No company can afford not to have the cost side under control. The figures from financial accounting serve as the basis for this. In many cases, the figures for the companies’ cost accounting are derived from this. A look into the cost accounting of companies often shows numerous meticulously recorded cost types, which are distributed to the different cost units (e.g. products, services) via cost centers.

In search of the relevant costs

Are these all costs? Are these the right costs? Are these therelevant costs that entrepreneurs and managers need to make optimal decisions for the future and across the relevant supply chain? Which data are these “classic” costs actually taking into account? Or are these costs that lead us into ruin in the worst case? Many questions, many open answers.

With the new toolsof Supply Chain Management – SCM – you can not only name the costs of unused opportunities, but also calculate them for your business future. However, these costs do not appear in any financial accounting or cost accounting. This gives you as a manager a powerful tool that enables you to minimize all relevant costs of future activities and maximize your future profit (added value) within your supply chain. Let us try to illustrate this with a simple practical example:

Practical example: Textile trade

A textile retailer – with numerous stores – has to pre-order fashionable jackets of a certain size and color for the winter season. Repeat orders during the season are not planned due to the long lead and procurement times from overseas and the short season. All unsold jackets must be sold in the clearance sale at a very low special price. Based on many years of experience and corresponding industry knowledge, the textile retailer estimates the demand at 100 pieces with a possible uncertainty value (average fluctuation = standard deviation) of +/- 30 pieces. The selling price is negotiated at EUR 70 and the purchase price at EUR 25. At the end of the season, the retailer must sell the unsold quantity at EUR 20.

On the basis of these few data alone, the so-called newsvendor model (also known as the paperboy model) can be used to calculate what quantity (number of units) the retailer must order in advance in order to maximize his profit (added value) within the supply chain, provided the planning data (forecasts) are correct at the time of the decision. In this specific case, the value is 138 pieces. This quantity is the pre-order amount for which the “visible” (classic inventory costs) and the “non-visible” SCM costs (understock and overstock costs) are minimized.

Understocking creates costs

This simple example already shows that both cost components are necessary for the relevant cost minimization, namely the overstock costs and the understock costs. These two cost components are the risk costs of the inventory. In classical cost accounting, however, one will look for both in vain. The most important costs – the relevant costs – are therefore not available for a management decision! In practice, many management decisions are therefore made on the basis of incorrect data.

However, the innovative tools of supply chain management make precisely those costs, relevant to the entire supply chain, transparent and available.

The detailed calculation can be found in the separate article Newsvendor Model.

For more information on costs in the supply chain, see Complexity Costs – Additional Costs in the Supply Chain

Image rights © Rental Realities / License (CC BY 2.0)

Also available in Deutsch (German)