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What's an overlooked cost in customer order management?

Managing customer expectations about order schedules is one critical element of achieving profit goals. Here's a look at why finance needs to be involved.

All sales are not created equal, and one key in customer order management is maximizing profit margins. Here's one way that might be falling short: Sales and customer service might be making critical finance decisions that are lowering profit for a given sale by promising orders more quickly than standard. Unless the customer is charged a rush fee, the profit margin will be lower or nonexistent for that order. Worst of all, the sales and customer service employees in question probably don't even know when they are committing the company to unprofitable sales.

To avoid unpleasant surprises that only reveal themselves when actual costs are analyzed after the order has shipped, companies need an approval process that includes representatives from finance. Their involvement should happen before any customer orders are accepted that would involve expediting or changing the production schedule.

Foundations of customer order management

Standards and cost estimates are developed using engineering documentation for materials required as well as labor and machine requirements. The typical method of creating cost estimates that form the basis for pricing decisions and margin expectations goes like this: The accounting department calculates standard labor and machine rates and cost estimates of overtime scenarios. The important point is that cost standards and estimates assume normal operating conditions.

A not-normal event that can and usually does increase actual cost is the extraordinary effort required to complete manufacturing in less than the normal lead time -- in other words, expediting. This is one reason comprehensive customer order management is so critical. When a product can be produced under normal conditions in, say, three weeks, making it in one week will almost always cost more.

Expediting is sometimes required to compensate for unexpected delays early in the process. Once a job falls behind schedule, expediting actions are an attempt to make up for lost time and complete the job on schedule. Those early delays may be the result of overcommitting production resources or scheduling more work than the available capacity can handle. Whatever the cause, expediting costs include overtime premium; additional handling; short runs, such as additional setups and distribution of fixed costs over a smaller lot of product produced; inefficiencies caused by chaotic shop conditions; and excessive scrap, rework and quality issues caused by the pressure to work faster, perhaps skipping checks and controls.

Unexpected expediting

One of the most common root causes of expediting expense is making unrealistic customer promises. Whether the product is made-to-order or shipped from stock, a promise to deliver earlier than the normal lead time or above the quantity available in stock or scheduled to be in stock per the master schedule cannot be accommodated without changing the schedule. That, in turn, will only be possible through expediting or breaking a promise to another customer -- in other words, delaying that customer's order.

A factor in this equation is that the sales department is often not aware of the existing master schedule, current backlog or the cost of expediting. Many ERP and customer relationship management systems include an available-to-promise capability that clearly shows commitments against future available inventory, so they can make realistic, non-expedited promises. A more sophisticated function called capable-to-promise, primarily for make-to-order manufacturers, provides even more commitment and capability information in conjunction with finite scheduling software in the ERP system. Finance should be consulted in cases where there is pressure to go beyond available capacity or promise more than what is in the master schedule.

Even if these tools are available and in use, companies need an approval process for accepting any order that is not within normal parameters as outlined above. Finance must be included in that approval process.

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This was last published in July 2016

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