Cracking the Cost Analysis Nut

Just when you think you've found all the ways to cut costs in your organization, there are more hidden just below the surface. One metals distributor shows that uncovering one layer of savings is never enough.

[From iSource Business, December 2002/January 2003] The waterjet cutters at TW Metals use a fine stream of water and sand, pumped out at 55,000-pounds-per-square inch, to cut through steel plating and alloys up to six inches thick with a remarkable degree of precision. But when it came to slicing and dicing the company's supply chain cost structure, the metals distributor and processor found that it lacked the right tool for the job. Now, however, TW Metals is using an activity-based costing solution to better understand  and better control  its costs.

Formed in 1998 by the merger of two old-line metals companies, Exton, Pa.-based TW Metals is one of the top 20 steel service centers in the United States. The privately held company offers more than 17,000 different products  everything from carbon steel to titanium alloys  to customers such as Boeing, General Electric, United Technologies and others in industries ranging from aerospace and automotive to chemical processing and utilities. With about 1,000 employees, TW Metals operates facilities in some 40 cities throughout North America, Europe and Asia.

TW Metals is something of a rarity in its market niche, a growing business that has seen many of its competitors sink into financial distress or bankruptcy. To maintain its edge, the metals firm has made cost control a priority, going so far as to make continuous improvement and rigorous performance measurement an integral part of its strategic mission statement.

Trouble was, even just a couple years ago, the company did not have the tools or processes in place to accurately measure its costs of goods sold, according to Aldo Miceli, vice president and chief information officer at TW Metals. "For years," Miceli explains, "we always measured ourselves on gross profit. When you looked at a sale, you would look at the GP dollars on that sale, and that was our yardstick." But those calculations did not take into account such outlays as the costs of preparing quotes, entering a customer's orders, or picking and packing those orders. TW Metals was using general allocations to divvy up its costs, but the company found this method could not produce an accurate accounting of its cost structure. "You may allocate based on sales volume, based on headcount or based on many other things, but it doesn't give you the true picture," explains Miceli.

As a result, TW Metals had no means to determine the total cost of servicing a given customer and, therefore, whether that customer was actually profitable for the metals company or not. For example, a client placing a large number of orders might appear to be a lucrative account under the gross profit measure. But if each order were for a low dollar value, the actual costs of servicing that customer could make the account a money-loser for the metals company. Yet TW Metals had no way to determine whether or not that was the case. In other cases, an individual branch office might handle orders for a certain client and therefore report the earnings for the account, but the work would be done at a different facility that stocked a particular metal or that had the necessary processing equipment. However, TW Metals had no way to associate the one office's revenues for that customer with the other office's costs of servicing the client.

Finding the Right Stuff

Determined to get better control over its costs, TW Metals began seeking a solution for effective activity-based costing (ABC) in early 2001. Through the Steel Service Center Institute (now called the Metals Service Center Institute), the company learned of a solution provider called Acorn Systems that was offering an application that employs an ABC approach to measuring profitability. Essentially the solution, called Profit Analyzer, allows a company to measure net operating profits down to the level of a given customer, order, product or supplier by modeling, and assigning costs to, the processes and resources necessary to complete a transaction.

Equally as important for TW Metals, Acorn also had a degree of experience in the metals industry. "They certainly gave us that warm and fuzzy feeling that they knew the steel business and had a product that would help us identify a lot of what we were looking to identify," Miceli says.

TW Metals began implementing the solution in May 2001. The metals firm operates in a hub-and-spoke environment, with seven regional offices that include major processing warehouses, as well as branch offices "spoking out" from each hub. Miceli's implementation team, along with Acorn specialists, started with pilots in a limited number of branch facilities to build and test the activity-based cost models for the company's operations before rolling the solution out to an entire region to validate the results of the pilot facilities.

By August 2001, TW Metals had the solution rolled out across 28 sites, encompassing all the company's distribution centers. The implementation team held seminars in each hub office at the outset of the regional deployments, both to educate sales and branch managers about the solution and as "fact-finding" missions to ensure that the cost models built into the solution were appropriate for a particular branch or regional operation. Once the solution and the localized formulae were in place at each facility, TW Metals then tackled its corporate allocations, assessing how to split out company-wide functions such as information technology, credit, collections and payables.

Stepping Back to Evaluate

By September of last year, with the solution fully in place, the company was in a position to look at the profitability of each branch, each customer and even each order, as well as the allocation of corporate costs and the breakdown of equipment utilization among its facilities. Further, this "value identification" process helped TW Metals identify the underlying processes that went into servicing particular clients and how the cost of those processes affected the profitability of a given client. Corporate executives and branch managers, provided with the analyses for their clients, were then able to draw up action plans to turn money-losing accounts into profitable customers. They took three approaches to achieve that goal.

First, the company took a look at its own internal processes for the simple reason that, as Miceli says, "If we run a sloppy operation, the customer is not profitable; if we run a tight operation, the customer could be more profitable." TW Metals found that, in particular, the software gave the company a clearer view of its equipment utilization. That allowed the branch managers to better track their volumes and assign work to different pieces of equipment to achieve the greatest efficiency. The company has also been able to identify the processes relating to the company's most profitable customers so that it can replicate those best practices with other customers and at other facilities.

Second, TW Metals worked to change its interenterprise processes, that is, the ways that the company interacted with its customers and suppliers. For example, in some instances the branches found they were expending too much effort doing manual order processing for certain customers. By working with the customers to automate the order process, either through electronic data interchange or through a Web-based interface, the metals company projected that the resultant labor savings could turn around an account and make the customer profitable. In other cases, where customers were placing a high volume of low-value orders, TW Metals worked with these clients to consolidate orders and shipments, producing a "win-win" for both sides, since the customers could lower their costs related to receiving a large number of shipments.

And finally, when necessary, TW Metals went back to its customers to renegotiate product pricing. Miceli stresses that only as a last resort did the company actually wind up walking away from a current customer. "The very last thing you do is fire your customers," he says.

Maintenance Mode

Now that the initial cycle of analysis and action is behind TW Metals, the company has gone into "maintenance mode," running the Acorn solution on a quarterly basis. The company posts the reports online so branch managers can review profitability figures for their offices and prepare follow-up actions when necessary. "We have increased the sophistication of our branch managers and our management team," says Miceli. "They have information they didn't have before, and they are able to better utilize [their assets]."

TW Metals has made some tweaks in how it is using the solution. "It's not a precise science," Miceli admits readily. "It's really more of an art, because you do a lot based on relativity or generalizations. Face it, you're making some assumptions: the time it takes to enter an order, the time it takes to pick and pack material and so on. A lot of that is calculated; however, it's not precise." So, for example, a customer may not look profitable at first glance, but upon closer examination, it may turn out that too much outside sales costs have been allocated to the customer.

The CIO estimates that TW Metals has invested up to $500,000 in the solution. He says the company has not tried to quantify the return on investment in the solution, in part because the high degree of volatility in the metals industry and the various facility rationalizations and other steps that the metals firm has taken in response to that volatility make ROI calculations problematic. Nevertheless, Miceli is confident that the company's new ABC process and the Acorn solution have more than paid for themselves. "Absolutely," he says. "It gives you information that you just didn't have before."

Up Next

Looking ahead, TW Metals is examining the possibility of using the costing solution proactively, to help the company make profitable decisions at the quoting or order entry stage. "We're performing analysis on historical data," Miceli explains. "Basically it's telling us our past mistakes. But wouldn't it be great if, instead of waiting for the results of the past quarter, we got that information up front rather than taking a bad order or not fully understanding the types of costs that go into that order."

Leslie Haight, vice president of marketing at Acorn, says the provider does have customers that are using Profit Analyzer to perform "what if" scenarios in analyzing business opportunities. Other companies are using Acorn's Profit Optimizer solution to analyze how they can optimize their operations to fulfill incoming contracts and orders. "They're looking at how they can optimize pallet size, terms and conditions, shipping methodologies, and other components of an order to write the best profitability scenario for their companies," Haight explains.

Meanwhile, at TW Metals, Miceli says the company's managers have responded enthusiastically to the new data they are receiving from the Acorn system. "You know, it's quite often that if you're talking about customers or equipment, the term they use is, Oh, yes, that Acorns very well,'" the CIO says. "It really became an adopted mechanism, a new paradigm, a new line of thinking for people."