In a business where profits routinely appear as fractions of single digit percentages, the details behind costs take on significance that tips the balance between successful operation and failure. In the wholesale grocery industry, the cost of serving individual customers often overshadows the simple-looking task of setting prices.
A cost allocation program recently adopted by Supervalu is designed to allow the supermarket operator and wholesale grocer to determine the cost of serving each customer so that the company can price its services correctly. The program functions by assigning an accurate cost to every aspect of the business.
Supervalu, based in Eden Prairie, Minnesota, is the largest wholesale grocer in the nation and is one of the largest retail supermarket operators. Founded in Minneapolis in 1870 as B S Bull, Newell & Harrison Company, today it operates 28 full-line distribution centers and 11 limited-line centers. As a wholesale grocer, Supervalu serves as the primary supplier to more than 3,500 customers in 48 states. It is a secondary supplier to an additional 1,300 customers. In its retail supermarket role, Supervalu operates 472 stores. In addition, Supervalu owns and operates 163 limited inventory Save-A-Lot stores and supplies 644 more operated under license by franchise holders. Save-A-Lot operates in 33 states. Supervalu has 60,000 full- and part-time employees.
$23 Billion in Sales For the fiscal year ended early in 1999, Supervalu had sales of $17.4 billion. The acquisition of Richfood Holdings in 1999 will boost revenue to more than $23 billion for the fiscal year soon to end.
Supervalu spent several years developing the program it now calls "the cost to serve system." This development was in response to seeing a need for a better way to track costs, says Gregory C Heying, senior vice-president-distribution for Supervalu. It is an activity-based costing system that is proprietary to the company. While the program was developed only for the internal use of Supervalu, the principles behind it should transfer fairly readily to other companies, he says.
Any accounting system must capture and allocate costs consistently if it is to provide a useful model for planning. In a multi-location company such as Supervalu, it must gather the same data in the same way for each location. Decisions based on inconsistent data gathering won't produce consistent results. The primary use of cost-to-serve within the company is to determine the potential for profit from each customer. Analysis of cost data can be used to improve operations and generate more profit while maintaining a high level of customer service.
Cost per Customer "We need a cost analysis system that allows us to measure and report income compared to the cost to serve individual customers," Heying says. "Instead of applying cost information to a broad range of activity, cost-to-serve assigns specific costs to specific activities. If the information is consistent throughout the company, it can be used to make decisions for operational improvement."
For the system to work properly, it needs to capture all components of cost for serving individual retailers. The purpose of digging out the cost details is to understand exactly what Supervalu derives from each customer. The second necessity in understanding profitability is a complete picture of all distribution center costs. In the cost-to-serve model, portions of warehouse cost are assigned to each customer. Different operators may assign costs differently than Supervalu does, but making consistent decisions about costs is essential to understanding the potential for profitability, Heying says.
Assigning costs to retailers is part science and part art. The Supervalu cost information system allocates costs to retailers based on operational specifics. In general, these are variable costs that change with each customer. Fixed and nonspecific costs are assigned to each store based on an internal model. When costs are appropriately assigned, the company can calculate profitability for every delivery.
"Not all retailers are created equal when it comes to profitability," Heying says. "We want to understand which customers provide the best results."
Distribution Center Costs Distribution center costs break down into three broad categories in the Supervalu cost-to-serve system-warehouse expense, building expense, and trucking expense. Although some food distributors might use the words interchangeably, warehouse expense and building expense are separate at Supervalu. Warehouse is an operational category that takes in receiving, order selection, trailer loading, and general overhead required to run the distribution center. Building expense involves rent, utilities, depreciation, and building maintenance.
An accurate information system also assigns value to SGA (selling, general, and administrative) costs. This somewhat flexible basket of expenses includes category management, merchandising, procurement, selling, and general and administrative overhead. Of these expenses, most are self-explanatory except category management. In the wholesale grocery business, this refers to a category of products such as meat, dairy, or produce.
Supervalu defines its warehouse expenses very narrowly. For instance, receiving is the process of bringing merchandise in the door, putting it into storage, and dropping it from storage to the order selection slot, Heying says. Selection costs do not become a factor until a carton is moved from the picking slot. Loading is the movement of product from the dock into a trailer. Carefully calculated overhead is applied to account for labor that does not actually touch the product as a part of the job but is still required for running the warehouse.
Define Receiving Costs Accounting for receiving at Supervalu attempts to define all the labor costs involved in moving product into a distribution center. Every time a carton is touched, the labor and benefit cost needs to be added to the model. The basic unit for this accounting is cost-per-pallet for getting product through the door, into storage, and into a picking slot. Carefully captured data allows the company to look at cost-per-case.
The cost model allocates cost-per-pallet for receiving a given quantity of a specific item ordered by an individual store. However, not all pallets are equal, Heying says. The cost of receiving can vary from item to item as a function of the number of cartons on a pallet at the time it comes in the door. Cost-per-case comes from dividing the cost-per-pallet by the number of cartons on a pallet.
Some cost factors become immediately obvious, Heying says. For instance, fast-selling items are much more likely to be received in full pallet quantities, so the receiving cost-per-case is lower. However, slow-selling products are usually received as one or two tiers on a pallet instead of full pallet quantities which drives up the receiving cost per case. As long as all freight is received on pallets, the cost-per-pallet remains relatively stable. It is the cost-per-case that varies, he says.
Costs Determine Inventory Data from receiving costs helps Supervalu decide whether or not to carry certain items. If the decision is made to keep a costly item in inventory, buying practices may be changed to lower the receiving cost. It becomes a decision between buying a full pallet as opposed to a couple of layers of product compared to the cost of keeping the extra product in inventory, Heying says. The data also helps evaluate receiving productivity. The company is constantly looking for ways to change receiving procedures to make the warehouse more efficient.
One quick way to get a handle on receiving costs is to use $5 per pallet as an example, Heying says. In this scenario, a full pallet of 60 cartons costs eight cents per case to receive. Half a pallet-30 cases-costs 17 cents per case while a single layer of 15 cases drives receiving costs up to 33 cents per case.
Selection costs are treated the same way as receiving by the cost-to-serve model. The goal is to capture all the labor associated with assembling a store order and getting it ready to load. The key to selection cost is the cost per order. Most food distribution businesses operate with engineered labor standards. These standards provide a method for measuring the set up time needed for each order, the travel time from aisle to aisle during selection, the time needed to select a given number of cases, and the time required to move between selection slots.
Selection Costs by Store At Supervalu, warehouse costs are allocated to individual stores. Selection costs are assigned to stores based on the actual order on a given day. These costs are calculated on the standard time for selection as defined by the company's engineered labor standards, Heying says. The cost per case results from dividing the selection cost by the number of cases in a particular order. Because it is a daily calculation based on actual sales, the selection cost per customer varies from order to order, he says.
Big orders for large customers cost less per case to select than small orders, Heying says. Part of this is based on the set up, which is the same regardless of order size. Setting up involves going to the order desk for paperwork and getting a pallet in position on the pallet jack. Dividing the set up time by a greater number of pallets obviously reduces the per-case cost. The same logic applies to travel time through the warehouse. If an order selector has to walk the entire warehouse to pick an order, the walking time per case will be less for a large order than for a small one. Order density also plays a part in cost calculations. The greater the case density per order-for instance, four cases in an order instead of one case-the lower the selection cost per case becomes.
Supervalu uses its cost-to-serve data to evaluate the selection cost for each customer. For instance, the data may show that customers carry a greater variety of products than they really should, Heying says. This is a category management tool. "We can help our customers understand exactly what the variety of products they carry in their stores costs," he says. "We can help them make rational decisions about the costs and benefits of offering a wide variety to consumers."
Variety Increases Costs Some Supervalu customers are noted for a wide variety in their stores. They make a conscious choice to pay the increased costs so that they can offer the widest possible variety to consumers. Other customers have used the cost data to remove excess inventory from their stores. Either decision is justifiable as long as it is made from reliable data, Heying says.
The cost-to-serve data also helps evaluate delivery frequency. A customer that wants several small deliveries a week incurs unnecessary costs from the warehouse as well as added transportation costs, Heying says. Helping customers reduce delivery frequency and increase order size helps them reduce costs and should help improve profitability.
In addition, the cost-to-serve data can be used to improve Supervalu operations. By using the data to compare distribution centers within the company, Supervalu can work to build productivity throughout its system. For instance, better warehouse slotting helps reduce costs. Another method for reducing costs is to remove as much warehouse travel time as possible, Heying says.
Assigning Loading Costs The same logic applies to trailer loading, Heying says. The basic accounting unit is a pallet. The cost for picking up a pallet and positioning it in a trailer is the same whether the pallet is stacked three feet high or five feet high. The more cases per pallet, the lower the loading cost per pallet becomes. This data is store specific at Supervalu. The loading cost per customer is calculated by multiplying the number of pallets loaded for each customer by the average loading cost per pallet. The immediate conclusion to be drawn from this data is that full pallets cost less per case to load and that large orders are more economical than small orders.
Supervalu uses loading cost data the same way it uses selection cost data. The company works with customers to reduce loading costs, especially by encouraging customers to reduce costs by increasing order size to increase the number of cases per pallet loaded.
Measuring Warehouse Overhead In addition to the variable costs of operational labor, Supervalu measures warehouse overhead. This includes the cost of supervision and administration right down to the telephones and postage, Heying says. Warehouse overhead also accounts for the materials handling equipment and for the racks. These costs are allocated to specific stores based on the number of cases of specific items sold. This is a proportionate allocation, because no good method exists to assign warehouse overhead costs to customers based on their behavior. "Some customers require more attention than others, but the method for allocating the overhead cost needed to serve those customers would be difficult and arbitrary at best," he says.
Cost-to-serve allocates building expense carefully. Supervalu captures depreciation, rent, taxes, utilities, and building maintenance. "This model is tied to our profit-and-loss statement to the penny," Heying says. "All the costs of doing business in the wholesale environment are included in the calculation. If a company takes the time and effort to put a financial model in place, it needs to make sure that every cost has a place. Leaving things out results in a distorted view of business."
Calculating building expenses is a matter of understanding how much the space in a warehouse costs, says Mark Ortenburger, general director of distribution at Supervalu. This includes depreciation of the distribution center, rent, utilities, taxes, and maintenance plus the cost of any outside storage buildings. These costs are applied specifically to the items stored in the building for allocation to individual stores. The key to these is the facility cost per day for each cube of product stored and the number of days the product is stored.
In a sense, calculating these costs is a matter of rent-how much does each product in the building pay for the space it occupies and the time it is in that space, Ortenburger says. Sales velocity and product cube are important factors in determining these costs. A fast-selling item costs less than one that sits in the racks for several weeks. Large items-a carton of paper products, for example-cost more to store than small cartons. An understanding of these costs can help a wholesaler decide whether or not to carry certain items, he says.
Determining Trucking Costs Trucking expense at Supervalu includes driver wages, equipment costs, and the other costs of operating the delivery fleet. Depreciation, leases, licenses, and insurance are part of the equipment cost. Fuel, tires, maintenance, and repairs are defined as operating cost. In addition, an accounting for trucking costs must capture the cost of supervision and clerical services. At Supervalu, dispatch is considered a trucking cost, but routing has been moved to warehouse costs, Ortenburger says.
The key to controlling trucking expense is a firm handle on the cost per trip, Ortenburger says. Supervalu uses actual cost data in this process. At some locations, the company captures data manually. Other distribution centers gather trip data from recorders on the delivery equipment. Trucking costs are allocated to customers based on actual deliveries to stores.
Distance traveled is the basic building block for trucking expense. It determines almost everything in the equation including driver wages and benefits, equipment utilization, and operating costs such as fuel, tires, and maintenance and repair expenses. The farther a store is from the warehouse, the more it costs to deliver a case of merchandise, Ortenburger says. Once distance has been established, the amount of product in a delivery becomes a factor. A full truck costs roughly the same to deliver as half a truck. The driving time is the same and the operating costs are almost the same, he says. A small load might use less fuel and cause less tire wear, but that's about all the difference.
Unloading Time Impacts Costs The time spent unloading at a store is a large variable in trucking costs. Turning the driver quickly gets equipment back to the distribution center for another load, Ortenburger says. Simply by receiving larger orders and by getting orders unloaded quickly, stores can significantly reduce the delivery cost per case.
Supervalu uses data from this part of the cost-to-serve model to help customers improve their operations. If customers can order in large quantities delivered infrequently and if they can unload quickly, they can have an important impact on costs. In addition, Supervalu uses this cost data to evaluate driver performance. Such an evaluation helps keep customers from paying for driver inefficiency. As a result, the company monitors driving time and the time spent checking-in and checking-out at the distribution center as well as the time spent unloading at stores.
This data also allows the company to analyze equipment utilization to smooth out work flow. In some instances, distribution centers can reduce their fleet size by changing delivery days to some customers. If the fleet is used constantly instead of in fits and starts, a smaller fleet is usually possible, Ortenburger says.
Stores Control Distributor Costs Stores are the key to controlling warehouse and trucking expense at Supervalu, Ortenburger says. Order size and delivery frequency determine costs more than any other factors. Large orders cost less than small orders, and full truckloads cost less than partial loads.
In addition to the operational costs, Supervalu accounts for its selling, general, and administrative costs by customer. This involves assigning a portion of executive compensation, merchandising, promotion, human resources, data processing, accounting, and finance costs to customers, Ortenburger says. These costs are affected by the number of customers the company serves, the size of the customers in terms of total sales or in terms of cases delivered, and the specialized services for each customer.
Not every company can use the Supervalu cost-to-serve model, but nearly every company can use the principles behind the model, Ortenburger says. The important thing is to allocate all costs; don't leave anything out. At Supervalu, some costs are allocated on the basis of fixed dollars per customer. Others are assigned to customers in terms of cases purchased or dollar volume. In addition, some costs can be allocated in terms of the specialized services required by customers.
The important thing about the cost-to-serve model is the structure it provides for monitoring costs, Ortenburger says. It can manage costs by function and by customer to help improve productivity within the company and to help retail customers change their behavior for increased efficiency.