SCM Costing

The costs associated with supply chain management is a complex question and one that is still quite fundamental to the profitability of any business in the supply chain remit. When defining costs associated with any service or business the first action should be to define what exactly you are going to pay for. This seems like a basic question but it is often overlooked as the awareness of how integrated a part or the supply chain is within a business is often misunderstood. As an example if one is looking at the costs for warehousing then this is based on different factors to someone looking at the costs of shipping. another factor is how long the goods are stored (static or dynamic) within the supply chain. Hence the costs are based on what elements of the supply chain are being used to move goods from point A to point B. As always the definition of the supply chain that is being used will drive the rationale behind the need to pay for these elements of the supply chain and the management thereof.

The primary objective of SCM is to fulfill customer demands through the most efficient use of resources, including distribution capacity, inventory, and labor. In theory, a supply chain seeks to match demand with supply and do so with the minimal inventory. Various aspects of optimizing the supply chain include liaising with suppliers to eliminate bottlenecks; sourcing strategically to strike a balance between lowest material cost and transportation, implementing just-in-time techniques to optimize manufacturing flow; maintaining the right mix and location of factories and warehouses to serve customer markets; and using location allocation, vehicle routing analysis, dynamic programming, and traditional logistics optimization to maximize the efficiency of distribution. The term “logistics” applies to activities within one company or organization involving product distribution, whereas “supply chain” additionally encompasses manufacturing and procurement, and therefore has a much broader focus as it involves multiple enterprises (including suppliers, manufacturers, and retailers) working together to meet a customer need for a product or service. Starting in the 1990s, several companies chose to outsource the logistics aspect of supply chain management by partnering with a third-party logistics provider (3PL). Companies also outsource production to contract manufacturers.

Total Cost Concept

In the era of control regime, the task of purchasing and selling was relatively easy – competition was less and the market was assured. But suddenly all that changed – the markets opened and competition increased; selling is now possible only if prices are reduced and quality improved – in other words, the customer wants more and more per unit cost.

To minimise the total production costs, it is recognised that one way is to tighten operations; another time tested method is to reduce cost of inputs. While it would be desirable that our suppliers reduce the cost of their supplies to us, the importance of building a relationship with the supplier has been recognised.

Establishing a long term relationship is possible only when the supplier and purchaser jointly decide to reduce the life cycle cost of an item by proper procurement, in such a way that it would lead to a win-win situation to both the parties – in other words, suppliers become “Partners in Progress”.

Purchaser cannot squeeze the supplier endlessly; sourcing the right item from the right vendors, getting it to the purchaser’s premises in the right way at the right price and at the right time can alone optimise costs for the purchaser. This is possible only if there is mutual trust, which builds up in long term relationships.

The purchase bill can be lowered if the total life cycle cost is optimum. In other words, the Total Cost of Acquistion and Ownership of the item must be optimum. The major costs involved as we trace the path of a product from it’s raw material stage till it is consumed in our process would look like this –

Wastage, spillage, pilferage1
Inventory carrying cost3
Handling and storage cost1
Inspection & testing cost2
Transportation & freight costs3
Packing & forwarding costs3
Duties & taxes4
Margins of supplier15
Labour & other overheads16
Manufacturing cost12
Raw Materials cost40

Total Cost of Acquisition = Rs. 100/-

Landed Cost = Rs. 95/-

Ex-Works Price = Rs. 83/-

The example given above is only an illustration. It shows that 83% of the total cost of an item is controlled by the supplier; 12% is logistics and 5% is internally controlled costs.

Each of these costs represent an opportunity for reduction. The basic price of the supplier cannot be reduced. The margins can be played upon. The opportunity for reduction therefore lies in the supply chain – packing, forwarding, transportation, wastages, handling, storing, etc. Efficient supply chain management helps in reducing the Total Cost of Acquisition (TCA) of an item.

It is important to know the right supply chain for an item – this is possible only through the study of the Total Cost of Acquisition. The TCA concept, which has begun to be followed by some progressive organisations around the world, looks at the following four major levers –


  • Are we using the correct specs?
  • Can we rationalise the variants/sub variants?


  • Are we buying the product the most optimal way?
  • Number of suppliers
  • Import/domestic or a combination of both
  • Commercial terms


  • Are we getting the product to our premises the right way?
  • Mode of packing and transportation
  • Handling losses
  • Stages of inspection
  • Inventory Management


  • Are we using the product the right way?
  • Operating parameters
  • Work practices
  • Wastage/recycling

In specifications, requirements should be minutely looked into – whether tailor made or general, number of variants and whether they can be clubbed, lot formation, etc. The organisation needs to relook into it’s own requirement in the changing times to be able to identify alternatives. One example would be the use of zinc for galvanising of steel. Traditionally, high grade zinc with purity of 99.5% has been used by the steel plants. Lately, it has been established that prime western zinc with purity of 98.5% is technically a better substitute, for galvanising of steel and also costs lesser by at least Rs.5OOO/Ton. To identify alternate specifications, periodic diagnostic studies need to be conducted to arrive at the best specifications for any item.

We need to identify and consolidate supplier base and decide on the best and most effective commercial terms with them. One should try to understand the supplier cost structure – his limitations, economics, overheads and margins, his competitors and industry benchmarks, to be able to identify the cost reduction opportunities. A supplier workshop could elicit a wealth of information. An effective negotiation strategy based on this information would help to reach the best price.

Logistics call for an understanding of the total supply chain, the elements of which include inventories, packing, forwarding, freight, storage and handling. The study of logistics is especially important for bulk raw materials, where substantial outflow of freight is involved. Management of logistics is an art which is extremely difficult to perfect – in India, JIT ends up being SHIT -Somehow in Time.

The study of logistics is important to establish a lean supply chain which would give the advantage of quick product changeover capability, excellent short and long term forecast visibility and JIT capability.

While studying the usage, one should look into their own operations and practices – the way the item is charged or fed, losses during charging, is recycling possible, ideas to reduce wastages, pilferage, etc. For example in a steel plant, reversing a conveyor belt whose bottom rubber layer has worn out, and using it postpones it’s replacement for some time. A belt which has worn out on the sides can be trimmed and used on a different location where lower widths are required.

Numerous instances are available on how little ideas can lead to good savings. In India most of the ISO certified companies have been exempted from pre-dispatch inspection. Creating a list of approved vendors, entering into profit sharing arrangements with selected vendors, assisting them in their expansion and diversification are only some ways in which companies ensure supplier loyalty. Supply chain management has become important like never before, with the revolution in Information Technology and breakdown of geographical barriers. A combination of meticulous analysis, sensible strategy and effective implementation can enable a company to manage its profitability.

Cost Analysis
What are Logistics Costs

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