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The Costs Of Inefficiency

( Originally Published 1939 )



Some of the high costs of distribution excused by distributors on the ground that "competition forces me to do it" are really due to ignorance of their own costs. Distribution in the modern sense of merchandising and demand creation is of recent origin. It has developed rapidly an amazingly effective technique in selling a multitude of new and varied products. But in the hectic struggle to educate the consumer and sell more goods distribution has lagged behind in the application of scientific methods to the study of operations and the control of costs. Also, it must be recognized that the task of determining and allocating costs in distribution is much more difficult than in production. But ignorance of costs breeds high costs, or at any rate prevents high costs from deing detected and reduced.

In the early days of machine industry production was conducted with the same lack of knowledge of the cost of its various processes as is distribution today. But since then careful studies have gradually been made of most of the processes in production. The progressive manufacturer today is likely to have accurate data on how much any one of the processes in his plant costs him and how much time is consumed in performing it. This is by no means universally true, but even in the less efficiently run plants there is more genuine information about production costs than about almost any part of the distribution process.

a. DIFFICULTY OF MEASURING COSTS

It is relatively easy to measure the material and direct labor costs in making and packaging a common article like a tube of tooth-paste. Such a product is made under standard conditions and the amount of raw materials, labor and machine time required to pro-duce a single unit can be determined accurately. Even such factory overhead costs as inspection, supervision, record-keeping, taxes, and insurance can be allocated with reasonable validity. A new enterprise could closely estimate how much it would cost to produce such a standardized product if a million customers could be induced to buy it regularly. But what it would cost to create this demand cannot readily be computed. Nor would it be easy to compute the cost of distributing and selling the product to the million potential users.

But that is not the whole story. When the manufacturer sells 10,000 tubes to a wholesaler, the wholesaler-although he may have a cost accounting system-is not likely to know how much it costs him to handle this particular commodity. He probably knows what it costs to store this toothpaste together with all his other stock, and what it costs to distribute the whole volume of merchandise sold by him to a thousand druggists. But this is an average figure and takes no account of important differences in cost of selling different items, of filling orders of different size, of selling to different customers and of shipping goods into different territories. And these differences are the vital elements in wholesalers' costs.

So also when the toothpaste is delivered to the retailer. He adds it to his inventory, which includes hundreds or thousands of articles bought from different wholesalers or manufacturers. If he thinks about analyzing his costs at all he is confronted with a complex job. The average store is not large enough to warrant specialization of personnel or space. Hence the allocation of these costs in retailing is even more difficult than in wholesaling.

The relatively large proportion of total distribution expense rep-resented by the costs of selling, advertising, and promotion are usually allocated to different products on the basis of their dollar volume of sales or their gross profits. In other words these expenses are charged roughly in accordance with the distributor's selling price or mark-up on each commodity. It is quite unlikely, of course, that this method will result in allocating expenses according to actual costs incurred, since the cost of selling any particular article may vary widely from the average cost. of selling all products carried by the firm. Often of course there is a rough and ready recognition of these differences by charging a smaller gross margin and paying a lower selling commission on items with a rapid turnover. Margins are rarely established, however, as a result of a commodityby-commodity and customer-by-customer analysis of actual costs incurred.

Problem Being Attacked

But some progress in this direction has already been made, particularly in the allocation of internal handling costs in wholesale and retail establishments. A good example is furnished by the Louisville Grocery Survey conducted by the United States Department of Commerce. In this study six different operations or functions in wholesale establishments were identified: investment, storage, checking, handling, promotion and reimbursement. Similar studies have been made by the department in wholesale confectionery, in retail and wholesale drugs and in the retail grocery business. Some of the larger and more progressive wholesalers and retailers have developed their own methods of cost allocation, while others are following the patterns suggested by the Department of Commerce.

This analysis "must be regarded only as a very initial step along the long road to the development of adequate selling costs." But it has already shown important variations in the cost of salesmen's calls on various types of customers in different regions and in the amount of the order received at each solicitation. This study is expected to provide a sound basis for computing selling costs and also to reveal opportunities for important economies.

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