|
|
 |
|
|
|
|
|
|
A Center's Profitability Can Be As Easy As A-B-C
By David N. Deinzer
President & CEO, Denman & Davis
Wouldn't it be great if you knew exactly how much it cost your business to do business? If you knew the cost of every activity involved in filling an order? Or knew why certain accounts just aren't profitable? Some of these questions are ongoing mysteries to many steel service centers. But if the centers adopted Activity-Based Costing (ABC), these mysteries would be solved.
Activity-Based Costing is a valuable accounting tool that gives management a clearer picture of what is generating a company's profitability and losses. It provides the ability to track operating profits for specific "cost objects" (customers, orders, products). Not only can ABC increase your center's bottom line, it can identify areas where you're efficient — as well as where you're weak. The system can also identify which customers and product lines make money for you — and which don't.
In most cases, the use of Activity-Based Costing will greatly help improve your bottom line. My company, Denman & Davis, has been using ABC for 2 years and as a result, we've been able to greatly enhance our operating profits.
Activity-Based Costing is a proven strategy to obtain or increase profitability, but surprisingly, probably less than 10% of steel distribution centers currently use it. The majority still cling to the time worn "sales, less cost of goods sold equals gross margin" method. This method does not account for the myriad activities that go into processing and delivering an order, which consume time and tie up money. By relying on the traditional method, steel service centers have no real way to systemically measure the source of their profits or losses. Those companies are often making poor decisions that reinforce poor performance. And in today's highly-competitive industry, no one can afford to do that.
The traditional method was perfectly fine during the early stages of our industry. Then, steel service centers acted as a wholesale distributors. We bought in large quantities and then sold small quantities and didn't do much processing. Business was simple.
As the industry became more sophisticated, customers began requiring more value-added services. Just In Time delivery started adding activities as well. All those activities drove up cost, and our industry never captured those costs very well. We forgot that to deliver JIT to customers you may have to deliver more often and in smaller quantities, process it into pieces or perform numerous other actions to satisfy the order, all adding to your total operating cost. Gradually those costs started to build and grow and nobody accounted for them by customer.
Today's reality is that there are far too many things we do as service centers that add cost to the operation and to our accounts and these must be measured. Activity-Based Costing can do this as an ongoing process and help boost your profit.
By using a computer software program and inputting data arrived at by your own management, the ABC system literally applies a cost to every single activity involved in supplying steel to accounts from the time your representative picks up the phone until after the customer's order is delivered and paid for. Major activities include:
• Quoting customers
• Filling orders
• Materials
• Value added processing
• Delivery
• Billing orders & collections
• Overhead costs
• Obtaining mill certifications
With the exception of materials, the biggest cost drivers are delivery costs and order processing. However, each activity must be taken into account in order to calculate the overall cost of an order. Yet management at most steel centers still doesn't think about these activities in terms of total cost. The result? Lost profit.
Some customers incur more costs than others, and ABC can help you determine which of them are "good" (or profitable) customers or not. Basically, a good account buys your products in large quantities with limited deliveries and knows what they want and when they want it. They pay their bills on time. An unprofitable account pays late, orders frequently in small quantities and contains "activity traps" — a great deal of things that go into filling their orders. Unfortunately, the marketplace and the lack of good cost information prevents you from charging what you really should for their orders. And since these customers have been getting extra services from you for years, they expect them as part of the normal price and service they receive — and your business takes the loss for doing so.
Surprisingly, you may not even realize certain accounts are losing money if you go by the traditional gross profit accounting method. But because ABC measures total cost by activity, an account that has always been viewed as profitable may instead be revealed as just the opposite.
So how do you determine which accounts are moneymakers vs. money drainers? And, for that matter, how do you identify your company's strengths or weaknesses? Denman & Davis elected to hire an ABC consultant to help us find out.
The entire process from selection to program implementation took six months. We interviewed several consulting firms and asked many questions to determine their understanding of our business. We also scrutinized their accomplishments for other clients. Ultimately, the company we engaged had its own software package and also had a strong background in distribution. Equally important, its representatives got on well with our managers.
There are many good consultants and software programs on the market; just be sure in selecting one that you carefully evaluate each and prioritize qualities that are important to you. Cost can vary widely, but you can likely find one for your particular budget and needs.
If you don't wish to go the consultant route, the Steel Service Center Institute (SSCI) is in the initial stages of developing software models, or templates, for value added processing that service centers can adopt. When completed, you'll be able to apply your company's specific data to measure specific processing activity costs. Find out more by calling the SSCI. It will be a great start toward improved profitability.
The internal demands of implementing an ABC system are not burdensome, considering that your steel center could double or triple its profitability, often in less than a year (and, recapture your initial investment). Ideally, a center's chief financial officer or chief operating officer can spearhead the team effort required for program implementation. At the start of our effort, Denman & Davis organized a core team comprised of managers from each area of the company. We also assembled individual teams from each department that would report to the core team. In the end, every area was represented and had input when we gathered information and decided how to allocate costs to the software program.
It should be noted that the ABC development/implementation process does not negatively impact on employees' normal workday schedules. Our core team met once a month for a full day. Individual department teams met once every week, for about two hours. When all our data was assembled and plugged into the software program, we obtained our statistics and were able to benchmark against our previous year's performance. Now, our models are automatically fed by our mainframe computer and are updated quarterly.
We measure our customers based on our costs, but we can also measure them against the industry, which is called "Activity Based Management." Industry statistics are released yearly by SSCI. And, on a quarterly basis for members, SSCI publishes a performance analysis report (PAR). The PAR contains data contributed by some two-thirds or more of its members, so you can take those findings and use your own ABC data to benchmark your steel service center against the competition. From there, determine what you need to do to enhance productivity and increase profitability.
For example, if your data shows that it costs $75 per delivery stop and the industry standard is $55, then you need to reassess your ABC data to learn why it cost you $20 more per stop than the competition. It may be the type of customers you deal with, or it may be that you deliver in a heavily-trafficked metropolitan area where the trucks are out longer and incur higher cost. It could be many things, but you must decide what you can do to make your company meet or beat the industry standard. For example, can you schedule deliveries better geographically? Get the customer to consolidate more shipments for fewer deliveries?
Sometimes, the ABC system shows you that the problem isn't coming from your company at all, but instead emanates from a "bad" account. In that case you must either work to make that customer profitable (change the customer's buying habits, raise the price or both) or decide to sever the relationship and let his activity trap paralyze your competition.
In our experience, certain accounts we'd always viewed as profitable under the traditional system of gross profit were not under the auspices of ABC. In analyzing those accounts, we discovered that each of them ordered numerous items in small quantities and required a great deal of value-added services with frequent deliveries that caused us to lose money. Simply put, we just weren't charging enough to cover our costs, even though their gross profit margin far exceeded industry norms. We ultimately met with each customer, walked them through the process of their individual ABC and renegotiated the way we do business with them, so it was a "win-win" situation. Most of these accounts are now profitable, and just as important, the customers are happy because we have also reduced their costs.
We also use ABC to review the profitability of our product lines. Based on the results of the data, we are able to evaluate whether we wish to continue carrying certain products or eliminate them from our inventory.
ABC has proven to be a valuable tool for my company. Granted, it isn't for every steel distribution center; there are still a few wholesaler distributors and niche specialists that only buy and sell and do very little value added work. Because there's no processing involved, they probably don't require ABC. But for the rest of us, it is definitely worth the commitment. And, the more centers that implement this system, the better for all of us. The smarter our competitors, the better off the entire industry.
David N. Deinzer is President and Chief Executive Officer of Denman & Davis, a steel service center headquartered in Clifton, N.J. He graduated from Lehigh University and is a member of the Board of Directors and a past president of the Steel Service Center Institute. He is also a member of the Associates Committee of the American Iron & Steel Institute.
|
|
|
|
|
|
|
|
|
|
|
