Mastering Costing Measures: A Beverage Industry Insider's Guide

In our previous blog From Annual Vision to Daily Execution: A Guide to Supply Chain Planning, we reviewed three critical planning horizons that must be effectively managed to ensure successful Supply Chain planning . In this blog we'll dive into costing measures that can make or break your beverage operation. Running a successful beverage business is more than just creating desirable products; it's really about taking control of  the details of financial management.

The Golden Metric: Inventory Turnover

Inventory is the lifeblood of your beverage business. Inventory Turnover is the heartbeat that tells you how efficiently you're managing this critical asset, and here's the formula for the secret sauce:

Inventory Turnover = Annual Cost of Sales / Average Inventory Value

Let's walk through a simple example; your business is selling 100 million cases of its signature drink annually with each case costing $5 to produce, therefore its Annual Cost of Sales would be $500 million. If the operation maintains an average inventory of $100 million, the inventory turnover is 5 which means that your business is cycling through its entire inventory five times a year.

Beware of Misleading Calculations

Pro tip: avoid the temptation of using annual sales revenue when calculating inventory turnover because this can artificially inflate results, especially for high-margin products. Stick to an actual  cost-based calculation for true insight into realistic financial performance.

Days in Inventory: Your Planning Crystal Ball

The Days in Inventory (DII) metric functions as a financial weathervane for your beverage business because it shows exactly how long inventory is sitting on the shelf. DII can be calculated as the Average Inventory divided by the Average Daily Cost of Goods Sold.

Days in Inventory = Average Inventory Value / [Annual Cost of Goods Sold / 365]

This metric is a game-changer for working capital management because it helps you capture dollar-weighted inventory time in storage, which is crucial for beverage manufacturers with diverse product lines.

The Hidden Costs of Poor Planning

Not all costs are created equal. When it comes to planning, eight key cost categories can significantly impact your bottom line:

1. Capital Cost of Inventory: Money tied up in stock.
2. Production Changeover Costs: Expenses related to switching between product lines.
3. Production Overtime: Extra hours cost needed to meet demand.
4. Transport Costs: Moving products around.
5. Handling Costs: Managing and storing inventory.
6. External Purchase Costs: Buying from other producers when demand can’t be met through production.
7. Dumpage Costs: Expenses from expired or discounted products.
8. Lost Sales: Potential revenue that is not gained due to unfulfilled orders.

 

With the exceptions of dumpage, unexpected external purchases and lost sales, each of these costs  is part of the typical standard cost calculation. All of these costs  can be controlled through good planning; Areté’s Tactical Replenishment Planning considers all costs required in an optimized resource plan. 

The Changeover Conundrum

When planning production line changes, for example, each switch from producing one product to another burns cost through syrup loss, idle workers, downtime:  all add up to increased cost. Efficient sequencing is the secret to avoid these types of cost; by carefully planning production runs, changeover costs can be minimized. Efficient run sequencing may be created through a modified Silver-Meal heuristic that can determine the ideal lot size of each run.

Overtime: Not Always a “Bad Guy”

Production overtime isn't inherently a bad thing; it’s all about understanding the why behind the need. Comparing forecasted demand against standard production rates, you can see if extra production hours are a symptom of poor planning or a necessary response to market demand. One method to evaluate if poor planning is an issue is  to first estimate Standard Production Hours required to cover demand by dividing forecasted demand by the standard run rates of the assigned production lines. Summing calculated standard hours for all products determines the required production hours that each line “should” have been scheduled for. Actual run hours can then be compared to standard run hours to give an indication of the efficiency of the production schedule.

The Transportation Tango

Here's a major cost-driver that many people overlook: transportation and handling. Imagine if your operation is shipping half-full trucks or shuttling products back-and-forth between warehouses every day; dollars are literally driving away from your bottom line. The goal? Optimize every load, every trip. Effective optimization must consider both cubic space and weight together in each truckload.

When Dumpage matters

Dumpage due to a product going out-of-date or sales of products at a significant discount to avoid dumpage is a controllable, relevant  cost. Dumpage due to quality problems is not relevant to planning, but must be addressed through better quality control and root-cause analysis.

The Golden Rule: Customer Service

Want to know the most damaging cost? Lost sales. But here's the catch—you can't just slap a dollar value on a missed sale and move on. It's not just about the immediate revenue loss, it's a risk of loss of:

• Customer goodwill
• Brand loyalty
• Customers switching to competitors

Instead of obsessing over cost numbers, you must focus on:

• Fill rates
• Service levels
• Keeping customers happy

When Capacity Becomes a Challenge

Operating near full production capacity now? Know that every minute counts because lost production time can lead to costs due to:

• Purchasing product from other franchises
• Holding inventory longer than usual
• Potentially losing sales and customer loyalty

When building a model to optimize a near-capacity production schedule, an estimate of the cost of lost production can be based on the cost of purchasing, transporting and carrying pre-built inventory. Similarly if a warehouse is near capacity, extra modelling cost should be added to reflect costs incurred for leasing additional warehouse space, transportation to and from an overflow warehouse and renting extra trailers. These extra modeling costs should never be considered real costs but rather  as the expense of loss of services to customers.

Summary

Mastering costing measures isn't about number-crunching, it's really about making optimal strategic decisions. You need to understand cost  metrics so that you can:

• Optimize inventory management
• Reduce unnecessary expenses
• Improve overall operational efficiency

Remember that in the beverage industry, your ability to balance production, inventory, and customer satisfaction can set you apart from the competition. A key objective of overall supply chain management is to maximize customer service while minimizing relevant costs. To learn more about what Customer Service measures are important, check out our recent blog  Key Customer Service Measures.