What Does an Appropriate Level of Service Cost?

Overview
The provision of availability will naturally incur costs for the supplier. One of the
major problems facing logistics management is that of accurately identifying the
total costs of the logistics activity. Many of the costs are either hidden or are
shared between different activities or cost centres thus making a proper allocation
extremely difficult. Nevertheless such problems must be overcome if the company
is to develop cost-effective customer service policies. Often management may not
be aware of the true costs of customer service strategy and thus be led to make
inappropriate decisions

What Costs Should be Included?

The Total Distribution Cost concept recognises that many more costs are incurred
through the provision of availability than just transport and warehouse costs
We could express the total distribution cost concept in the form of an equation:
TDC = TC + FC + CC + IC + HC + PC + MC
TDC = Total distribution costs
TC = Transport costs
FC = Facilities costs (depots, warehouses, etc.)
CC = Communications costs (order processing, invoicing, etc.)
IC = Inventory cost
HC = Materials handling costs
PC = Protective packing costs
MC = Distribution management costs.

Trade-off Analysis
One of the benefits of being able to identify the specific sources of total logistics
costs is that it becomes easier to identify potential cost "trade-offs". A trade-off
occurs where an increased cost in one area is more than matched by a cost
reduction in another area thus leading to an improved situation overall.
Generally, the effects of trade-offs are assessed in two ways: first from the point of
view of their impact on total system costs; and secondly from their impact on sales
revenue. It is possible to trade-off costs in such a way that total costs increase, yet
because of the better service now being offered, sales revenue increases. If the
difference between revenue and costs is greater than before, the trade-off may be
regarded as leading to an improvement in cost-effectiveness

Some Basic Features of Logistics Cost Analysis

Missions Orientation
There is a requirement in logistics costing to be concerned with the cost of flows.
The flows of a logistics system cut across traditional functional boundaries. Thus,
the costing systems must seek to determine the total systems cost of meeting
desired objectives (the "outputs" of the system) and the costs of various inputs
involved in meeting that output.

How Much Should We Spend on Customer Service?

The alternative approach, that of service maximisation, is based upon the notion of
a fixed budget with the consequent management task of maximising the service
offering within the budget constraint. It is not possible to lay down hard and fast
rules as to which of these two approaches is preferable. In those market situations
where customer service is very competitive, then the cost-minimisation approach
may well be the only viable strategy.

Customer Service Missions

The emphasis of the missions concept is on outputs — recognising that the purpose
of all business activity should be to create outputs rather than to use up inputs. This
recognition leads to a different concept of the business, not just in terms of seeing
its purpose as that of meeting a number of mission objectives, but also in terms of a
radically new approach to budgeting and to organisation.

Operational Approaches to Service Decisions

Customer service objectives must be established at two levels: the "macro" level,
reflecting the overall missions of the firm, and the "micro" level, dealing with
specific standards established for the various components of the logistics task.
The first is grouping customers. The strategy of "market segmentation" is well
established, the notion being that in most markets customers are heterogeneous;
they do not all share the same characteristics, neither do they have the same needs.
What we need is a costing analysis which helps us identify the different costs of
servicing different customers called Customer Account Profitability (CAP)
A customer profitability analysis helps an organisation evaluate the impact of its
prices, or terms of trade offered to the various customer groups, or individual
customers, on the relative profitability of these groups to the supplier. From that,
develop a basis for taking decisions on prices and the level, and mix of service
offered to each customer, or group of customers.