DOLLARS & SENSE

Months before the horrific events of Sept. 11, 2001, the direct-to-customer business was performing erratically. Afterward, all bets were off. For many merchants, weathering the next several months with as few losses as possible will be the key to survival. So take a deep breath and start thinking: What must you do differently in 2002?

If there’s only one change you can afford to implement, reduce your cost per order. And if you think your cost per order can’t possibly be cut any further, think again. There’s always something you can do, some area you can look at in a new light. Vigilant avoidance of profit-draining backorders, judicious use of overflow services, investment in technology such as scheduling software, and perhaps most important, increased productivity, will all help reduce your costs.

Measure up

First things first: You have to measure your cost per order to figure out where and how to reduce it. I define cost per order simply as all the costs associated with the call center and warehouse, compared to the total number of orders shipped.

Call center costs include those of direct labor (both sales and customer service); indirect labor such as management/supervision and support functions such as training and recruitment; occupancy, including facility and equipment depreciation or leasing; telecommunications; dedicated system hardware and software; and benefits. Warehouse costs include what you pay for direct and indirect labor, occupancy, facility and equipment depreciation or leasing, shipping materials, dedicated system hardware and software, and benefits.

Not included in cost per order are expenses for information technology, marketing, merchandising, accounting and finance, human resources, and senior management; these fall into the category of selling and general administrative (SGA) costs.

Back down

Just adding up the various categories of expenses won’t give you a clear picture of your cost per order. You also need to determine whether each of those costs is “legitimate.” There may be no getting around a high pay rate in an area where unemployment is low. A significant backorder rate, on the other hand, is a signal that somebody has to manage inventory and forecasting better. Returns are a little more complicated, relying in large measure on consumer preference; however, returns stemming from picking and shipping errors mean that somebody has to do a better job of monitoring accuracy.

Consider this: Based on our database analysis, the overall cost per order in the direct-to-customer business is between $8.50 and $13.50. (Cost-per-order statistics can vary significantly based on the number of transactions, type of product, service level goals, seasonality, and call-to-order ratios.)

The cost of processing a backorder is between $7 and $10, and many companies routinely have a backorder rate of 10% to 25% of all business. Likewise, a return caused by an error in the pick-and-\pack operation that requires a reshipment can cost $25-$30 if all associated costs of reshipment are included. The math is simple: A backorder or return due to company error can cost as much or more than the initial cost of filling the order. Is your profit margin high enough to withstand that?

Top ten

There are many things you can do to reduce cost per order. Some require capital investment, while others need managers to be more attentive to little details that might have been overlooked in an era of gung-ho prosperity. Here are a few ideas to think about:

  1. Use some type of scheduling software in the call center. Scheduling software reduces the many hours spent on programming agents’ time and frees up supervisors for other tasks. If you get a Web-enabled system, it also makes your call center reps more productive; they can download their schedules, request time off, or trade shifts with their peers, all without leaving their workstations. Companies that use scheduling software report an average cost per call of $4.10; those that don’t have an average cost per call of $5.96. (For more information on selecting a scheduling system, see “Software: For Whom the Bell Rings,” Operations & Fulfillment, September 2001, page 70.)

  2. Make sure you institute and enforce a well-thought-out upsell and cross-sell program in the call center. You’ll have to make every effort to overcome your staff’s natural reluctance to undertake such a program, but you’ll likely be pleased with the results. The old rule of thumb says that it’s easier to sell more to a current customer who’s already on the phone with you than to prospect to find a new one. It’s still true. Surprisingly, in one of our recent surveys, only about one-third of the catalog companies interviewed had a formal and well-organized program of upselling in the call center. If you aren’t taking advantage of your upsell potential, you may be missing out on a way to reduce your cost per order by increasing the average order value from your customers. Our experience indicates that you should be able to increase your net sales by 2% to 3% with a well-run program.

  3. Use overflow call services if applicable. Call centers using overflow or off-hours outsourcing show a slightly lower cost per call than those with 100% in-house call handling. Our data indicates that those call centers using outsourced overflow services experience a cost per order of $4.65, while those not using outside services show costs of $4.99. This may seem like a small difference per call, but with a large call volume, the grand total can be very significant. Overflow services can help in several ways. In typically slow periods (during nights and weekends), it’s probably more expensive for you to staff your center than to hire an overflow service (which might well be handling dozens of companies’ orders on the same slow shift). In peak periods, an overflow service can reduce your call abandonment rate and boost sales.

  4. Control stock to lower your backorder rate without increasing inventory to a level that is cost prohibitive. (Balance your fill rate against inventory cost.) The initial fill rate (IFR) has a significant effect on total warehouse costs (not including the call center). Those showing an IFR of more than 90% have a warehouse cost per order of $4.19, whereas those with an initial fill rate of less than 90% show a warehouse cost of $3.74. You should be able to lower your overall cost per order if you carefully consider both the costs of processing a backorder due to low inventory against the carrying costs associated with very low backorder rates and higher inventory levels. Striking the balance to achieve the lowest total cost is the challenge you face.

  5. Undertake an organized program to analyze reasons for and level of returns to develop a return-reduction scheme. Clarifying merchandise descriptions, arming call center staff with more information, and instituting quality control in the warehouse can all help. If you consider the added expense to process a return caused by an error in fulfillment (picking, packing, shipping, return freight, return processing, customer service calls), it can easily cost $25-$30 to correct a single error. This does not put a value on the potential erosion of customer satisfaction and harm to the potential lifetime value of that customer. Anything that can be done to reduce returns will decrease your overall costs and bump up the bottom line. A little investment in this area can yield big returns. In fact, it’s difficult to find another investment that yields as large a potential return.

  6. Focus on layout, workflow, and equipment requirements in the warehouse to minimize delays that hurt productivity. Too often, warehouse fundamentals and their underlying cost components are ignored or overlooked. Proper layout, efficient workflow, and careful equipment selections form the basics of warehouse infrastructure. Trying to increase employee productivity without providing the tools and workplace required for maximum efficiency is like asking workers to perform with one hand tied behind their backs.

  7. Make sure you have system support for slotting, replenishment, and product tracking in the warehouse. As with the physical attributes discussed earlier, certain warehouse system software basics should be in place. Among them are a sound and flexible slotting system, a variety of replenishment concepts to drive adequate product to the picking locations when needed, and a product-tracking capability that monitors items from receiving through shipping. Without these three processes in place, you will be spending unnecessary time and effort to meet fulfillment needs. Increased search and travel time, avoidable delays, and decreased accuracy are all potential results of neglecting these essentials, and all of these negative outcomes will increase your overall cost per order.

  8. Aggressively negotiate packaging, telephone, and freight rates. As your business navigates slow times, your service providers will experience similar problems and challenges. It is a good time to renegotiate your existing contracts and do some comparison shopping. Your customers are doing it; so should you. You may find savings available as your vendors and suppliers face increased competition for static or reduced demand.

  9. Re-evaluate your packaging methods to look for cost reductions. In addition to looking for ways to lower material costs, evaluate whether you are using the most cost-effective packaging concepts and methods available. Packaging costs per order can vary from 50 cents to $4 per package, with the top range unlimited, based on the need to protect extremely fragile items or very large-cube products. There will be some cases when high packaging costs cannot be avoided. However, among our clients, we repeatedly see packaging that might be classified as being in the “overkill” category. A close look at the materials you need to meet customer expectations while protecting the product could alter your packing methods and ultimately reduce your cost per order.

  10. Finally, comparing your shipping and handling revenue to your outbound freight costs can yield some interesting results. Typically, this issue is not directly related to the internal fulfillment cost per order and falls in the realm of marketing functions, but I present it here for consideration because it can have a dramatic effect on overall profitability.

Our surveys show that approximately 50% of catalog merchants make a modest profit on their shipping and handling revenue. Your goal should be to make a small profit (1% to 2% of net sales) while maintaining your competitive position and not having your customers view your charges as being excessive.

Look for simple, proven solutions to reduce your cost per order. In times like these, we can use whatever edge we can get. Exploring cost-effective solutions to reduce your cost per order should be an ongoing process and priority even in good times, but in times of uncertainty, these activities take on even more importance.

By starting a logical and systematic review of the vast number of components that make up your cost per order, you are doing everything in your power to control this important facet of your bottom-line profitability in the future. What you do differently in 2002 may give you the opportunity to succeed in 2003 and beyond.

Curt Barry is president of F. Curtis Barry & Company, a consultancy specializing in direct-to-customer operations strategies, systems selection, and implementation. He can be reached at 1897 Billingsgate Circle, Suite 102, Richmond, VA 23233; phone: (804) 740-8743; e-mail: cbarry@fcbco.com; Web site: www\.fcbco.com.

All in a Day’s Work

Based on F. Curtis Barry & Company’s proprietary database analysis of more than 200 leading direct-to-customer companies, costs per order break down like this:

Call Center
Direct labor 52%
Indirect labor 13%
Occupancy costs 12%
Telephone and system costs 23%
Warehouse
Direct labor 45%
Indirect labor 16%
Occupancy costs 27%
Packaging materials 12%

Not surprisingly, direct labor accounts for the lion’s share of your cost per order in both call center and warehouse. Your workforce, and how you use it, is therefore the biggest factor in calculating your cost per order.

Pay rates obviously affect direct labor costs, but often they are not easy to control. Wages vary widely throughout the country, depending on local market conditions and employment rates. Typically, wages for both call center and warehouse range from $7.50 to $12 an hour (although in some cases they can reach $15 an hour or more). If your workforce and facilities are located in an area where there is a lot of competition for labor, your pay rates will fall at the higher end of the scale. Therefore, instead of concentrating on reducing wage costs, a better strategy is to increase productivity.
CB

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