Best Practice: Fleet Cost Management



By Dr. Barry Lawrence, Texas A&M University



Senthil Gunasekaran, Texas A&M University










Pradip Krishnadevarajan, Texas A&M University



Transportation is a key wholesale distribution function, in terms of cost and customer service. In some lines of trade, distributors spend more than a third of their gross margins on transportation services. Optimal transportation management is essential to maintaining profitability and gaining a competitive advantage. It carries an even greater importance when you own or lease your transportation fleet. Although private fleets are more expensive, they are sometimes necessary for providing quality customer service. The various processes in transportation management are shown in exhibit 1.



Key findings from a transportation study conducted by Texas A&M University in collaboration with FedEx for the Industrial Supply Association in 2006 (Texas A&M, FedEx, and ISA, 2006), are as follows:

• Cost ranked first. Cost was the top concern regarding the transportation function then and for the next three years, superseding customer service and reliable delivery times. Cost was the most important factor in choosing a transportation provider.
• Technology investment should be leveraged. Technology had finally come to transportation, as many survey respondents said they were using some sort of shipping system. However, most respondents did little more than process orders or pass along invoices and material safety data sheets. Far fewer used IT for any other function, including tracking carrier performance.
• Planning makes a difference. Companies with a formal strategic plan for their transportation function outperformed others. After analyzing the data, one key variable pointed to both a low transportation cost and high customer service level: having a plan for the transportation function. Those respondents with a transportation plan reported lower transportation costs as a percentage of revenue and a higher on-time delivery rate than those companies without a plan.

Compounding these findings, companies that had transportation plans had, on average, more movement of product from supplier to customer than those companies without a plan—a fact that should have resulted in higher transportation costs.

The NAW Institute for Distribution Excellence book, Optimizing Distributor Profitability: Best Practices to a Stronger Bottom Line (available at http://www.naw.org/optimizdistprof), details best practices, their implementation, and ROI. These practices are valid in any economy, but the significance of one best practice versus another may change under different market conditions. Each month in this blog, we have been introducing a best practice and how it can improve earnings and/or ROI under current economic conditions. We encourage readers to ask questions, debate results, and offer their own experiences with such practices so that we may further the knowledge of the community and the understanding of the science of distribution.

The book breaks business processes into seven groups (SOURCE, STOCK, STORE, SELL, SHIP, SUPPLY CHAIN PLANNING and SUPPORT SERVICES) based on various distributor asset categories as shown in exhibit 2. This month, we focus on the SHIP group. The SHIP group has seven processes, and we are discussing “fleet cost management” in this blog post.




Best Practice: Fleet Cost Management

An automotive distributor delivered parts to car dealerships. Their market-entry strategy was to provide two same-day deliveries for metro customers/dealers. Over time, the distributor’s inventory management practices deteriorated due to the market strategy. The dealers began relying heavily on the two same-day deliveries and stopped stocking a wide range of parts. This raised the question about the benefits of the two same-day deliveries service; whether it contributed to additional revenue or led to an enormous increase in safety stock / inventory at the distributor’s warehouses. In order to understand the impact of two same-day deliveries service, the distributor began focusing on fleet cost management.

In general, a fleet cost management process consists of two analyses: cost per mile (CPM) analysis and break-even analysis. The practice levels for this process are as follows:

COMMON practice: 1) No CPM calculation is performed 2) Cost groupings at asset level

GOOD practice: 1) Measurement based on major cost categories such as leasing and fuel

BEST practice: Comprehensive methodology that defines two major cost components: 1) Fixed components—leasing, depreciation, insurance, misc., and 2) Variable components—fuel, driver salary and benefits, maintenance, rental

Let’s first look at CPM analysis. This process focuses on identifying cost per mile components and determining the contribution of each component. Best practice recommends data be input into the system to track the following metrics for better decision making:

• Fixed cost breakup
• Leasing: tractor and trailer
• Depreciation: tractor and trailer
• Insurance
• Miscellaneous: licensing, citations, taxes, and so on
• Variable cost breakup
• Fuel
• Driver salary and benefits
• Maintenance: tractor and trailer
• Rental

Both fixed and variable costs are a part of CPM analysis. Considering these costs separately (fixed and variable cost components) can be helpful in designing any cost control measures. CPM analysis is important because this metric drives many critical decisions, such as owning a fleet versus using a third-party carrier. This number can be used to benchmark the firm with the industry. A sample breakup of cost per mile components for a building materials distributor is shown in exhibit 3.



Now, let’s look at break-even analysis. This provides information about the number of miles that has to be traveled by private fleet vehicles to equal the cost of for-hire service. This information allows you to determine which option (private fleet versus for-hire) is most cost effective. A major challenge is that all these analyses are unique to each organization, depending on their business processes. Proper consideration should be given to the level of customer service required, transportation costs, and benefits. Exhibit 4 compares the cost of a private fleet (for company X) with the available cost per mile market rates from various carriers (ranging from 1.25 to 2.25) based on a break-even analysis of one firm’s freight data. The initial investment for the private fleet is indicated as the fixed cost. It also indicates the number of miles that have to be covered in case there are various carrier selections. For instance, company X’s cost line crosses the cost line of a carrier (providing 1.75) at 53,474 miles. This shows that the carrier rate is economical if company X plans to drive less than 53,474 miles. In general, it would be beneficial for a firm to benchmark itself against the market and improve accordingly.




Getting a Handle on 3PL Costs

A large distributor serving small contractors found transportation management to be especially challenging. The distributor maintained its own fleet, but also hired trucking services for deliveries that cost millions of dollars. Company managers found it nearly impossible to keep track of the transportation carriers that the branch operations staff called on, and they also questioned whether their freight bills were accurate. Freight bills are often inaccurate for a few reasons:

• Carriers are often under contract to give a firm discounts under some sort of schedule. However, many times the freight bill may not reflect these discounts.
• If a product carries a lot of risk—for example, it is high-value, fragile, contains hazardous materials, and so on—the freight carrier charges a higher rate. Often, warehouse people will lose the distinction between different rates and send all products at a higher than necessary rate.

To prevent paying excessive freight bills, this distributor employed an outside specialist to do freight bill auditing. The process eliminated a lot of expensive errors. Soon the auditing firm began negotiating freight contracts for the distributor, since they had developed expertise in working with the trucking firms. Questions arose soon, however, when branches discovered that the only freight errors the auditing firm was discovering anymore were from trucking companies that had not signed contracts with them. Trust began to erode between the distributor and the auditing firm and in time the relationship broke down.

Capturing 3PL costs and tracking metrics is vital in transportation management. The opportunity to create cost savings exists whether transportation is outsourced or not, and distributors are among the world’s largest transportation customers. Not understanding cost structures and how to manipulate routes will decrease net margins. Distributors need to apply more science to this practice.

About this Blog

“Managing in an Uncertain Economy” is a blog created by the Council for Research on Distributor Best Practices (CRDBP). The mission of the CRDBP, created by the NAW Institute for Distribution Excellence and the Supply Chain Systems Laboratory at Texas A&M University, is to create competitive advantage for wholesaler-distributors through development of research, tools, and education. CRDBP encourages readers of this blog to send in comments and e-mail this blog to other interested parties.