The cost of unrealized opportunities in supply chain management

No company can afford not to have the cost side under control. The financial accounting figures serve as the basis for this. In many cases, the figures for the company’s cost accounting are derived from these. A look at a company’s cost accounting shows numerous meticulously recorded cost types, which are allocated to the various cost units (e.g. products, services) via cost centers.

In search of the relevant costs

Are these all the costs? Are these the right costs? Are these the relevant costs that entrepreneurs and managers need to make optimal decisions for the future and across the relevant supply chain? What data do these “classic” costs even take into account? Or are these costs leading us into the abyss in the worst-case scenario? Many questions, many unanswered questions.

With the newtools of supply chain management (SCM ), you can not only identify the costs of unused opportunities, but also calculate them for your company’s future. However, these costs do not appear in any financial accounting or cost accounting. As a manager, this gives you 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’s try to illustrate this with a simple practical example:

Practical example: Textile trade

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

Based on these few data alone, the so-called newsvendor model (also known as the paperboy model ) can be used to calculate the quantity (number of units) that the retailer must pre-order in order to maximize its profit (added value) within the supply chain, provided that the planning data(forecasts) at the time of the decision are correct. In this specific case, it is 138 units. This quantity is the pre-order quantity at which the “visible” (classic inventory costs) and the “non-visible” SCM costs (understocking and overstocking costs) are minimized.

Understock also 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 classic cost accounting, however, you will search in vain for both. The most important costs – the relevant costs – are therefore not available for a management decision! In practice, numerous management decisions are therefore made on the basis of incorrect data.

The innovative tools of supply chain management, however, make the costs relevant to the entire supply chain transparent and available.

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

Further information on costs in the supply chain can be found under Complexity costs – additional costs in the supply chain

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