Posts Tagged ‘Saving Costs’

Globalisation 4

In my opinion Logistics industry can be described as wheels of Globalization and key to the market expansion and competitive product availability to the growing global consumers. Dynamic business conditions and confronting economic conditions are driving globalization. Globalization is resulting due to expanding markets, exploding retail market, product proliferation, ever changing needs of customers, economic downturn, cost pressures, technology, cultural integration and government policies around the world. It would be wrong to assume that globalization influences economy and trade only; we are seeing integration in the areas of culture, media, education, research and development, tourism and even climate change.  On political front, we see collaboration and collective approach in addressing daunting challenges we face today.   Globalization will make our societies more creative and prosperous, but also more vulnerable and in transforms economies more competitive.

Let us review some vital statistics (Source: Armstrong & Associates Inc.).  First let us review the region wise Logistics spend vs. 3PL revenue (2012):

Globalisation 1

Obviously Asia Pacific Region heads the chart in all categories if we exclude remaining other countries which were consolidated under other countries.  It would be worth looking into Asia Pacific region by country in order to identify the growth countries.  Top five are highlighted here under:

Globalisation 2

If we look globally, it would be interesting to compare the numbers and easy to identify the globalization impact on different countries:

Globalisation 3

It would be very interesting to analyse 2013 numbers as the world trade is not promising.  World trade is expected to grow by 2.5 percent this year and 4.5 percent in 2014 (source: The World Trade Organisation).  More and more companies are developing agile supply chains and compressing product supply lead time and at the same time reduce the cost of production.  In order  to achieve all these goals, outsourcing supply chains is one of the solutions.  According to CAPGEMINI Consulting 2014 report 72% of the shippers are planning to increase use of outsourced logistics services and whereas the 3PL companies believe that 78% increase in business.  Let us hope economy responds well in 2014!

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How Variance Analysis helps in understanding Cost Improvements in Supply Chain?

How many supply chain financial plans turn out to be exactly as planned? Very few or negligible percentage and this means difference between the budgeted level of cost and revenue and the actual level of costs and revenues. This is known as Variance. In short we are all aware of it. We plan a budget for a month and invariably end up with more than planned. We know that there is a variance. But we may not know how that variance did occur. This is an exercise to make that easily understandable for all.

Why should we understand the variance? We may know that material cost is over and above the plan. But we do not know whether it is due to consumption norm variance, price variance or volume variance. We often notice that the warehousing costs have gone. Every one is upset because it is an expenditure which would hurt the profitability. But do we spend time to understand what went wrong and are there opportunities to improve the cost spent on warehousing? Yes, that is possible through variance analysis.

Can any one right away implement Variance analysis? The answer is no, one should follow few steps in order to implement the Variance analysis. What are those steps?

1.Bench mark organizations performance against the best of breed performance and agree the performance norm or standard. For example a store man is expected to receive X number of pallets in a given environment per hour and that would be best of breed performance. After carefully understanding the limitations and opportunities within the organization, one should determine the number of pallets to be received in an hour, which is also known as productivity. And that becomes a norm for receiving activity. This would help us to determine how many store personnel are required to handle receiving activity based on given volume.

2.The next step would be to prepare budgets identifying three important factors, cost, volume, and norm. In other words every cost item in the budget should be derived using the above three drivers. This may not be applicable for fixed costs. This budget should be aligned with the organization’s overall activity plan for the year. This should be specific and customized for each product line.

3.Prepare periodical actual performance with regard to revenue and expenditure and compare with the budgets in order to understand the variance. The periodical actual performance data would be provided by your Finance Department.

4.Now, prepare the variance analysis in three forms, Cost Variance, Volume variance and Norm Variance and understand limitations and opportunities.
Isn’t it very simple? Now let us understand the variance analysis with an example.

Step 1: We have to create the standards:

Standard raw material consumption: 3KG per Unit;
Standard Cost: $11.00 per kg;
Standard labour norm 3 hours per Unit manufactured;
Standard Labour Cost: $4.00 per hour;
Fixed overhead was estimated to be $ 2,520

Step 2: Create the budget, in this case production budget:

The production budget can be drawn up as follows for 300 Units:
Budgeted Material Cost: (300 x 3 Kg. x $11) = $9,900
Labour Cost: (300 x 3 hours x $4) = $ 3,600.00
Fixed overhead: $ 2,520.00
Total Cost of producing 300 Units would be: $16,020.00
Unit Cost: $ 53.40 ($ 16,020/300).

Step 3: Prepare the actual performance (generally taken from Finance Department):

Let us now assume that the following actual information is now available:

Actual raw material consumption: 2.90 KG per Unit;
Actual raw material Cost: $10.77 per kg;
Actual labour norm achieved: 3.41 hours per Unit;
Actual Labour Cost: $4.23 per hour;
Fixed overhead: $ 2,520.00;
Total Units Produced was 325.

Total Cost of Production:

Material Cost – $ 10,150.73
Labour Cost – $ 4,687.90
Fixed Overhead – $ 2,520.00
Total cost – $ 17,358.62
Unit Cost – $ 53.41


There is no significant change in the Unit cost. However, one can notice few positive points and few opportunities for improvement. If we look at the material cost, the raw material usage was efficient by 3.33%; Procurement did a good job by procuring raw material at 2.09% cheaper than budgeted price. However, one can notice labour activity is an area of improvement. The labour productivity has gone down by 13.66% and the cost of labour also has gone by 5.75%. At the end of the day the improvements noticed in material usage saved the day by maintaining the same unit cost in spite of increase in the volume by 8.33%. The below table explains the variance in the form of Norm, Cost and Volume variance.

Action Points:

1.By using appropriate tools, one should evaluate the labour productivity and measure against the best of breed performance in order to understand the areas of opportunity and initiate necessary improvements.

2.At the same time, review the budgeting process and understand what went wrong with regard to labour costs. Implement the improvements to avoid lapses in future.
Before adjusting the budgets, it would be ideal to verify that the raw material consumption pattern is within the allowed limits and product quality is not at stake. And work closely with procurement team with regard to making sure that the material cost savings is sustainable.

It need not be the job of accountants to investigate variances directly, it is up to the supply chain manager and their analysts to monitor the costs closely and make sure that we add value to the business by improving cost efficiency.

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