[Originally published in Supply Chain Practice (Cranfield School of Management), Volume 7, Number 2, June 2005 , pp. 58-67(10)]
Industry under pressure:
Logistics and Supply Chain represents a business function under pressure from many fronts. The realisation that elements of the supply chain are – or rather can be (or might once have been) – a source of competitive advantage has catapulted what was once the back-room part of businesses into the limelight. And this at a time when the economy and government have apparently conspired to add heat to the pressure – the growing shortage of drivers, the looming imposition of the Working Time Directive, road congestion charging (itself in response to the unacceptable levels of road congestion) and the proposed creation of emission levies all add to the challenge.
One response from major retailers is to seek factory gate pricing and to squeeze prices both on manufacturers and on logistics service providers (LSPs), resulting in paper-thin margins. Another is the formation of consortia both for buying and selling logistics services – the objective is to increase buying power on the one hand or for mid-sized suppliers to be able to compete more effectively with all but the largest players on the other. The jury is still out on the effectiveness of many of these, but there is ample evidence that this is not an easy route. The response none of us like to think about is the widespread closure or “streamlining” of LSPs and the accelerating pace of consolidation in the industry.
And yet despite the recognition of the fact that most companies do not exist in a supply chain but rather in a complex supply web, the importance of LSPs as active partners within this more challenging landscape is not well recognised. For example, how many manufacturers expect their LSPs to guarantee availability and price but will not themselves make any commitment on volumes or timing, and yet still are seeking regular price reductions and more exacting service level agreements?
There are some well-known and often discussed symptoms of the conflicting interests of buyers and sellers of logistics services, notably:
- Empty running – statistics vary but suggest that from 20-40% of vehicle miles are empty running, and the under-capacity figures bring this upwards of 60%. This is financially inefficient for LSPs, reducing their margins, despite being pressed by their customers to cut prices. In addition, there are the obvious deleterious effects on the environment – road congestion, fuel consumption, pollutant emissions.
- Fragmented supply – few fleets are large enough to completely handle any but small contracts, so subcontracting or managing multiple suppliers is inevitable. This means procurement is more complex, in that buyers must consider either building a patchwork of suppliers or entrusting large volumes to a lead provider who will subcontract out any volume that cannot be optimised into their own fleet.
- Though logistics buyers want high service and quality levels, they want to buy transport as a commodity. This is frequently fuelled by the desire to bring to logistics the disciplines and tools which have proven by Purchasing departments to be so effective in buying true commodity raw materials and indirect products from sugar to office supplies. The result is that price squeezing has become the focus of the purchasing process rather than finding optimal partners with the willingness, technology, management capacity and flexibility to engage in close working relationships.
- Business relationships between buyers and their LSPs are tenuous, not often based on partnership, with variable commitment or loyalty from either side. It would appear that many long-term relationships are based more on inertia and complacency than on clear benefits accruing to either or both parties. And yet it is almost a proverb that LSPs complain about the lack of real volume and the buyers complain about patchy service.
- LSPs find it difficult or impossible to make a meaningful profit on transport – they have to make margin on warehousing and value-added services. LSPs too often chase ANY traffic rather than the RIGHT traffic. LSPs find themselves under pressure to adopt mileage-based pricing because it makes it easier for buyers to compare bids – even though 100 miles in one direction will almost certainly mean an empty return, while 100 miles in another direction might have tie in with a full return load. Is it any wonder that suboptimal routing costs rather than earns, and that too much of the wrong kind of miles can literally kill a transport provider?
- Inadequate visibility – LSPs and buyers carefully guard their market knowledge, which means “optimisation” efforts fall far short of expectations. There are numerous optimisation tools available to help transport operators maximise loadfill and minimise dead miles. These range in cost from a few tens of thousands to telephone-number price tags. The hope of the purchasers is that somehow using such tools will cut their deadhead miles, ramp efficiency and generate better margins. But the best optimiser in the world will prove a disappointment if the traffic being routed is not optimal – all the tool will do is tell you faster that you are losing money on a lane or a network. For an optimiser to generate real efficiencies and hence real savings, the widest possible pool of traffic needs to be churned through the optimiser. But despite this being all but a truism, lack of wide market visibility is a perennial problem.
- Goods inbound and outbound are frequently treated as completely separate business processes, indeed frequently the transportation of goods in and out are managed by different people. Many manufacturers and surprisingly even distributors are missing out on potential operating efficiencies by not improving coordination of traffic between their goods in and out. In some instances, the opportunities will be limited – if your raw materials come in tankers and go out on pallets, there is only so much you can do. But although the same trailer that carries in pallets of flat cardboard packaging is often perfectly capable of carrying out pallets of finished product, yet it is remarkable how few companies seek to use the same LSP as their packaging supplier and to coordinate flows to suit.
- Product buyers or sellers operate independently from logistics. It is remarkable how frequently buyers in an organisation strike a fantastic deal with a supplier without considering the logistical implications of the deal. Adding a new supplier or a change in volume from an existing one, can have a disproportionate impact on whole product cost if the transport and/or storage requirements cannot be cost-effectively absorbed.
It should go without saying that all businesses need to make a profit – and at the very least to cover their costs. If a logistics supplier has to operate at a loss to win business from a manufacturer that is being squeezed by a distributor who is being price-crunched by a retailer, then a piece of the supply web will soon come apart – which we are seeing today. Likewise, it is in nobody’s interest for transport to be run inefficiently – the buyer, the provider, the environment and the public all suffer. Yet (we are told) customers demand lowest shelf prices, so retailers clamour for lower prices from manufacturers, and manufacturers demand price cuts from logistics suppliers, and the result is everyone wants the backhaul rate and not surprisingly transport buyers want their products moved when they want it moved, not necessarily when the carrier can offer a real backhaul.
The solution for transport:
In order to consider a broad solution, it is necessary to create a simplified model of the operational landscape and then push the model outwards into the more difficult cases to see how it performs at the margins.
At the simplest level, let it be assumed that most companies have been making efforts to purchase transport effectively and have pushed their suppliers to reduce prices to the point that margins are low. Further, let it be assumed that the LSP (or LSPs) that provide the service are making good efforts to route and load plan to achieve as high a level of efficiency as possible. These are subjective assumptions, and in any given set of buyer-seller pairs the parties will hold differing views of their validity.
In this situation, it is difficult to see how the buyer can expect the supplier to reduce prices just because they are asked – whether the charges are based on an hourly rate or a mileage rate, the LSP can demonstrate that they are operating to the scheduling demands of the buyer and hence are unable to improve efficiency. Unit-based charging (i.e. pallet rates), even when regionally based, serve only to obscure the real elements that make up the charge as the maximum distance or travel time within the region will be used rather than the real distance or time. If the supplier simply agrees to cut prices because the buyer demands it, eventually the “safety factors” of defensive pricing will be eroded to the point that losses become unacceptable and the supplier will break off the arrangement, go under or sell out to a larger player. Inevitably, this means a loss of choice. So it will be necessary to improve efficiency to cut costs.
Now let’s introduce an element of buyer-side load plan optimisation. The buyer uses a tool to identify where individual orders can be consolidated into larger consignments, or where a primary haul from factory to warehouse can be linked to an onward load to a customer. This can improve cost and efficiency considerably if
a) the better-optimised traffic pattern is reflected in the service purchasing process – the arrangement between the buyer and LSP must reward both parties for cost savings based on efficiency improvements, or the motivation to achieve them will be lacking
b) the predicted pattern is realised on a day to day basis – a pricing and service agreement based on assumptions that do not reflect what ultimately occurs will result in one or both parties being negatively impacted. Defensive pricing, service failures and imposed penalties are common outcomes
c) the better-optimised load plan from the company in question does not negatively impact the overall traffic plan of the LSP – the buyer can only optimise their own traffic, whereas the LSP must seek to optimise all of the traffic they handle, plus add in the traffic of potential new customers. The flow changes put forward by the buyer – which they have made efforts to optimise – might in fact disrupt the wider network calculated by the LSP, resulting in a net reduction in load fill, vehicle utilisation and lane efficiency.
If any of these is not true, then the benefits to at least one of the parties will be reduced.
Network topology and flow problems are now taught at A-Level in the UK school syllabus. Just as in statistics, there is a theoretical “universe” which if used in the calculations will result in the most accurate outcome of the calculations. Working with a sample or subset of the “universe” will result in a less optimal outcome; the smaller the sample the less certain or optimal will be the result.
So the simple solution is for all the traffic for all users of logistics to be thrown into a big pot and optimise it all and allocate it in perfectly apportioned and matching legs with little or no empty running and high service levels. That is the illogical extension of seeking greater visibility for optimisation. But the objective is valid.
In a recent discussion with a manager from a large manufacturer about pooling volume with other complementary companies, the reaction was surprising – he said he thought that the volume he would be offering LSPs would be so huge that they would not want any more and hence he would not get a better price. Although understandable, he was missing the point. Getting a price for 1000 loads from a supplier and expecting to get a better price by offering another 1000 loads on the same lane is not likely to achieve the objective – whereas finding that another manufacturer has 1000 loads coming back from the destination for your 1000 loads is what makes great margins for the LSP and great rates for both buyers. As would finding someone to use the two or three spare pallet positions you regularly leave empty in your “full” loads. Repeating this over hundreds or thousands of lanes and hundreds of thousands of movements is where the benefits of less empty running, reduced road congestion and emissions – not to mention reduced cost – can be achieved. It is only by enabling significant improvements in the efficiency of the transport fleet – as a whole – that real and sustainable transport price reductions can be achieved.
A question of attitude
So what will it take to put this into practice? The technology already exists and has for some time. The biggest barrier is attitudes – companies have to be willing to collaborate, and to expose their data to others. They have to be willing to adjust their tendering schedules to tie up with others; they need to form clubs of companies with similar but (ideally) opposite transport requirements. Collaborating with non-competing complementary companies is a growing trend.
More controversially, companies should consider collaborating with competitors. The argument goes like this – if it is true, as manufacturers like to say during negotiations, that moving a pallet from A to B is a commodity (not an argument being made here!), then it is not a source of competitive advantage. So why should two ice cream manufacturers with complementary transport flows and precisely the same handling requirements not collaborate to share a supplier for mutual benefit? By all means they can and should let brand values slug it out in materials purchase, production, in the marketing departments, on the billboards, TV and track-side at the Grand Prix, but perhaps it is time to take the fight off the streets.
There is growing evidence that senior management is responding positively to the siren call of the benefits of collaboration. The formation of the European Logistics Users, Providers and Enablers Group (ELUPEG, http://www.elupeg.com), a forum that has put collaboration in all forms at centre stage, is but one example of this. The key to overcoming the attitudes that inhibit wider collaboration is probably not therefore generating enthusiasm; rather it is sponsorship at the highest level. Board-level directors must be laying the ground rules, and empowering their teams to seek out and implement collaborative schemes. With this must come the recognition that not all parties to the collaboration will benefit equally, but that collectively there will be benefits both to the participants and to the wider public.
As well as needing a considerable attitude adjustment amongst the participants, this might entail some cooperation or clarification from legislators – anti-competition laws might need to be revisited in the interests of the environment and the customer, lest collaborating companies be accused of anti-competitive behaviour.
But there are simpler things that can be done without wholesale process re-engineering:
- Smarter working within organisations
- Integrate inbound and outbound flows – not everything will work, but efforts will be rewarded; think about inbound packaging for example.
- Optimise order patterns to maximise load fill – as on the standard school report, making good effort now but could always do more
- Stronger commitments between buyers and suppliers – work as partners not as adversaries; this might mean making some guaranties of volume in exchange for benefit sharing when either party finds an opportunity for collaborate that cuts real cost
- Seek good partners and then nurture them and do everything practical to make them successful. If an LSP is a good one, rather than force down their prices, go out and find them backhauls so that they can share the rewards with you and will want to continue to give you a great service. LSPs should try to share their customer’s objectives and efforts to achieve them – if your customer is making money and sees you as an important part of the process, they will fight to keep you as a supplier (even if they don’t let you see the fight).
- Transport procurement should be based on value not just price, with the objective being to find the best partners. Market coverage should be as wide as possible to achieve this, and companies should invest in finding partners that are smart enough to identify inefficiencies, to find workable solutions, and to implement those solutions to realise the benefits.
- If LSPs want to be viewed as selling more than a commodity, they need to invest in brainpower and technology, because the customers are doing so and it is vital that LSPs know more about their business than their customer does. Smart people with good tools can make massive improvements to operating efficiency. Even if margins cannot be significantly increased, the presence of brainpower could improve the saleability of the services being offered.
Although the preceding discussion used transport as the focus, many of the issues apply equally to other aspects of logistics – materials sourcing, warehousing, track & trace, payment systems, and even transport management systems can be shared, used in collaboration or purchased by groups to add collective value to an individual company’s investment, and maximum visibility in any of these areas widens the benefit.
In the 1990s, during the height of the IT boom, there was a phrase used to open the minds of aspiring entrepreneurs – “Collaborate or die”. The 90s are behind us, the IT boom is over, but the need to collaborate in the mainstream is greater now than ever.