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Logistics cost is a recurring element for every business. Businesses have to transport their goods to distribution centres, wholesalers and end users, and the decision to outsource logistics services or to build inhouse capabilities can be a difficult decision. What is needed is an accurate calculation of logistics cost per unit and logistics cost analysis, so that as a business owner or logistics company owner you know where and how to optimise logistics costs and spends.
What is logistics cost analysis?
Logistics cost analysis, refers to the process of calculating various logistics costs and strategising to minimise total costs based on optimising the different factors.
To understand the meaning of logistics cost analysis, let’s understand what is logistics cost and what factors are considered when calculating it.
Logistics cost, in simple terms, refer to all the costs that a company incurs to transport goods. It involves all the different expenses incurred in the supply chain including warehouse rent, payments to 3PL and 4PL service providers, packaging costs, operational costs, staffing costs, cost of software licences, delivery systems costs and any other. For a business therefore, (either a logistics company or one managing logistics operations internally), it’s vital to calculate all expenses in logistics to understand its spends and identify areas to cut costs.
Some of the areas you should consider for analysing logistics costs and expenses are:
- Raw material acquisition and transportation
- Inventory management, warehouse and cross-docking
- Packaging and labelling
- Technology and software licence
- Compliance and tax (may include customs)
- Shipping and transportation
- Operational, infrastructure and staffing
What is cost per unit and importance in analysing logistics costs?
In logistics, there are fixed and variable costs involved in logistics. Cost per unit refers to the total cost (including fixed and variable costs) that a company incurs to produce and transport a single item.
This is important from a business perspective as it enables businesses to set the right pricing strategy, calculate overall profits and analyse logistics costs to identify the cost drivers.
How to calculate cost per unit in logistics with formula?
To analyse logistics and supply chain costs and areas to cut expenses, it is important to understand how fixed and variable cost per unit works. To find cost per unit, you can use the simple cost per unit formula:
Cost per unit formula:
Cost per unit = (Total fixed costs + Total variable costs) / Total units produced
How to calculate fixed cost per unit:
Fixed costs are expenses that are predetermined and remain the same over a period of time (e.g., 1 year). It is fixed in that it does not change much depending on the profits/losses of the company or how the company is performing.
Some of the fixed expenses in logistics (or general) include – rent (e.g., rent on factory, warehouse, etc.), phone/internet bills, employee salaries, loan repayment (e.g., EMI on machinery loans, commercial vehicle loans), cost of software licences, insurance (e.g., cost of transit insurance policy), etc.
To calculate the total fixed cost per unit you will have to:
- Identify all fixed cost items
- Calculate the amount spent on each (e.g., warehouse rent ₹50,000 per month, i.e., 6 lakhs annually)
- Determine the annual number of units
- Use the formula to calculate the fixed cost
How to calculate variable cost per unit:
Variable costs on the other hand are business costs that change over a period of time. These are based on multiple internal and external factors and the overall performance of the business. Some of the common examples of variables costs in logistics are – indirect labour costs, electricity bills, cost of raw materials, taxes, transportation costs, etc.
To calculate the total variable cost per unit you will have to:
- Identify all components of variable cost
- Calculate the amount spent on each (i.e., for June 2023 – transportation cost ₹22,000, contract labour costs ₹1,40,000 etc. Note, this must be calculated on an annual basis)
- Determine the annual number of units
- Use the formula to arrive at the variable cost
Logistics cost per unit example using formula:
So now that we understand the concept of fixed and variable costs in logistics, and how they impact overall expenses, let us look at an example and analyse logistics costs here.
Consider yourself a garments manufacturer.
Fixed costs: You have a manufacturing unit/factory that you pay rent for, machines, operating expenses, and salaries to pay. These are your fixed costs.
Variable costs: You also have to procure raw materials for producing the garments and have them shipped to the factory. For transporting the ready garments from your factory to the wholesaler, you have partnered with a trucking company. There are also costs involved in storing finished goods, packaging and labelling, and managing returns if goods are returned. These are your variable costs.
Considering the numerous expenses, your total fixed costs stand at ₹10,00,000 and total variable costs at ₹4,00,000. Overall, you produce 5000 pieces of garments.
Using the cost per unit formula:
Cost per unit = (10,00,000 + ₹4,00,000)/5000 = ₹280
i.e., Your overall cost for producing one piece of garment will cost you ₹280. To earn profits, you will have to price your product above this sum.
E.g.: For 25% profit = 280 x 1.25 = ₹350
Price per unit = ₹350
As can be understood, it is difficult to reduce fixed costs. However, if you want to increase your profits, you can either:
- Increase production and hence reduce cost per unit (economies of scale)
- Reduce variable costs by identifying areas where costs can be cut
This will enable you to reduce transportation expenses and variable costs and overall dip in logistics costs.
Things to keep in mind when calculating cost per unit
As a part of logistics cost analysis, when calculating cost per unit in logistics, you also need to take account the total number of units produced and other components.
For instance, economic order quantity (EOQ) or ordering the optimal quantity will help you keep check on logistics expenses, in terms of reducing the number of trips, managing inventory and storage space, scheduling reorders/deliveries on time etc.
In this respect, some of the key things to keep in mind when calculating cost per unit in logistics are:
- To increase profits, you will either have to reduce variable costs or increase the number of units produced
- By having supply chain visibility and optimising logistics management, you can reduced logistics expenses (e.g., having fulfilment centres closer to distribution units)
- You can improve the process of raw material procurement (i.e., sourcing from local vendors and suppliers) and reduce logistics expenses
- Bringing efficiency in shipping and delivery (through last-mile delivery) and reducing the volumes of returns
- Collaborate with 3PL and 4PL service providers or look for logistics transporters with integrated logistics services
Logistics cost analysis – Tips to get you started
In a country like India, it is imperative that you consider all factors for analysing logistics costs. Some of the common factors that you should include when calculating domestics logistics freight cost are:
- Fuel charges, distance travelled, nos. of vehicles used
- Transporter reputation, delivery efficiency, packaging and shipping
- Availability of services, value-added services offered, competitor pricing
- Compliance factors, customs (when applicable), taxes
When doing logistics cost analysis for a business and evaluate efficiency in logistics operations, there are several methods that can be adopted. To begin with, start by identifying all the factors that affect fixed and variable costs.
Top cost drivers in logistics:
- Distribution centre costs – i.e., cost of inventory and storage, volume of goods to be delivered, frequency of orders, etc.
- Transportation costs – i.e., the delivery routes, the distance travelled, the number of days travelled, the number of trips being made, the logistics network used etc.
Next, the goal is to calculate costs incurred with each of these factors. Calculation can get complex and there might be overlaps or dependencies. For example, the costs involved with delivering light-weight goods like garments or books, is different from delivering grocery and furniture. Similarly, logistics expenses involved in delivering foodgrains is different from transporting steel.
Also, what is important is to calculate unit costs and total costs and keep room for unforeseen costs. For example, additional costs incurred due to road blockage and delays, or goods returned due to damage in transit.
The basic lost analytics in logistics management is to minimise the difference between expected and actual costs. A key benefit of efficient logistics management is to analyse cost drivers and identify ways to minimise them.
For instance, if the number of units ready for dispatch is not sufficient to fill an entire truck load, an alternative is to go for part truckload services. PTL services costs are lesser that full truckloads, delivery is on time and there are lesser instances of loading and unloading ensuring lesser scope of damage.