"The margin is high, so let's carry a lot of that product." "Our direct-store-delivery system seems to be operating efficiently." "Private label is boosting the bottom line."
These and other seemingly fair statements that failed to raise an eyebrow as recently as last year are now undergoing scrutiny as retailers and wholesalers adopt a new way to determine the real cost of doing business.
The strategy is activity-based costing, and manufacturers have used it as a decision-support tool for some time. In recent months, however, wholesalers and retailers are more aggressively venturing into ABC with pilot programs that essentially unbundle traditional costs to reveal some enlightening information.
Sometimes the revelations lead to a change in business processes, sometimes not. Regardless, ABC practitioners insist companies can't compete today if they make key decisions using yesterday's tools: a heavy dose of intuition and old costing models that may yield distorted views of their business.
By contrast, an ABC accounting system factors in the cost of all activities related to a business process, be it receiving operations, carrying a particular product on the shelf or working with a certain supplier.
Corey Davis, business process analyst responsible for ABC at Spartan Stores, Grand Rapids, Mich., said new partnerships are emerging as manufacturers and wholesalers share costing data previously held close to the vest.
"There's some real interesting information going back and forth now as far as how costs are constructed at the manufacturer level and at the distributor level," he told SN. Sharing of ABC data is allowing companies to make more sound decisions.
With comparative costing data, "we can ask, 'Does our supplier send their truck out here with the product or is it cheaper for me to send one of our trucks out to get it?" Davis said. "These are questions that are getting answered now. We now have an idea of what is involved in our costs from our manufacturer.
"More than anything, ABC means improved decision-making, less intuition, more hard facts," he added.
Sam Thurston, senior vice president of distribution at Giant Food, Landover, Md., agreed. "I think our industry can benefit from an objective measure of its costs and a very effective way of examining alternatives.
"In that respect, an accounting system that gets down to where the costs are can help make some effective decisions," said Thurston, who served on the Performance Measurement Operating Committee of the Joint Industry Project on Efficient Consumer Response.
More effective decisions and operational changes have resulted from recent and ongoing ABC pilots. Among them:
· DSD Done Better: Pay Less Supermarkets, Anderson, Ind., revamped direct-store-delivery operations after an ABC pilot identified an opportunity for better efficiency. Deliveries, previously made seven days a week during the busy 6 a.m. to 10 a.m. time frame, were changed to nighttime deliveries four days a week, cutting costs for both the vendor and retailer without affecting shelf presence or sales volume.
· You Delay, You Pay: An ABC pilot at Spartan Stores revealed that each minute the wholesaler's truck spends at a receiving dock costs 67 cents, and that cost was passed on to the retailer. As a result, retail customers invested in better equipment and procedures, cutting average receiving time in half.
"Essentially, we will charge our customers a certain amount per minute from the time our truck leaves the gate to the time they close the door of their back room," said Spartan's Davis.
"We said, 'If our truck is at your store for two and a half hours, it's going to cost you this much.' They said, 'If it's only here for an hour, it's going to cost me half that?' And we said, 'Yes.'
"Well now, all of a sudden that forklift makes a lot of sense, a new loading dock makes a lot more sense" as investments for retailers to increase receiving efficiency, he said. Average receiving time dipped from 2.5 hours to less than an hour during the test, saving money for both retailers and Spartan, whose capital spending on trucks decreased.
The need to cut costs and boost efficiency is at the heart of ABC projects in the industry today, according to Kevin Twomey, vice president and controller at Fleming Cos., Oklahoma City.
"What I see driving [ABC] is a need to improve profitability. If you have limited ability to raise prices, and that's certainly our case, then the only other alternative is to reduce costs. To reduce costs you have to understand processes and activities and what they are costing you and whether then can be improved or pared," he said.
As a group, wholesalers are further along with ABC programs, he said, although retailers' interest is growing.
Category management projects, in particular, are leading some retailers to get involved with ABC, according to Peter Eschenburg, senior manager of the Food and Consumer Products Consulting Group at KPMG Peat Marwick, Houston.
"Many retailers are struggling with category management. If their [cost] measurement systems are flawed, their management team may be making erroneous decisions for the whole category," he said.
As an example, he cited one West Coast retailer that carried an upscale, high-margin health and beauty care item whose costly special handling was not factored into the category management equation. The item was stored individually on warehouse shelves and stores were allowed to order the product piecemeal.
"That's what activity-based analysis would show: It would show what resources your organization is putting against this category. Those resources are all hidden if you just look at [gross margin] in the general ledger," he said.
Retailers are beginning to recognize the value of ABC as a decision-support tool, as evidenced by pilot programs launched by the likes of H-E-B Grocery Co., San Antonio; Wegmans Food Markets, Rochester, N.Y., and Fleming Cos., Oklahoma City. A sampling of other retailers closely examining ABC today include Vons Cos., Arcadia, Calif.; Dominick's Finer Foods, Northlake, Ill., and Albertson's, Boise, Idaho, industry observers told SN.
"We have two efforts going on right now in ABC," Alan Markert, vice president of finance at H-E-B, told SN. "We are looking at both our home, health and beauty department and grocery department as one effort and our perishables department as another."
Although he declined to elaborate on ABC pilot specifics, Markert did indicate the year-long program would be ongoing. "We still have a lot of work to do, so I don't have any comments on the results of our efforts yet," he added.
H-E-B and Wegmans' interest in ABC, along with their industry stature as leaders in category management, further amplifies the relationship between ABC and category management. A survey conducted by Ernst & Young LLP, New York, found that 75% of retailers pursuing ABC are linking their programs to category management projects.
"I think where it's going to make a big difference on the retail side is when you link ABC to category management," said Chuck Harrison, senior adviser for the food industry at Ernst & Young.
He said traditional category management approaches are based heavily upon gross margin, but ABC looks beyond that point. ABC addresses such questions as "What does it cost you to get a product ordered, delivered, put on a shelf in a particular category?" he said.
For example, "I think people are beginning to have their eyes opened a little bit as they look at the true profitability of private-label vs. branded merchandise," he said, careful not to make value judgments about the categories. More important, ABC may provide "an opportunity for the retailer to better understand his true cost of handling private label and quite possibly increase his retail price to cover more of his costs."
Although the gross margin indicates private label can be an important profit-driver, ABC incorporates other factors such as delivery, inventor storage costs, handling and in-store shelf stacking costs to arrive at the real cost of "landing" the product on the shelf.
"So, instead of selling the brand name at 99 cents and selling private label at 79 cents, after looking at real costs, the retailer may raise his [private label] price to 89 cents and still be the price leader in that category," Harrison said.
ABC programs will likely proliferate at all levels within the distribution chain, retailers and industry observers told SN.
"This robust cost allocation methodology can make everybody a little more aware and maybe a little more responsible in managing costs," said Fleming's Twomey. "But it must be done in a way where [individuals] feel like it's representative of how they are using that resource.
"Activity-based costing is right up that alley in terms of using drivers and allocating costs based on those drivers," he said.
KPMG Peat Marwick's Eschenburg said ABC's penetration throughout the industry can open doors to new types of relationships.
"When you do a partnership, for example between a manufacturer and a retailer, you could say, 'I do these activities and it costs me this much and you do these activities within our partnership' -- and that's where you can start trading off activities, saying, 'If you do this for me, I'll do this for you,' " he said.
