What have the Customers done for us ? (with apologies to Monty Python)

What have the Customers done for us?

Xerxes: Sales.
Reg: Oh yeah, yeah they gave us that. Yeah. That’s true.
Masked Activist: And the money!
Stan: Oh yes… Regular orders, Reg, you remember what the inventory control used to be like.
Reg: All right, I’ll grant you that the Sales and the Money are two things that the Customers have provided…
Matthias: And the secure employment…
Reg: (sharply) Well yes obviously the Employment… the Employment goes without saying. But apart from the Sales,Money, the Inventory Control and the Employment…
Another Masked Activist: Profit Margins!…
Other Masked Voices: Cost Structures…. Stakeholder Value…. Training….
Reg: Yes… all right, fair enough…
Activist Near Front: And the free Wine/Hamper at Christmas!
Omnes: Oh yes! True!
Francis: Yeah. That’s something we’d really miss if the Customers left, Reg.
Masked Activist at Back: Improvements to our IT systems too!
Stan: And it’s safe to walk in the warehouse now
Francis: Yes, they certainly know how to keep us in order… (general nodding) let’s face it, they’re the only ones who could in a place like this.
(more general murmurs of agreement)
Reg: All right… all right… but apart from Sales and Money and Inventory Control and Employment, free hampers at Christmas and better Cost Control, Profit Margins, Stakeholder Value Improvements, enhanced our Training, IT systems and Warehouse Management… what have the Customers done for us?
Xerxes: Brought peace!
Reg: (very angry, he’s not having a good meeting at all) What!? Oh… (scornfully) Peace, yes… shut up!

So with due deference paid to the Customers, how is it that Companies today take one of the key business drivers for granted. The purpose of this article is to explore the impact of Good Customer Relationships and the impact on the Firms supply Chain Management Structures with particular reference to the Cost based approached beloved of Accountants.

Lets start at the end of the Cycle and Managing Cash, most Companies now have employed experienced Credit teams or Controllers, indeed in current climes, they are worth their weight in Gold, they know how to chase credit down and reduce the impact of the credit crunch.

It is self evident that the Sales Generators and Administrators understand the need for correct paperwork, invoices are final and not a negotiable instrument.

Sales personnel now know the necessity to deal direct with the cheque signatory or decision maker in order to speed up the cash flow.

Debt management nowadays is much more based on individual strategies than common policies.

Blanket ‘on stop’ Policies will not work where competition is rife and there are plenty of substitutes to take your place.

This kind of situation , knowing that payments will be delayed ( because this is the behaviour of that customer) requires careful consideration ( and pricing) before the order is taken.

More successful Companies are stratifying their Sales ledgers and taking a Holistic view, managing the Customer Base with one eye on Stock levels and Supply Chain Management.

Managing the Debt Book is crucial to the supply chain as raising cash from sound Debt can mean that further down the supply chain, discounts may be obtained for early payments, anything near a prompt payment discount of 5% will probably offset the cost of working Capital.

The trouble is most traditional information systems don’t have the ability to properly assess the true value/cost of the Customer to the Business.

How much do Customers Cost the business?

Many Accounting systems provide post hoc measurement, and indeed are functionally based and not transactionally based.

A typically traditional accounting system will show departmental (functional) cost overhead allocation so Sales/Marketing/Research/Human Resource/Warehousing/Admin will all have their costs allocated on some arbitrary basis; headcount, square footage, throughput.

These tried and tested methods use a cost based approach to departmental activities, they do not capture data derived from Customer based activites.

So a different approach is required to answer the question of just how profitable the Customer is.

The (relatively) easy part of the equation is examining the Direct Costs, at the Gross Margin level it is reasonably easy to attribute direct costs of product in terms of raw material, processing costs and stock holding costs, these are typically within the realm of the Management Accountant and using considerable expertise in activity based costing, these direct costs can be attributable to the product shipped to the Customer. What is not readily available is the associated costs with administering the order.

Management Accounting will typically attempt to allocate overheads based on predicted volumes produced/ sold , and the more sophisticated accounting systems could allocate all possible overheads into this direct category.

At it’s extreme point this means that there will be no fixed/ indirect costs whatsoever in the costing system, and all costs are absorbed into the product, so by allocating costs to products and hence customers, this extreme accounting would give some measure of customer worth.

The problem with this approach is the dichotomy between the Management/predictive volume driven/cost allocation model with the measurement of actual costs and the more Financial Accounting methods which produce the periodic Profit and loss Accounts. The gap therefore between Financial and Management Accounts becomes much wider. What is required is a shift of thinking, just how much cost is absorbed by this customer in servicing it’s demands/ behaviour?

This new paradigm means that there needs to be an even greater degree of thinking behind traditional cost accounting methods. Firstly Pricing, as stated earlier, there are accounting models that can be utilised to allocate direct costs, what any business will say is that to compete, they must also provide a level of service that meets the customers needs.

These can typically be written into Service level agreements in terms of Deliveries in full, on time, minimum, credit notes and other non financial service elements, the challenge is to cost out these Service levels and then make decisions on pricing, or alternatively additional charges where agreed service levels have been compromised as a result of Customer behaviour (e.g. not being able to accept predetermined deliveries)

Secondly, this differentiation in Customer Service is seen as a growing part of the transactional relationship with the Customer, yet we have not developed accounting systems to monitor the effectiveness of this approach. Competitive advantage will accrue to that Company that blends the Quality/Service/Cost and Time mix into a Value that the customer perceives as relevant to their needs.

We stated earlier that a block Policy with Debtors may not work, indeed the customisation of Sales is another thought shift and so therefore the capture of data relating to the Customer relationship is paramount to the firms success. There have been several pieces of research on Customer Lifetime value, all using an NPV approach, and this approach whilst laudable still suffers from the predictive problems which are at the heart of Management accounting. i.e fairly subjective views on future volumes and certainly subjective assessments of risk in adjusting the relevant discount rates.

The principle behind all this is that Companies should develop Customer Strategies to maintain and Strengthen Loyalty, but at what cost?

We again are faced with a dichotomy, in the smaller business , instinctively the CEO will have his ear to the ground, there will be regular meetings no doubt with the sales/marketeer and credit staff and the discussions will gravitate around those customers that’ mess us about’ i.e change orders at last minutes, delay payments etc, the costs of this are unknown, although it is fair to say at this level of business the Company will have a better intuitive feel for profitability or not and the respective tolerance levels for the type of Customer they are accommodating.

At the larger end of the scale, there will be a logistics based system that attempts to measure Inventory levels and service costs, yet even these approaches sometimes take the decision to concentrate on products rather than customers, preferring to concentrate on Stock Keeping Units not Customers.

So, what is the Endgame, if we go back to our Monty Python Analogy, there are several benefits to be derived from Customers, the endgame surely must be to survive and thrive as a business, which means taking a Holistic approach to Customers Value.

Customer Value drives Shareholder Value, there are all sorts of efficiencies to be gained from tight financial control of fixed and working Capital tied up in Plant and Inventory.
If we take a logistics based view of Accounting, and using a flow oriented approach, it means that we measure and capture Customer Data as much as we can, not only via direct allocation of cost but also direct allocation of time.

Let’s borrow a concept from the second oldest profession, every time you ring a Solicitor, he has recorded his time.

This Service based approach to time management is worth exploring and has it’s roots in Financial accounting, ask any Professional Solicitor or Accountant how much each Customer is worth and he will be able to produce a computer generated summary of time spent answering calls, tending to queries, writing correspondence and general and holding of his customers, each time unit (usually quarter hours) costed out.

His stock in trade is time, for logistics to flow, there is an underlying principle of lead time reduction and elimination of bottle necks, the principles of logistics management and service oriented approach to Customer value has it’s roots in time management.

The flow of materials and the time scale should mirror the costs, this can only be accomplished , I would suggest with the benefit of some form of time recording which not only incurs idle time of Inventory being transported, but also time in relating to Customers and collecting Cash.

I have yet to see a logistics firm set up a fully integrated time recording system (suitably costed of course), but I think we will see this beginning to occur and although there are some Sevice level agreements that do have penalty clauses for time delay, I have not seen a robust system that will back these up.

What is required is a cross functional time recording cost system that cam measure the actual cost of servicing the Customer, time being measured instock holding/processing days and personnel days/hours in shifting inventory through the supply chain.

It is people and processes that generate value, we should be able to cost this.

Conclusion

Conventional Cost accounting especially in Supply Chain approaches to Customer Service does not answer the question of how much does it cost to Service this Customer. Companies do not understand Customer Costs, they do understand Product costs.

Activity based costing goes someway to rectifying this information imbalance, coupled with a relevant time recording system, then some balance can be achieved. I have seen this described as mission costing, this in itself is an attempt to identify unique customer costs, however, the definition of mission costing still dwells on resources and activities, it does not include the cocktail of time measurement.