How can logistics costs be represented

• Key issues

What are the various ways of

1 cutting up the total cost
‘cake’?

What are the relative merits

2 of each?
How can logistics costs be represented

• Problems with traditional cost accounting

as related to logistics (Christopher, 1998)
– The true costs of servicing different customer
types, channels and market segments are
poorly understood.
– Costs are captured at too high at a level of
aggregation.
– Costing is functionally oriented at the expense
of output.
– The emphasis on full cost allocation to
products ignores customer costs
How can logistics costs be represented

Fixed
Variable

Engineered

Direct Indirect
Discretionary

Three ways to cost cube

How can logistics costs be represented

Fixed / Variable costs

Fixed cost Variable cost

Volume of activity Volume of activity

How can logistics costs be represented

Fixed / Variable costs

Cost or revenue
Sales revenue

Break-even point
Total cost

Variable cost

Fixed cost

Volume of activity
 How can logistics costs be represented

Fixed / Variable costs

Cost or revenue Sales revenue Cost or revenue Sales revenue

Break-even point
Total cost Total cost
Break-even point

High variable cost Fixed cost

Low variable cost

Fixed cost

Volume of activity Volume of activity

How can logistics costs be represented

Direct / Indirect costs

Direct labor

Direct costs

Direct materials
Whether the cost
can be directly
allocated to a Managing
given product director’s salary

Indirect costs Administration

(overheads) expenditure

Rent rates
 How can logistics costs be represented

Direct / Indirect costs

• DPP (Direct product profitability) method

Gross sales for product group
Less product-specific discounts and rebates
Net sales by product
Less direct costs of product
•Sourcing costs
Gross product contribution
•Operations support
Less product-based marketing expenses •Fixed-assets financing
Product-specific direct sales support costs •Warehousing and
Less product-specific direct transportation costs distribution
•Inventory financing
Less product-attributable overheads
•Order, invoice and
Direct product profitability collection processing
How can logistics costs be represented

Engineered / Discretionary costs

Example
Engineered
costs
prevention

Input-output Quality cost appraisal

relationship

Internal and
Discretionary external failure
costs
 Content

Where does value come from

How can logistics costs be presented

Activity-based costing

A balanced measurement portfolio

Supply chain operations reference model

 Activity-based costing

• Key issues

What are the shortcomings of

1 traditional cost accounting from
a logistics point of view?

How can costs be allocated to

2 processes so that better
decisions can be made?
 Activity-based costing
Today’s businesses are working in an
increasingly complex environment.
Use of Advanced Technology
Product Life Cycle
Product Complexity
Channels of Distribution
Quality Requirements
Product Diversity
 Activity-based costing

Criticisms of Traditional Cost Allocation

• Assumes all cost is volume-related

• Departmental focus, not process focus
• Focus on costs incurred, not cause of
costs
 Activity-based costing

Conventional Costing
• Total Cost = Material + Labour+ Overheads
• Overheads are allocated to the products on volume
based measures e.g. labour hours, machine hours,
units produced

Will this not distort the costing in the new

environment?

ABC provides an Alternative.

 Activity-based costing

Allocation of indirect costs based

on causal activities

Results in better allocation ABC Purpose

Does not provide “true” cost

 Activity-based costing

• Traditional allocation method

Costs Products

• Activity-based allocation method

Costs Activities Products

First stage Second stage

 Activity-based costing

When is ABC Most Useful?

• High Overheads
• Product Diversity or Multiple Products
• Customer Diversity
• Service Diversity
 Activity-based costing

Example

Production line A B C D Total

Machine hours 8,000 8,000 8,000 8,000 32,000
No. of changeovers 50 30 15 5 100
Equal allocation 250,000 250,000 250,000 250,000 1000,000
Allocation by activity 500,000 300,000 150,000 50,000 1000,000
Difference 250,000 50,000 -100,000 -200,000 0
 Activity-based costing

• Cost time profile (CTP)

Cost-time profile

120

100 delivery
Cumulative cost (%)

80 loading
60 sort
processing
40 storage
20 transport

0
15 45 60 70 75 85
Cumulative time (hours)
 Content

Where does value come from

How can logistics costs be presented

Activity-based costing

A balanced measurement portfolio

Supply chain operations reference model

 A balanced measurement portfolio

Financial Financial

Past Future Past Future

Operation Operation

Traditional Balanced
A balanced measurement portfolio
 Content

Where does value come from

How can logistics costs be presented

Activity-based costing

A balanced measurement portfolio

Supply chain operations reference model

Supply chain operation reference model
Supply chain operation reference model