Reducing Cost of Goods

On average, 47 percent of the cash disbursements our industry makes goes to cost of goods. Our managers make significant efforts to reduce the cost as fast as reimbursements decline. Our manufacturers also make significant efforts in response to the need for lower cost of goods. It is like we are stuck in a cycle — reduce reimbursement, reduce cost of goods, around and around.

There is, however, an approach to reducing the cost of goods that can yield more savings to those who adopt it, but it is a departure from what has become the norm.

Of course the downside to adopting new ways of doing things brings risk and work. But the rewards can be enormous. Consider some new approaches that paid off well, like automobiles, airplanes, oxygen concentrators and so on.

This new approach starts by redefining “cost of goods.” We generally think of goods as physical items, i.e. bedside commodes, lift chairs, walkers and the thousands of other items we acquire. The reality is that goods are much more than metals and polymers: Goods include activities.

After the manufacture of an item, there are at least 16 activities — each consuming time and, thereby, cost — that a manufacturer incurs in getting the goods to the provider. All of these activities are included in the cost of goods. In addition to the manufacturer’s activities, there are additional activities required of the provider, each consuming more funds but not accounted for in cost of goods.

The manufacturer’s activities included in the cost of goods are:

In addition to the activity costs that are included in cost of goods, the manufacturer includes the costs of occupancy, insurance and capital.

The price providers pay can and should be relevant to the activities they use. Further, providers should know that they can affect the cost of the activities that they actually use.

For example, why should a provider with an impeccable credit history with a manufacturer pay the same price as one that requires monthly collection activity? Shouldn’t the timely provider get a discount because he doesn’t use the collection activity and the slow-paying provider pay a premium for using the collection activity?

Granted, the manufacturer may charge the slow-paying customer a late fee, but only the largest invoices generate a sufficient fee to offset the collection cost. Therefore, the timely customer winds up paying for the slow customer.

Providers could issue purchase orders that are coordinated with the manufacturer’s production schedule to take product right off the assembly line, allowing the manufacturer to avoid the activities of stocking, warehousing and picking the goods. The provider and manufacturer will also eliminate occupancy, insurance and capital costs.

The same concept could be applied by manufacturers that are purchasing goods assembled and packaged for resale. It is not a new concept, and simply requires the option for the provider to have a drop ship.

Providers could aggregate orders for a market area and have one large shipment, thereby reducing the number of times certain activities are performed by the manufacturer and reducing the freight charge from less-than-(trailer) load to a load rate. It only requires providers to coordinate some purchases.

The six activities that providers perform when acquiring goods are a mirror image of activities performed by the manufacturer. Properly developed software that interfaces with the sales and purchasing modules of provider and manufacturer systems could be developed to eliminate activities on both sides of the transaction. It has been done before, and it could be taken as an industry initiative to eliminate millions of dollars of cost that unduly burden our industry.

Wallace Weeks is founder and president of Weeks Group Inc., a Melbourne, Fla.-based strategy consulting firm. You can reach him at 321/752-4514 or [email protected].