Supply Chain Currents Part I: Is there a different way to move freight more effectively?
This is the first of two columns that visits the concept of “index-based variable-rate pricing” as a way to establish more market stability for both shippers and carriers.
Moving freight consistently and economically can be challenging for all players in the supply chain game. Frequently it’s subject to volatile swings in market pricing, particularly in the truckload and airfreight segments.
The way shippers and carriers historically have behaved is often to the detriment of both parties over the long-haul. The key elements don’t change: assets (trucks, ships, planes, terminals), labor, and fuel.
Changes in these operating costs do affect the market, but the radical swings in pricing and allocation of capacity are commonly driven by the disparity between shipment volume and available transportation capacity: too much freight versus carrier capacity, prices rise; too much capacity versus volume, prices drop. No mystery here.
There’s been a long-running game where the party with the leverage exercises it to the extent they can. When capacity is tight, freight rates rise, as carriers try to harvest value while they can for as long as they can. When there’s over-capacity, freight rates drop as shippers press their advantage and carriers do their best to hold market share.
This kind of boom-and-bust behavior is hard on everyone, yet nobody has broken the cycle in any significant way. While this is endemic in all modes, to varying degrees, this column is focused on domestic truckload.
After deregulation, establishing contracts was thought to be the answer—but never really solved the underlying problem. Virtually all agreements have sufficient wiggle room that either party can opt-out or ignore provisions when the opportunity arises. If market rates rise and contract rates are low, trucks become harder to find. If market rates fall, shippers seek alternatives at better prices.
Typically, due to real or perceived risk, neither party is willing to put sufficient teeth in the agreements to prevent this, and so the pattern continues. This can wreak havoc on transportation budgets for shippers and in allocating capacity and resources for carriers. The disruption occurs when capacity becomes tight, as volumes rise. This drives up rates, which often means many carriers move capacity into other spots to harvest the higher rates.
This leaves the shipper with loads they can’t cover without going to the spot market at higher rates, which clearly disturbs operational and financial planning. We’ve actually seen instances where carriers turned down load tenders at the contract rates, only to reappear later with sufficient power to cover the loads at the spot market price.
Network play
During my 30-plus years of transportation consulting with Andersen/Accenture, Transplace and Breakthrough Supply Chain, we did many sourcing and procurement projects, helping our shipper clients—and some 3PLs—with their efforts in seeking optimization of their freight transportations networks.
Our process at Accenture was to dispense with the notion of transportation “bids.” In our view, the word “bid” connoted a rate-shopping exercise and not much else versus a comprehensive, holistic look at the entire multi-modal network of freight and how to make it more efficient for both shippers and carriers.
We sought to produce a stable and optimized situation, based on the power of over-lapping networks of freight flows and capacity, of which price, of course, played a key role. The objective was improving service and capacity management and simultaneously amping-up carrier efficiency by reducing empty miles in the process. This helped the shipper get the best prices and service because the carriers were hauling freight on lanes that were more attractive to them.
Equally, the carriers did well because they became operationally more efficient, with fewer empty and deadhead miles, ending up with freight that better fit their network operations. Empty miles are akin to the “angel’s share” in wine-making—it’s what leaks away and affects productivity and profitability, with no upside.
Why is this important for carriers? Empty and deadhead miles can wreak havoc on an otherwise good operation: The costs continue, without countervailing revenue. This is a bogeyman that has plagued trucking since well before deregulation in 1980. Despite all the advances in operational capabilities, performance analysis and technology, nothing has, so far, materially jarred the ogre looming over every dispatcher.
In a 2019 article, one-time high-flyer Convoy reported: “Survey estimates from the mid-1970s—the earliest published estimates that we could find—suggest that between 20% and 30% of miles driven by freight carriers at that time were empty. It appears that empty miles fell slightly by the late 1990s: Survey results from the late 1990s and early 2000s put empty miles between 15% and 18%. But, there appears to have been no sharp improvements since then: Surveys from the past half-decade also put empty miles in the range of 15% to 20%.”
So, is there any way to move the needle and change this? Perhaps. During what we now call the “good old days” prior to the pandemic, common practice was the nearly-ubiquitous “annual bid.” These were shipper-driven efforts to tap the market and attempt to generate savings. When the market became substantially more volatile, the notion of fixed contract rates, typically good for a year, became more of a fairy tale than a reality.
Networks were just too fluid: Shippers had to deal with changes in their networks as new customers came on board and some old customers vanished; and distribution centers opened, closed or relocated and product volumes shifted with customer demand.
Carrier networks were equally volatile, in large part, as a result of what was happening with their shipper customers and partly because of changes in freight flows—losing backhauls, gaining headhauls, adding new customers and losing old ones, with rates fluctuating as the struggle to maintain growth in volume and profitability continued.
True optimization
Some people claimed to execute bids in a very short time (30 days to 60 days). Our typical sourcing and procurement activity aimed at more comprehensive and holistic redesigning of the procurement and contracting processes, with the objective of producing true network optimization. Timing typically ranged from three months to nine months, depending on scope, scale, and complexity, although this has tightened up more recently.
We utilized the leading-edge optimization technology, based on mixed-integer linear programing, which allowed us to collect data and run an almost unlimited number of constraint-based scenarios. We took great care in designing RFI/RFP documents, particularly with respect to contract design for service structure and provisions.
These documents, when carefully engineered, can be used to streamline and improve terms and conditions that may have been ineffective or onerous, and updating provisions, such as freight payment, fuel management/recovery and accessorial charges that reflect market realities.
Traditionally the single sticking point has been guaranteeing price stability. If you think of deals between shippers and carriers as trading commitments of volume for commitments of capacity, the tricky part is the key critical variable of price. If a shipper wants a carrier to guarantee a rate for a 12-month period, the carrier inevitably needs to hedge against unforeseen market pressures, which usually takes the rate above the prevailing market rate, making such deals unattractive.
“Both parties have key, core interests they seek to protect in the best way possible. Shippers want product picked up and delivered on time at a price that’s as stable and economical as possible. Carriers want to be sure their assets and employees are being utilized at a high level with an attractive and profitable price.”
Shippers likewise have challenges committing volumes of freight when their market and orders fluctuate. They don’t want to be caught in a “take-or-pay” circumstance, should volume fall or even vary significantly. Both parties can gain a greater element of market stability if they can trust each other enough to deal in good faith, with the over-arching goal of improving service to customers, which deserves to be the ultimate objective of both parties.
Both parties have key, core interests they seek to protect in the best way possible. Shippers want product picked up and delivered on time at a price that’s as stable and economical as possible. Carriers want to be sure their assets and employees are being utilized at a high level with an attractive and profitable price.
Of course, the market has been so volatile in recent years that the ritualistic process of the “annual bid” is unworkable. No matter how long a shipper takes to execute a sourcing event, it’s functionally out of date before the ink is dry, as the speed of change in the market shifts capacity and price rapidly.
During my time working with shippers on projects to source and optimize all modes of transportation across a shipper’s network, we moved away from the practice of annual contracts to developing a comprehensive network reset, augmented with “mini-events” as circumstances warranted to continually tune the network to market realities.
Generally, the main goal as a shipper is to ensure I can move all of my product, with good service, at a competitive price. I also need to be able to predict operating costs for proper budget compliance.
As a carrier, I’m focused on keeping my expensive assets (trucks and drivers, ships and crews, or planes and crews) as well-utilized as possible, preferably at the best rates I can get. So, how can these often-contradictory goals be reconciled so both parties feel they’re being treated fairly and simultaneously mitigate volatility, which is the bane of both shippers and carriers? •
In Part II, coming in April, we’ll present some thoughts and analysis on a different way of approaching this age-old problem—index-based variable-rate pricing.
