Freight costs often represent a significant percent of a manufacturer or retailer’s expenses.   While many companies have highly qualified CFOs and VPs of Logistics or Transportation, the management of freight costs is often sub-optimized.  This appears to be a result of a lack of collaboration between these executives with each having a different set of metrics and perspectives.  Here is my take on why this is happening.

 Business Strategy versus Transportation Strategy

CFOs are focused on the strategic direction of the business, on earnings, cash flow and return on invested capital.  They are under pressure to reduce the amount of inventory tied up in supply chains. To a CFO, lean inventory means “reduction in working capital tied up in inventory.” 

VPs of Logistics and Transportation are preoccupied with efficient supply chains.  Leaner inventories mean smaller production lots and faster transportation, which can command premium rates since they preclude the use of cheaper, longer-transit modes, and may even require paying a premium for expedited freight. On the inbound side, this can cause plant or production line shut-downs due to lack of raw material or parts. On the outbound side, it can lead to empty shelves or the loss of a customer and its associated revenue stream.

Inventory is a component of working capital. Investors look at the levels of capital tied up in the supply chain – the lower the better. However, if you take your inventory, and therefore working capital, too low, your profit margin may suffer.

Over the past several decades, “Offshoring” has become a very popular supply chain strategy.  The low costs of production in many Asian countries combined with enhanced ocean shipping and improved North American intermodal services have made this sourcing option very attractive to many manufacturers and retailers.  The Offshoring movement accelerated as companies in a variety of industries followed their competitors abroad and moved manufacturing jobs to other countries.  The Great Recession was a further tipping point in the reduction of North American manufacturing jobs. Recent economic data suggest that manufacturing is slumping in the United States and Canada and it is being pulled down by drops in new orders and shipments.

The Asia outsourcing curve may be about to reach an inflection point.   Labour costs in China have been doubling every three years.  Changes in currency levels and energy prices have also altered the equation.  If one factors in labour costs, freight costs and the Total Cost of Ownership in bringing goods from China to North America, as compared to manufacturing them here, the TCO’s are expected to converge in 2015 according to Harry Moser, Initiative Founder at the Reshoring Initiative (http://www.reshorenow.org/), a non-profit organization based in Chicago, Illinois. 

Mr. Moser argues that about sixty percent of cost studies are flawed.  They do not reflect the full set of variables and the full range of costs involved in offshoring. 

The Reshoring Institute offers a free software tool (TCO Estimator) and a manual to perform detailed calculations and allow users to make informed decisions.  The cost model includes 29 cost factors.  Using a set of pull down menus, freight costs from 17 countries, duty costs and various risk elements, the TCO tool allows companies to make accurate comparisons. Mr. Moser indicated that the model is based on moving goods from China to Chicago and the calculations use in $U.S.  Upon questioning, he indicated that Canadian companies should be able to use the model and make the appropriate adjustments for moving freight to a major Canadian city (e.g. Toronto, Montreal). 

Results from a recent survey indicate that 61% of larger companies are considering bringing manufacturing back to the United States.  He listed a number of major corporations that are Reshoring at least some of their manufacturing back to the USA.  They include Caterpillar, General Electric, Ford, NCR and Master Lock.

The proxy battle at CP Rail is unprecedented in Canadian business since it resulted in the resignation of the company's CEO and 4 directors.  It is hard to recall another proxy battle in recent history that produced such a profound and dramatic result.

It is easy to discount what happened at CP Rail as the result of the work of a determined, experienced shareholder activist who was able to convince other shareholders that the company could achieve superior financial performance with a new executive team.  If that is the only takeaway from this “palace revolt,” that would be unfortunate.

From my perspective, there is so much more to learn from the changing of the guard at CP Rail.  The fact is that CP Rail was an “underperforming” company in its segment of the transportation industry for a long time.  A rail renaissance has been under way for more than a decade.  Smart investors like Warren Buffet and more recently Bill Ackman realized that there are only 7 class 1 railways in North America and that there are large barriers to entry.  As an oligopoly, the industry has huge pricing power.  As energy prices rise and driver shortages increase, rail transportation becomes a very cost and service competitive option to trucking.  Moreover, many truckers are converting much of their long haul and even medium haul (e.g. 500 miles) movements to rail.  The growth prospects for rail are excellent.

One cannot criticize the CP Rail CEO, a CP Rail “lifer,” who was ousted, and his team, as inexperienced railroaders.  One cannot criticize the chairman and the board of CP Rail as not being a “blue chip” group of experienced business leaders.  The “rub” is that this team did not keep pace with where the industry was going.  An inbred management team coupled with a “clubby” board did not produce results in line with other top performing railroads.  It took an activist investor to shake the tree to remove some of the apples.

The question is what would have happened at CP Rail if Bill Ackman had not come along?  How long would the company have continued to drift under its leadership team?  How many other public transportation companies are in the same position?

Carriers and the transportation media have laid out a compelling case as to why transport companies should be receiving rate increases in 2012.  As the Great Recession of the late 2000’s unfolded, shippers put significant pressure on their carriers to roll back their rates.  For many carriers, rates have not returned to pre-recession levels.  The driver shortage is putting upward pressure on driver pay.  Government regulations (e.g. CSA, HOS) are being cited as some of the causes for a shrinking driver pool.  Despite the recent easing in fuel costs, petroleum costs have also been on the rise this year.  The increased cost to purchase insurance and upgrade fleets are driving further cost increases.  Shippers are being told to accept the proposed rate increases to ensure they have available capacity if the economy begins to grow at a more rapid pace.

These are compelling reasons and the various Canadian and American rate indices suggest that shippers are consenting to rate increases.  What can shippers do to help mitigate these increases in their supply chain costs?

Here are a few suggestions.  In my last blog I outlined a number of steps that shippers should take.  These include looking inward at their current packaging, taking advantage of consolidation (e.g. combining small LTL shipments into larger shipments), modal conversions (e.g. over the road truckload to intermodal) and other related opportunities to reduce costs.

Every shipper should also look outward at the market rates for their freight.  An annual freight bid that goes to an extended range of carriers and logistics service providers is also a must to ensure the company is paying competitive rates.

The operating ratios of publicly traded transportation companies are easy to access.  While costs have certainly gone up for most transport companies, one of the “dirty little secrets” of the Great Recession is that many costs have gone down.  Many trucking companies parked equipment, reduced wages, changed their operations (e.g. switched some long haul trucking business to intermodal) and improved their efficiency.  In other words, they adjusted their cost base to correspond with their reduced volumes.  This begs the question of what level of increase should a shipper accept?

In the most recent Transportation Buying Trends Survey undertaken by Canadian Transportation & Logistics magazine, there is an interesting set of questions that pertain to fuel surcharges. Over 68% of shippers support the view that “fuel surcharges are necessary as long as fuel costs continue to be highly volatile.”  Slightly less than half of the survey respondents believe “carriers apply fuel surcharges correctly.”  Over 61% agreed with the statement that “fuel surcharges are a way for carriers to squeeze additional revenues from their customers to improve their profits.”  Over 55% of shippers support the view that “carriers should adjust their freight charges to market rates that include fuel surcharges and as a result simplify their billings.”

Perhaps the most interesting finding is that 25.8% of shippers have created their own fuel surcharge index.  Since I interact with both shippers and carriers in my daily work, I would like to weigh in on this topic.  This set of responses begs a few questions.  Should shippers be taking their precious time to create fuel surcharge indices and formulas?  How should shippers approach the topic of fuel surcharges?  What should shippers do to optimize their freight costs?  Here are my thoughts.

For shippers that use both private fleet and for-hire carriers, it is essential to be fully informed on all aspects of fuel costs and fuel surcharges.  Even for carriers that use exclusively third party carriers, there is a requirement to have some familiarity with the leading indices and the current surcharges being applied.  For Canadian and cross-border shippers, a subscription to the Freight Carriers Association of Canada’s weekly fuel calculation bulletin will provide you with one of the industry standards for LTL and truckload shipments.  For shippers that use intermodal service or are considering it in their freight programs, they should obtain a copy of the railway/IMC fuel surcharge formulas.  These differ (e.g. are lower) from the over the road surcharge numbers.

The next thing a shipper should do is to gain an understanding of the components of a freight rate.  One needs to understand that a carrier’s freight rate or tariff is based on several components.  There is the cost of pick-up and delivery, the line haul component, the cost for any special handling (e.g. residence, construction site deliveries, etc.) and of course, the fuel component.  For LTL and small parcel shipments, there are a number of other variables that come into play such as shipment weight, density, cube, packaging etc. 

Shippers need to understand that each carrier has its own mix of freight, its own fleet size and specifications (e.g. straight trucks, tandems, tridems etc.), its own head haul and back haul requirements in terms of both yield and volume and its own primary and secondary markets.  In other words, fuel costs and surcharges are a large piece of the puzzle but they represent one element of a carrier’s total cost structure.  At the end of the day, the carrier looks at each shipper’s freight and relates it to their costing model, business requirements, profit objectives and of course, market rates to determine their rate structure.