Note: This post is authored by Sajag Agarwal is the CEO and Founder of Movley
For ecommerce and consumer packaged goods companies, a large majority of cash flow is actively invested in the supply chain and in inventory. When managing budgets, business owners tend to underestimate and miss a big chunk of supply chain costs. This post will go through 5 key areas of supply chain costs that often go unconsidered, and that should be factored into your business model moving forwards.
1. Procurement/Coordination Costs
Although obvious, this is easily overlooked by many business owners, especially when they are the ones building the business as a single-founder or managing the supply chain directly. Your time matters. As a business owner, you have limited time to work on all aspects of your business, and at some point, different tasks need to be delegated. One of the biggest and most time-consuming tasks is handling the supply chain. Often due to complexities, it’s not just a simple standard operating procedure you can send off to a virtual assistant.
For every product order you place, you will spend time talking to your suppliers, negotiating new rates depending on your volume changes, and checking up with your suppliers as the products are produced. You’ll also have to spend additional time to coordinate inspections, wire transfers/payments, coordinating with freight forwarders (and comparing rates), and not to mention your 3PL or Amazon putting together shipping plans for when it arrives. This could easily be 40 hours of time per order and often feels like even more when most of is done in the wee hours of the night.
You should account for your time spent at a fair hourly wage, and if possible amortized and proportioned out in your finance calculations for you to project the true cost of your supply chain.
2. Factory Relationship Management
Factory relationship management goes hand-in-hand with procurement and coordination. In addition to the actual coordination, there is a large amount of both time and expense that goes specifically into building and managing relationships with factories. Specifically, this bucket includes the time you spend when sourcing new products and meeting with dozens of factories. Additionally, when finding new suppliers and even with existing ones, it’s critical to be conducting factory audits.
Without conducting a factory audit, you are essentially gambling tens of thousands of dollars in an overseas virtual casino. Factory audits give critical information on your factory, how it runs, who runs it, and all the processes/procedures/departments that make it tick.
Is your factory even manufacturing your products, or do they subcontract the work? Is it a one-man show, with the owner managing all of your production out of a paper notebook? If so, there’s no consistency or reliability in the factory’s behavior as it’s not governed by a set process for manufacturing or sales. Factory audits are done on the top list of suppliers before kicking off production, and most companies depending on the volume they do with the supplier will repeat them once a year to keep tabs on the facility. All factory audits are not the same either, so finding a company tailored specifically to auditing for ecommerce brands such as Movley can go a long way!
If you opt to travel to China to meet your suppliers, you also need to consider the cost of your transportation, meals, and pocket expenses as part of your supply chain costs. As a business owner, you may often see a value in splitting the production of different products to a large number of suppliers for short-term price savings with new suppliers. However, after you’ve factored in the on-going costs of managing multiple relationships, travel expenses, and the cost of auditing/monitoring your supplier base, it may make more sense to consolidate your suppliers into as few, reliable ones as possible.
3. Bad Products, Returns, & Warranty Claims
You will never find a physical products business that doesn’t have defective units, returns, and warranty claims. It’s part of doing business in consumer goods. When calculating the true price of your products, business owners often do not consider the cost of these problems or take action to mitigate against them. In fact, return rates in ecommerce are almost 4x higher than brick and mortar, and likely even higher on Amazon!
A common trend in contract manufacturing is quality fade—when the product quality slowly decreases with each order from your supplier. It’s often gradual, however, it’s also common to see a sudden steep decline as soon as the 2nd order or even after 2 years on the 15th order. Defective products in the supply chain cost a lot more than just the cost of the product! You must factor in not only the product cost but also freight from the supplier to your warehouse, packaging, shipping to the customer, lost profit on returns, customer service costs, warranty replacement product, and shipping costs. A defect rate of 30% on a $10k order after all these costs are considered, can cost you almost $6,000 (or double the product cost of $3k)!
A common way to mitigate against the risk of bad products is doing product quality inspections at least once an order. Catching just one bad order before it leaves the supplier can pay for all of your quality control inspections for sometimes 7 years! A good product inspection in China after the labor rate and other associated costs are considered is around $300 a day. It’s important to go with a good provider that can do them effectively, as the costs outweigh the savings more than 20x over the long-term. Fraud and bribery are extremely common in China, especially in the inspections industry. A good company like Movley that tackles fraud with humanizing inspectors and their work, reasonable time quotas, and tech can significantly improve your ability to catch defects before you pay your suppliers!
Additionally, a percentage of your sales on an accrual accounting method should be forecasted for warranty claims and returns and adjusted with actual results as time goes on. This keeps your profit calculations real, and not overstated during the grace period before the customer complaints come in.
4. Miscellaneous Costs
With any supply chain, you’ll have a variety of small, everyday operating costs. For example, you might ask your supplier to send samples every now and then, or you might ship your approved samples to vendors around the world. It’s important to factor in these miscellaneous costs and properly account for these expenses in your supply chain account.
5. Pricing Fluctuations
Everything in supply chain changes! Business owners often make the mistake of believing that their product costs, freight costs, and other costs are the same whenever they decide to reorder. That couldn’t be farther from the truth!
Raw materials are often seasonal, and pricing can fluctuate rapidly throughout the year. The cost of labor can also change, fluctuating around holidays and other times of pressure due to overtime wage laws. That means your supplier’s manufacturing costs fluctuate, and in the end, your costs will too. Similarly, freight, shipping, and currency exchange costs are highly seasonal as well.
When you hold your supplier to a contracted price based on previous orders or ask your supplier to work DDP (Delivery Duties Pay), you are asking your supplier to do the impossible and forecast with 100% accuracy their future costs. Predicting freight costs even a few weeks out, let alone months, is almost impossible. Rather than potentially absorbing losses, your supplier will mark up your products for the worst-case scenario to meet your demands.
About the Author
Sajag Agarwal is the CEO and Founder of Movley, a Chicago-based company working to streamline and automate worldwide manufacturing and supply-chain through tech.