Customer stratification is a framework that produces an in-depth understanding of how your customers are impacting your bottom line, allowing you to rank your customers on multiple key performance factors. Without this insight, defining and deploying results-driven sales strategies, assessing their impact, and making decisions about how your sales team best prioritizes their resources becomes incredibly challenging. In this article, we’re going to focus on a particularly important component of calculating customer contribution to your bottom line–freight-in cost.
The Intricacies of Freight-In Cost and Impact on Customer Stratification Calculations
In previous articles, we’ve pointed out that customer stratification involves assessing a customer’s merit based on their scoring in four critical drivers impacting your growth and profit: profitability, buying power, cost to serve, and loyalty. Freight-In cost is significant in its influence to accurately quantify each of these four drivers because of its impact on the cost of materials to capitalize on inventory. The intricate relationship between freight-in cost and customer stratification calculations means that even the smallest inaccuracies in determining the cost of materials, capturing those costs to inventory, or apportioning those costs to items correctly can have a significant impact on the following:
1. Customer Profit Margin
Freight-In cost directly affects the metric that often serves as the truest barometer of customer contribution to the bottom line, profitability. Categorizing a high purchase volume customer as generating significant revenue would only tell a partial story. Accurately accounting for freight cost ensures that reliable net margin contributions are calculated for use in assessing the profitability of your customers.
2. Company Gross Margin
If the freight-in cost is not fully captured and applied to inventory but instead is expensed directly to the cost of goods sold, the gross margin on the company’s financials will be lower than expected. Properly matching these costs with the related sales through capitalization to inventory provides a more accurate representation of gross margin and financial performance and will help to keep customer level and company level margin analysis in sync.
3. Pricing
Failure to correctly capture or allocate freight-in costs at the inventory level undermines efforts to effectively optimize pricing which will drive top line revenue and EBITDA erosion. Pricing will not be set where it needs to be to capture all direct costs and achieve margin goals. Additionally, comparative pricing analysis against the competition will be misrepresented because the company’s pricing benchmarks will be understated.
Why Calculating Freight-In Cost Can Be a Challenge
We’ve just made the case that freight-in cost significantly influences customer stratification calculations. Freight-In has become a significant acquisition cost in the purchase of inventory–and in many companies, freight-in is the most expensive cost incurred to acquire an item. Consequently, capitalizing freight-in cost to an inventory item in the correct proportion is critical to determining accurate gross margin per item.
There are different scenarios wherein freight-in cost-capture inaccuracies occur. However, they derive essentially from the same challenges:
- Accurately associating purchase orders with the freight-in cost incurred.
- Reasonably apportioning the freight-in cost among all items on a purchase order.
- Eliminating the degree of variance at the PO line item level between assumed freight-in capitalized and actual freight-in cost incurred.
- Eliminating the amount of time that transpires between inventory receipt and validating the actual freight-in cost incurred.
- Ensuring an ERP’s capability to support adjusting inventory item cost to account for freight-in cost variance after its purchase receipt is received.
Limitations or degrees of error in any of the above areas will impact the reliability of the calculated gross margin per inventory item.
Next Steps: Adopt the Consistency Principle
Manufacturers and distributors must carefully consider freight-in costs to accurately stratify customers and optimize their operations and customer relationships. In doing so, each organization will need to find the most accurate way to capture and allocate freight-in cost per item, even if the approach isn’t perfect owing to the above challenges. Consistency will allow for comparing the results for different customers, even if there is a slight inaccuracy in the calculation method used.For more information about customer stratification and how freight-in cost applies to customer segmentation models, download our resource guide, “Growing Profitably Using Customer Stratification.” It provides an overview of the fundamental concepts of customer segmentation models that result in a customer stratification framework.
