The Lowdown on Total Landed Cost (Part 2)

This is the second of two parts on Total Landed Cost. The first part can be found here.

Innovations in Accounting

For several decades, accounting has progressed largely unchanged. Yes, accounting systems used to be on large servers. Some companies are still using the AS400 systems as their ERPs.

Then came along the Client-Server architecture, which was an innovation allowing for modules and expanding the functionality.

Web-based ERPs were the next significant innovation, which enabled the delivery and access of the application almost anywhere.

And today, there are cloud-native ERPs like SAP S4/HANA, Oracle Cloud ERP, and NetSuite that were designed to take advantage of the latest technology advancements, like communicating via APIs, scalability, and so on.

These innovations are almost exclusively on the architecture and infrastructure side of things. With the exception of IFRS, GAAP updates, and SOX compliance, very little has changed as it relates to Accounting rules, and the accounting methodology has largely remained unchanged.

If there has been innovation, it has been on the automation side of things. Reconciliations might be faster. Corporate roll-ups have been largely automated.

But one significant problem has not been automated away: Inventory accounting.

It persists.

To summarize the problem that was discussed in part 1, when indirect costs are planned for and incurred, they are accounted for in an inventory account and NOT directly allocated to the product (or more specifically the product lot) at the time of recognition. It isn't until the product is taken out of inventory that the allocation takes place. And the allocation is an estimate of the aggregate indirect costs, with the reconciliation taking place at a later time.

This method of accounting was started in the AS400 era, and persists to this day.

I think most people would intuitively understand that it would be better to allocate the indirect costs to the product in real time (i.e., when the product enters inventory)...but virtually no tier 1 ERP does this.

(SIDE NOTE: if there are ERP providers that do do this, please DM me...I'd love to chat.)

Why?

Because solving the problem is reasonably challenging. It requires the system to have an architecture that understands the various cost types, how they work, where they get incurred, and an ability to plan for them.

All this to say, while there have been significant innovations on the delivery of ERPs, solution providers have not solved this problem. And it's pretty fundamental.

This accounting lesson is important if you care about Total Landed Cost.

Because this is the reason that you are having trouble with it.

And you don't really have many good solutions to solve your problem. (3rdwave is one of your few real options.)

So what is 3rdwave doing to solve this problem?

Let's dive in.

Solving Total Landed Cost for Importers

Let's think about what is really needed to help a Finance or Buying organization manage TLC.

The proximate problem that CFOs want solved is an accounting of the indirect costs, organized at the product or item level. So, for any given product that the company buys, the CFO wants to get a breakdown of where the costs came from.

The catch is that they need it reconciled against the invoices.

Let me quickly explain.

Imagine a freight invoice of $1,050 for the movement of a container that contains 40 of Item A, 30 of Item B, 20 of Item C, and 10 of Item D. How do you allocate the cost? There are only a few different options. You could do it by quantity: there are 100 total items, so $1,050/100 = $10.50 per item. But that is likely the worst option. If Item A was a tractor, and Item B was a pencil, allocating the cost of moving these goods by quantity is clearly a bad method. It costs more to move a tractor than a pencil.

Another option is to do it by value of the goods moved. If Item A cost $10/item, Item B $8/item, Item C $6/item, and Item D $4/item, then the total value of the goods being moved is $800, and you should prorate the freight cost accordingly: 50% to Item A ($13.125/item), 30% to Item B ($10.50/item), 15% to Item C ($7.875/item), and 5% to Item D ($5.25/item).

A third option is to prorate the invoice by volume of goods (often freight is charged this way).

A fourth option is to prorate the invoice by weight of goods (often freight is charged this way).

And a fifth option is prorate the invoice by dimweight of goods, which is determined by a calculation and is a combination of volume and weight. Freight is often charged by this method.

In most instances, you would want to account for freight costs using the third, fourth, or fifth option, as it is the way decisions are made.

The point that I want to be clear on, is that whichever allocation method that a company chooses to use, the exercise needs to be done for every, single, indirect invoice. Which means that either the ERP will support it, or it will need to be done manually. And let's be honest. Once a company gets to a certain size, it won't be doing this activity manually. Which means that if the ERP isn't support this, it isn't getting done.

What you need to understand is that the allocation methods that are most useful require:

1. a systematic understanding of weight, volume, and dimweight for each product/item, AND
2. an understanding of the different cost types, AND
3. an understanding of a shipment, AND
4. an understanding of the products contained in the shipment.

ERPs have the capability of requirements 1 & 2. But they typically don't have 3 and 4.

(Yes, I hear a bunch of people saying, "but wait...we have the SAP TMS, or Oracle's TM. These modules have those objects. To that I say, "maybe". They are effectively third-party modules that have to be purchased, integrated, and configured. And there are still a number of challenges that we haven't spoken about yet.)

Even still, does this solve the TLC problem?

Kind of yes...but mostly no.

It's time to think about time

If your goal, at the end of the day, is to get an accounting of what the TLC is for any given product, and be able to compare it to the sale price and do a gross margin calculation, then maybe this is sufficient.

My thinking is that this is very short sighted, and you will discover very quickly that what you want is something more fundamental. What you are really looking for is the ability to estimate the costs of the inputs ahead of time, and then compare the estimates with the actuals in somewhat real time to make decisions that will help your organization.

What I'm talking about is the ability to budget or plan costs, and make the plan evident and explicit.

This is important, because time matters.

Within the supply chain, there is a time lag between when services are delivered (and therefore costs are incurred) and when the invoices are received (i.e., when costs are recognized). Often, the time lag is significant, as in weeks or months.

If your TLC capability is purely based on actuals, then you will need to wait weeks or months to do the analysis as the invoices won't have been received contemporaneously. Which makes the analysis somewhat useless.

For real utility, you would want to be able to analyze at any point in time, based on your best estimates. This requires the ability to understand what cost elements you would be expecting, estimate them ahead of time, and then reconcile them to the actuals when the invoices are received.

If these are things you care about, it introduces a couple new requirements that need to be accommodated:

• The ability to understand the universe of cost elements prior to invoices being received, AND
• The ability to estimate the cost of each element ahead of time

What cost elements are we talking about?

Everything we discussed in the previous post, namely:

• Freight/Transportation
• Accessorials
• Duties, fees, and taxes
• Per diems (like chassis days, demurrage, and detention)
• Warehousing and storage
• Customs brokerage fees
• etc.

And for each of these elements, you need to understand their allocation method so that you can appropriately estimate the costs and then reconcile against the invoice when they get received.

Most importantly, you need to be able to analyze and report, at any point in time, where things stand as it relates to TLC, appropriately using estimates (when required), actuals (when available), and variance.

(Yes...I know that some companies can do this...

Before I get shade thrown at me for making this seem like I have just discovered the wheel, there are some companies that have figured this out and are capable of doing this. Some companies have even been able to do this using SAP and Oracle. Companies that have been successful at doing this have spent a lot of time and money figuring this out.

I can already hear some people saying that some companies had figure this out years/decades ago. (I know...3rdwave was helping some of these companies in the 90s.)

But it is important to note that these companies are few and far between. It is far for the standard state of affairs.

My goal is to help companies get here...and to make it standard for the industry.)

Summary

Total Landed Cost management is more than just an accounting exercise; it's a strategic capability that can help businesses make better, faster decisions. The complexity of international trade, with its multitude of cost elements, and the limitations of traditional ERP systems, make TLC a challenge for many importers. While the process may seem daunting, it's clear that the solution lies in more than just tracking costs—it’s about creating a system that understands the entire lifecycle of a product, from purchase to delivery, and the costs incurred at every step.

The companies that figure out how to manage TLC not only gain better visibility into their supply chains but also put themselves in a position to make smarter, more profitable decisions. Whether through better software, more integrated systems, or simply a more robust understanding of cost allocation, the businesses that embrace this will have a distinct advantage in today’s complex global market.

For importers who are serious about understanding and managing their total landed costs, investing in the right tools and processes is not just a nice-to-have, it's essential. The future of supply chain management lies in being able to balance operational efficiency with cost control, and TLC is at the heart of that equation.