Achieving Organizational Goals by Understanding Truckload Pricing
Pricing is one of the more intriguing topics within the freight industry and often one of the most misunderstood. There are a myriad of variables and factors (political, geopolitical, weather, economic, etc) that impact freight costs both negatively or positively. The purpose of this blog post is to not pinpoint exactly WHY freight prices go up and down but to rather give more insight into how to think about these costs and the true impact they can have on your organization as a whole. In addition, we will look at a potential pricing model that can add transparency within your supply chain and encourage collaboration with your logistics vendors and partners, to help mitigate the constant pricing fluctuations.
In microeconomics, supply and demand is an economic model of price determination in a given market. Freight markets are certainly not exempt from these supply and demand principles. As freight volumes increase this creates more demand for trucks to haul the freight. If the demand is greater than the supply of trucks this will inevitably lead to higher freight prices. Obviously, no consumer wants to pay more than they need to for a product or service just as no consumer appreciates being ripped off. In our experience, the quickest way to spoil a healthy customer relationship is by taking advantage of that trust that has been given or earned. Money can often complicate things and a lack of transparency can then lead to mistrust. Once that trust has been broken it can be very difficult to repair and as a result, shippers are often reluctant to put all of their eggs in one basket in an effort to hedge their bets. Shippers will often play with different pricing models, bidding strategies, and even routing guides in order to find the best approach to alleviate the volatility that can be inevitable in a healthy marketplace.
Often the goal is to lower your freight costs and increase service at the same time, which is easier said than done as these two seemingly independent concepts are very much closely correlated. The old adage goes 'You get what you pay for' and this certainly rings true within the freight industry. We at Custom Pro Logistics are not naive to the fact that price is always going to be an important factor when making buying decisions or selecting transportation partners, but It is our belief that when these decisions are made solely on price can
lead to some unintended consequences. Which could ultimately cost your business much more in the long run. If your goal is singularly focused on reducing your overall freight spend then often sacrifices must be made on service, and at times this may be a perfectly acceptable tradeoff. If reduced costs come at the expense of on-time delivery, unreliable supply chains, and unhappy customers, maybe it is time to rethink your transportation goals and ensure they are aligned with broader company objectives.
It is our belief that the price you pay does go hand in hand with the service you receive. These costs are a necessary cost of doing business and can never fully be eliminated. The more goods you sell, likely the higher transportation spend you will have even if all things remained constant. If freight is sold as a delivered cost or F.O.B, ultimately someone is paying these transportation costs regardless if you are billing directly for them. Therefore your transportation costs should not be viewed as merely a budgeted line-item expense. This expense can not be arbitrarily reduced without impacting other fundamental aspects of your business, like sales or customer service. A study put out by The Aberdeen Group, a leading independent market research firm, found 83% of companies interviewed have become aware of this direct correlation and they do not see transportation as just an isolated budget item to be monitored. These companies recognize that not only cost, but service can have a dramatic impact on their overall supply chain performance. This fact became even more evident as global supply chains were stressed and interrupted during the Covid-19 global pandemic. It is important to not be penny wise and pound foolish when selecting transportation partners as it is critical to take into account the bigger picture impact of how short-term thinking can negatively impact your supply chain performance and ultimately the company as a whole.
With that in mind, let’s dive into a few concepts, address some often wildly misunderstood beliefs within the transportation/ freight market, and touch upon some buying strategies to ensure your transportation goals are congruent with broader Company Objectives.
COST-PLUS-LOGISTICS
In a highly volatile freight market logistics providers across the US and Canada have turned to a Cost-Plus model to not only provide transparency but build trust. Often when the price on a particular lane moves up dramatically from the previous or historic price, the initial thought might be that you are being misled or being taking advantage of. The Cost-Plus pricing strategy allows all parties to understand clearly what is impacting rates, understand why the costs are what they are, and allows for a better partnership. In this model, you calculate all current and potential fixed and variable costs and apply a percentage or predetermined amount on top of those costs for the service being provided. Some companies use this and provide a complete breakdown of their prices.
We recently spoke with professionalmover.ca. to understand how a Cost-Plus pricing model benefits them when determining the pricing for moving household goods. They were able to shine some light on the major advantages of this approach. “It is our belief that transparency allows buyers to make more informed decisions. More informed decisions will often lead to making more correct decisions that are aligned not only with overall company objectives, but also customer satisfaction.”
With the help of the Cost-Plus model, you are building a connection with your clients based on trust and understanding. You can justify your prices, and no one can tell you that the service is too expensive.
THE VOLUME DISCOUNT FALLACY
It is a commonly accepted practice that the more you buy something the better price you should receive. Volume discount pricing, or volume discounting, is a pricing method used by manufacturers or sellers that rewards customers who purchase more of a product or service with an increased discount. Essentially the more you purchase, the bigger the discount you should receive. Let’s dig a little deeper to understand why this typical correlation often does not exist within the full truckload market.
As we previously discussed, supply and demand economics is often the biggest factor when determining price within the truckload freight market. As often increased volumes do not necessarily correlate to better pricing, but why is this? It may seem a little strange, but let’s consider and view trucks as a commodity in order to wrap our heads around the volume discount fallacy within the truckload freight market.
A Commodity is a basic product or raw material used to make all the goods and services that we need in our everyday lives. Transportation costs therefore could be considered a raw material that goes into the cost of goods sold. You are unable to make the sale if you can not physically deliver the goods to the person buying it and therefore it is just another input costs. Commodity prices aren't set by a single individual or entity and may be traded on an exchange or marketplace. There are many economic factors and different catalysts that affect and move a commodity’s price each day. Supply and demand plays a big role in the way commodities are priced in the market. When supply is low, demand is high, this leads to higher prices. Prices drop when the situation reverses— supply is high and demand is low. This is very much akin to how the full truckload freight market operates in which freight rates are primarily determined by the forces of supply and demand.
For example, if the supply of oil increases, the price of one barrel decreases. Conversely, if demand for oil increases (which often happens during the summer), the price rises. It doesn't matter if you are buying 1000 barrels of oil, or 1M barrels of oil, if supply remains constant, there is no such thing as a volume discount. In fact, your increased demand for barrels of oil might end up having the opposite effect, resulting in prices going up and commodity inflation. So it should be understood, while increased volumes should always lead to an increase in total freight spend, it will not necessarily increase your ability to influence price positively in your favor just because you have increased volume, rates for a shipper may not necessarily improve.
While it certainly may be true that large shippers can influence price in their favor when negotiating directly with larger truckload carriers, It should also be understood that these price discounts to the market rate are not strictly the result of increased volumes alone. More often than not a tradeoff is made by shippers to carriers to receive this better pricing. Contracted rates with truckload carriers will often create consistencies in volumes and shipping patterns. These consistencies will often reduce risks that come with owning assets by allowing truckload carriers to better load plans. Better load planning will improve fleet asset utilization, reduce empty miles driven, and typically improve operating leverage. By essentially reducing risks and improving operating ratios, not only will the bottom line be impacted but this can also lead to predictable and steady growth for a carrier. A large truckload carrier may be willing to make the tradeoff for a cheaper contracted rate in exchange for increased stability and efficiency.
THE BOTTOM LINE
Increased volumes alone will not lead to better truckload pricing, increased volumes along with increased efficiencies can positively impact pricing and reduce volatility for both shippers and carriers alike. In order to figure out what might be the right price on a lane, it is important to research the market, get customer feedback, and consider how efficiently your supply chain as a whole is operating. Looking at the big picture and understanding what KPI’s you might not be hitting, you can work with your transportation partners to achieve the overall company objectives.
