Cost-to-Serve: Where Transport Quietly Eats the Margin

Most companies know their gross margin by product to the decimal. Very few know their margin by customer after the cost of serving that customer: the order handling, the picking, the delivery, the returns, the credit. Those costs are booked as overheads and freight, spread across everyone in proportion to revenue, and the spreading hides the most important fact about the commercial portfolio.

Two customers buying the same product at the same price can have margins twenty points apart. One orders a full truck every week to a single dock; the other orders a few boxes three times a week to five shops in the city centre. The invoice is identical per unit. The cost to serve is not.

Drop size drives the cost of delivery

Transport cost per delivery is mostly fixed: the truck, the driver's time, the stop, the paperwork. Divide it by a small drop and it becomes a large percentage of revenue. Plotting freight cost as a share of revenue against the average drop size of each customer almost always produces the same curve.

Above roughly a tonne per drop the curve flattens and freight becomes a minor cost. Below 500 kg it climbs steeply, and the smallest customers spend more than a tenth of their purchases on delivery that the company pays for. Nothing in the price list reflects this, because the price list is built per unit, not per order.

Margin before and after cost-to-serve

Allocating the logistics and commercial costs to the activities that cause them (orders, lines, drops, kilometres, returns) and then to customers changes the ranking of the channels. The segments with the best gross margin are frequently the most expensive to serve.

The online channel looks like the most attractive segment on a gross margin report, at 38%. After picking single units, parcel delivery and returns, it loses money. Key accounts, which sales teams often describe as margin-dilutive because of their discounts, turn out to be the most profitable segment per unit of revenue once their full trucks are counted.

Levers that do not require losing customers

1. Minimum order and delivery charges. A minimum drop or a visible delivery fee below it moves customers to order less often, in larger quantities. Most accept it when it is explained.
2. Fixed delivery days. Serving a zone on two set days a week instead of on demand fills routes and raises drop density without changing what customers buy.
3. Channel by service level. Small customers can be moved to a distributor, a cross-dock or a pickup network whose cost structure suits them.
4. Price the order, not only the unit. Discounts based on order size and frequency, rather than on annual volume alone, reward the behaviour that lowers cost.
5. Pay sales on margin after cost-to-serve. As long as commissions are paid on revenue, the sales force will keep winning the customers that cost the most to serve.