Control of Total Distribution cost & Supply cost26th February 2021
Distribution Cost or the Distribution expenses are the costs that a company incurs to make its goods or services available to the end-users or resellers. It is a broad accounting term that covers several types of expenses.
Total distribution cost (TDC) analysis requires some assumptions. These include current observed rates and transit times for standard air freight, full containerload (FCL), and less-than containerload (LCL) service.
For any company which is involved in distribution, distribution cost is a major bottleneck. There are many different distribution expenses which must be taken care of. Furthermore, these expenses are not consistent and may change from time to time thereby changing the distribution cost as well.
If the shipper is a distributor and it further sells to the retailer and the retailer sells to the end user then all the separate distribution costs at each stage would be included in the total distribution cost. Moreover, in some cases the manufacturer has a production unit at one place and the “product pick up place” by the forwarder at another place. The cost of moving the product from the place of production to the pickup point is also included in distribution cost.
There are other types of costs as well that that are included in the distribution’s costs. Handling cost of inventory at all points for example production place, storehouse, sales point is part of distribution cost. Packing costs are also part of distribution costs. Distribution managerial cost such as the salary expense of distribution manager and his/her office expenses are also part of distribution costs.
Freight cost is usually the most important component of distribution costs. If the product is manufactured and sold in same country then freight cost refers to the “Trucking” or such transport fare to deliver the product.
If the product is sold internationally then it may include “Air Freight, Less than container load (LCL), Day-Definite LCL or Full container load (FCL).” In case the product is transported by air the cost would be higher and if it is transported through LCL the cost would be lower but there is one further point to contemplate i.e. “Transit Time”. The transit time for LCL is longer and the transit time for moving by air is smaller. Covering all ends there is a need for comparative analysis between the product demand urgency and transport cost. If the product is urgently needed and the shipper is losing sales revenue then it is optimum to reduce transit time and increase the freight expense.
Distribution expenses: The individual expenses made by the company for various reasons is known as Distribution expenses. These are individual or repeated transactions happening over time. An example may include; Rent, Salaries, Administrative expenses etc. All these are individual transactions or repeat transactions and these transactions can be called distribution expenses.
Distribution cost: The combination of all distribution expenses made by a company is known as Distribution cost. So, continuing the above example; the total of rent, salaries, and administrative expenses will be considered as distribution cost. In terms of Formula
[The sum of all Distribution Expenses] = Distribution cost
1) Sales returns
If a dealer or a retailer rejects a material, then the material comes back to the manufacturer provided it is in the returns policy of the company. This returned material may have come back due to cosmetic conditions (it was damaged or dented) or it may have come back due to performance issues. In any condition, the returned product is a cost to the company.
2) Direct Selling Expenses
Any expense made towards selling the product to the target customer is a direct selling. Many manufacturers, wholesalers, and distributors carry out direct selling in the regions that they want to expand. They also would like to know the distribution cost of that region. Thus, they consider all direct selling expenses as the primary expense made by the firm.
3) Commercials & Accountancy
It is a government requirement to present all your sales and purchases as well as balance and profit sheets to the government to determine profit earned by your firm. Furthermore, these statements are also important for the firm itself to note the growth year on year as well as to determine the performance and future potential. Thus, commercials and accounts are documented precisely in any firm.
4) Advertising & Sales promotion expenses
If a company wants to establish itself in a new region, it needs to have OOH advertising, it needs to run in-store branding, it needs to run ads in local newspapers or local channels. Thus, the company will be spending a lot towards advertising and promotions which are various forms of distribution expenses.
5) Product and Packaging expenses
The product packaging was good but was not strong. As a result, the packaging suffered a huge wear and tear by the time it reached the customer and the customers returned the product.
6) Shipping and Delivery
With the rise of E-commerce, delivery is a huge focus area for all manufacturers. The stock must be in the market, whether it is on an E-commerce portal or in a retail outlet or with the distributor. Everyone knows that if there is no stock on display, the sale will not happen and this creates friction between the different distribution channels.
7) Trade discounts
Besides sales promotion exercises like advertising and marketing, a company launches several trade promotional exercises as well. This includes giving discounts to retailers, distributors, and suppliers on achieving certain targets.
8) Market research
When reputed companies like Samsung, LG or Sony want to establish themselves in a new market, they buy market research reports from the likes of IMRB or Nielson. These reports may cost hundreds or thousands of dollars. Not only in a new market, even in an old market, a company might want to conduct a satisfaction survey or a survey of new ideas regarding distribution.
9) Credit, Outstanding and Overdue
A distributor who operates in a regional market needs the huge amount of money to conduct business. To arrange this money, the distributor takes a loan from the banks. This is known as an Overdue account. Hypothetically, If the distributor takes 1 lakh from the bank, within 30 days he should give back 1 lakh + 1% interest. Thus, a dealer suffers a loss when his money does not come back from the market in time.
10) Warehousing and handling within warehouse
Warehousing is a major cost of distribution. When a company expands to newer markets, it needs to have new warehouses in each new territory. Domino’s or McDonald’s practically have warehouses for every 3-4 towns so that they can supply to local retail outlets very fast. Because of Domino’s and McDonald’s handle frozen goods (burgers or fries), their expenses are even higher because they need cold rooms and cold chains to deliver the products.
NOTE: Warehousing cost is different from transportation and delivery cost which is calculated separately.
Under these assumptions, the analysis shows:
- Standard LCL would minimize transport-related costs, but would incur by far the highest inventory-related expenses due to long and highly variable transit times.
- Using full containerload (FCL) rather than LCL reduces inventory-related costs but to do so would spend more than the inventory-related savings on transport-related costs due to the wasted space in 20-ft. containers occupied by only 2,500 metric tons of freight.
- Switching to air freight to minimize inventory-related costs would incur the highest transport-related expenses, leading to the highest overall total distribution costs.
- Day-definite LCL could minimize total distribution costs (sum of transport and inventory related costs). Compared to LCL, the shipper would spend about $600,000 more on transportation to use day-definite LCL service ($1.8 million vs. $1.2 million per year) but would capture approximately $825,000 in inventory related cost savings ($1.3 million vs. $2.2 million per year).