ACCOSTING COSTS

CHRIS O'LEARY

Imagine a wholesaler confronting one of its largest retail customers with concrete evidence that many of its business practices are simply unprofitable for both parties.

The wholesaler shows that its partner is ordering an abundance of less-than-truckload orders at high-activity times. That its receiving docks are a source of high labor costs

and inefficient storage. That its scarce electronic data interchange usage has cut the gains from its high sales volumes.

"It may be as simple as going to a customer and saying, 'I know you like to order every day, but you're killing me,' " said Chuck Harrison, senior adviser for the food industry at Ernst & Young, New York.

For a few supermarket distributors, this has become reality. Activity-based costing represents a whole new approach to price negotiations and profit, distributors and analysts said.

ABC initiatives, which unbundle costs from general operations and break them down as far as the individual stockkeeping unit, have as yet only taken hold in the largest, most technology-savvy distributors. But many more are drawing up blueprints.

Wholesalers have been the prime movers in ABC, analysts said, because as they enhance their basic functions with more Efficient Consumer Response services, the need to identify the exact cost of each link in the supply chain has become paramount.

"We need to determine the cost of every activity we perform," said Robert Boyd, executive vice president and chief financial officer at Oshawa Group, Etobicoke, Ontario.

Analysts said ABC usage in the supermarket industry most often evolves in three stages:

General Analysis: Distributors analyze their operations in broad areas like transportation or warehousing to determine the nature and extent of costs, and which measures can reduce them. It's the first step in using ABC.

Category Analysis: ABC is used to examine product categories and individual SKUs, allowing distributors to determine, for instance, whether a high-volume product is ultimately unprofitable due to inefficient distribution methods. Supervalu, Minneapolis; Fleming Cos., Oklahoma City; H.E. Butt Grocery Co., San Antonio, and Wegmans Food Markets, Rochester, N.Y., reportedly have reached this level.

Menu Pricing: This is perhaps the most sophisticated use of ABC to date in the supermarket industry. Once costs are unbundled, wholesalers can offer retailers basic service rates, with separate value-added features available to customers as if on a restaurant's a la carte menu. Fleming and Supervalu already offer such programs; this month, Spartan Stores, Grand Rapids, Mich., joins them.

Menu pricing represents a radical departure from traditional pricing structures. But once the basic concepts are explored, new pricing strategies become evident, wholesalers said.

For Fleming, ABC has provided some of the internal support for a broader menu pricing incentive called the Fleming Flexible Marketing Plan, available in dairy, frozens and dry grocery at more than 40% of its divisions.

"From an ABC perspective, FFMP provides incentives to retailers to change their behavior," said Shane Boyd, a spokesman for the wholesaler. He added that Fleming eventually plans to roll the program out to all its divisions.

"This puts everything on the table and allows retailers to see exactly how their ordering practices affect their charges," he said.

"If the retailer was ordering efficiently, they're going to see charges that represent that and reward them for that," Boyd said. "A retailer that was not quite as efficient will see that [reflected] as well."

ABC also provides the backbone for a broader based intracompany charge structure that encourages operational efficiencies at Fleming's product supply centers, said James Scribner, manager of analysis for the wholesaler.

"One purpose of the internal charges is to incentivize our business unit -- which is a major cost unit -- to reduce costs," he said.

One West Coast wholesaler that has been offering some menu pricing options said the initiative has created a greater sense of responsibility among its retail customers.

"It's been well accepted. Our retailers know more and more every day about where exactly their costs are, so they're willing to pick up their share of the expenses when they see they are the ones generating it," the West Coast wholesaler said.

"We have a lot of small customers and I'm sure we're losing money on some of them," said David Hayes, director of information services at Associated Grocers of New England, Manchester, N.H. "But we have no way of really knowing which ones.

"When we send that truck out, there might be 20 orders on the truck and on one of those we may be losing money," he added. "It's masked because they're all combined together."

By unbundling operational costs, companies can see more clearly which cost drivers represent the "low hanging fruit," or biggest opportunities for cost reduction.

Using ABC to make decisions in areas like warehouse operations is a great leap forward from using general spending histories.

"You may have activities like selection, loading and overhead," said Mark Czerwonka, manager of the activity cost group at Supervalu. "With ABC we are trying to identify all these different activities and trying to find out what the cost drivers are."

Although general analyses represent a majority of ABC programs occurring in the supermarket industry today, a small number of leading-edge distributors are taking ABC to greater levels in areas like category management.

This is where ABC is effective for retailers, analysts said. Giant Food, Landover, Md., has used ABC to analyze categories down to the individual SKU. Through its system, the retailer can take two similar-selling units in the same category and examine the revenue, acquisition cost, product gross margin and productivity cost of each.

According to a company source, ABC has disproven its belief that product cost was the major factor in determining item profitability. Giant Food now uses ABC to determine SKU profitability and help category managers improve distribution efficiencies.

Wholesalers also can enhance their category analyses through ABC. In a recently analysis of its general financial ledger, Spartan used ABC to break down its category costs to better understand order replenishment, selection and receiving time.

"We went down to the family classes," Ferguson said. "Through our business processes we could tell what each one of the categories was costing us."

In future programs, Spartan hopes to gain more in-depth analysis. "We may look at why put-away costs us X amount per cube in grocery vs. X amount per cube in perishables and do some re-engineering there," he added.