Chapter Two

Transportation Management
Transportation is critical to logistical performance. Today a wide range of transportation
alternatives are available to support product or raw material logistics. Transportation is a very
visible element of logistics. Consumers are accustomed to seeing trucks and trains transporting
product or parked at business facilities. Few consumers fully understand just how dependent our
economic system is upon economical and dependable transportation.

Transport Functionality

Transportation enterprises provide two major services: product movement and product storage.

Product Movement:

Whether in the form of materials, components, work-in-process, or finished goods, the basic
value provided by transportation is to move inventory to the next stage of the business process.
The primary transportation value proposition is product movement up and down in the supply
chain. The performance of transportation is vital to procurement, manufacturing, and market
distribution. Transportation also plays a key role in the performance of reverse logistics.
Transportation consumes time, financial, and environmental resources.

Transportation uses time resources because product is generally inaccessible during the
transportation process. Product captive to the transport system is referred to as in-transit
inventory. Naturally, when designing logistical systems, managers strive to reduce in-transit
inventory to a minimum. Transportation also uses financial resources. Transportation cost results
from driver labor, vehicle operation, capital invested in equipment, and administration. In
addition, cost results from product loss and damage. Transportation uses environmental
resources both directly and indirectly. In direct terms, transportation represents one of the largest
consumers of fuel and oil. Indirectly, transportation impacts the environment through congestion,
air pollution, and noise pollution.
Product Storage

A less visible aspect of transportation is product storage. While a product is in a transportation

vehicle, it is being stored. Transport vehicles can also be used for product storage at shipment
origin or destination, but they are comparatively expensive storage facilities.

Transportation Economics and Pricing

Transportation economics and pricing are concerned with factors and characteristics that drive
cost. To develop effective logistics strategy, it is necessary to understand such factors and
characteristics. Successful negotiation requires a full understanding of transportation economics.
An overview of transportation economics and pricing builds upon four topics: (1) the factors
that drive transport costs, (2) the cost structures or classifications, (3) carrier pricing strategy,
and (4) transportation rates and ratings.

1. Economic Drivers

Transportation costs are driven by seven factors. While not direct components of transport
tariffs, each factor influences rates. The factors are: (1) distance, (2) volume, (3) density, (4)
stowability, (5) handling, (6) liability, and (7) market. In general, the discussion sequence
reflects the relative importance of each factor from the shipper's perspective. Keep in mind that
the precise impact of each factor varies based on specific product characteristics.

Distance: Distance is a major influence on transportation cost since it directly contributes to

variable expense, such as labor, fuel, and maintenance.

Volume: The second factor is load volume. Like many other logistics activities, transportation
scale economies exist for most transportation movements. The management implication is that
small loads should be consolidated into larger loads to maximize scale economies.

Density: A third factor is product density. Density is a combination of weight and volume.
Weight and volume are important since transportation cost for any movement is usually quoted
in dollars per unit of weight. Transport charges are commonly quoted as amount per
hundredweight (CWT). In terms of weight and volume, vehicles are constrained more by cubic
capacity than by weight. Since actual vehicle, labor, and fuel expenses are not dramatically
influenced by weight, higher-density products allow relatively fixed transport costs to be spread
across more weight. As a result, higher density products are typically assessed lower costs per
unit of weight.

In general, traffic managers seek to improve product density so that trailer cubic capacity can be
fully utilized. For example, Kimberly-Clark was able to reduce transportation expense by
reducing air contained in paper products. Such compression increased product density.

Stowability: Stowability refers to how product case dimensions fit into transportation
equipment. Odd package sizes and shapes, as well as excessive weight or length, may not fit well
in transportation equipment; this results in wasted cubic capacity. Although density and
stowability are similar, it is possible to have items with similar densities that stow very
differently. Items having rectangular shapes are much easier to stow than odd- shaped items. For
example, while steel blocks and rods may have the same physical density, rods are more
difficult to stow than blocks due to their length and shape. Stowability is also influenced by
other aspects of size, since large numbers of items may be nested in shipments whereas they may
be difficult to stow in small quantities. For example, it is possible to accomplish significant
nesting for a truckload of trash- cans while a single can is difficult to stow.

Handling: Special handling equipment may be required to load and unload trucks, railcars, or
ships. In addition to special handling equipment, the in which products are physically grouped
together in boxes or on pallets for transport and storage will impact handling cost.

Liability: Liability includes product characteristics that can result in damage and potential
claims. Carriers must either have insurance to protect against possible claims or accept financial
responsibility for damage. Shippers can reduce their risk, and ultimately transportation cost,
by improved packaging or reducing susceptibility to loss or damage.

Market: Finally, market factors such as lane volume and balance influence transportation cost.
A transport lane refers to movements between origin and destination points. Since transportation
vehicles and drivers must return to their origin, either they must find a backhaul load or the
vehicle is returned or deadheaded empty. When empty return movements occur, labor, fuel and
maintenance costs must be charged against the original front-haul movement. Thus, the ideal
situation is to achieve two-way or balanced movement where volume is equal in both directions.
However, this is rarely the case due to demand imbalances in manufacturing and consumption
locations. For example, many goods are manufactured and processed on the East Coast of the
United States and then shipped to consumer markets in the western portion of the country;
this results in more volume moving west than east. This imbalance causes rates to be generally
lower for eastbound moves. Movement balance is also influenced by seasonality, such as the
movement of fruits and vegetables to coincide with growing seasons. Demand location and
seasonality result in transport rates that change with direction and season. Logistics system
design must take such factors into account to achieved backhaul movement whenever possible.

2. Cost Structure

The second dimension of transport economic and pricing concerns the criteria used to allocate
cost. Cost allocation is primarily the carrier's concern, but since cost structure influences
negotiating ability, the shipper's perspective is important as well. Transportation costs are
classified into a number of categories.

Variable: Variable costs change in a predictable, direct manner in relation to some level of
activity. Variable costs can only be avoided by not operating the vehicle. Aside from exceptional
circumstances, transport rates must at least cover variable cost. The variable category includes
direct carrier cost associated with movement of each load. These expenses are generally
measured as a cost per mile or per unit of weight. Typical variable cost components include
labor, fuel and maintenance. On a per mile basis, the carrier variable costs range from $.75 to
$1.50 per vehicle mile. The variable cost of operations represents the minimum amount a carrier
must charge to pay its day-to-day bills. It is not possible for any camer to charge below its
variable cost and expect to remain in business long. In fact, rates should fully cover all costs.

Fixed: Fixed costs are expenses that do not change in the short run and must be serviced even
when a company is not operating, such as during a holiday or a strike. The fixed category
includes costs not directly influenced by shipment volume. For transportation firms, fixed
components include vehicles, terminals, rights-of-way, information systems, and support
equipment. In the short term, expenses associated with fixed assets must be covered by
contribution above variable costs on a per shipment basis.
Joint: Joint costs are expenses unavoidably created by the decision to provide a particular
service. For example, when a carrier elects to haul a truckload from point A to point B, there is
an implicit decision to incur a joint cost for the back-haul from point B to point A. Either the
joint cost must be covered by the original shipper from A to B or a back-haul shipper must be
found. Joint costs have significant impact on transportation charges because carrier quotations
must include implied joint costs based on considerations regarding an appropriate back-haul
shipper and/or back-haul charges against the original shipper.

Common: This category includes carrier costs that are incurred on behalf of all or selected
shippers. Common costs, such as terminal or management expenses, are characterized as
overhead. These are often allocated to a shipper according to a level of activity like the number
of shipments or delivery appointments handled. However, allocating overhead in this manner
may incorrectly assign costs. For example, a shipper may be charged for delivery appointments
when it doesn't actually use the service.

3. Carrier Pricing Strategies

When setting rates to charge shippers, carriers typically follow one or a combination of two
strategies. Although it is possible to employ a single strategy, the combination approach
considers trade-offs between cost of service incurred by the carrier and value of service to the
shipper.

Cost-of-Service: The cost-of-service strategy is a build up approach where the carrier establishes
a rate based on the cost of providing the service plus a profit margin. For example, if the cost of
providing a transportation service is $200 and the profit markup is 10 percent, the carrier would
charge the shipper $220. The cost-of-service approach, which represents the base or minimum
for transportation charges, is most commonly used as a pricing approach for low-value goods or
in highly competitive situations.

Value-of-Service: Value-of-service is an alternative strategy that charges a price based on value

as perceived by the shipper rather than the carrier's cost of actually providing the service. For
example, a shipper perceives transporting 1000 pounds of electronics equipment as more critical
or valuable than 1000 pounds of coal since electronics are worth substantially more than the coal.
As such, a shipper is probably willing to pay more for transportation. Carriers tend to utilize
value-of-service pricing for high-value goods or when limited competition exists.

Value-of-service pricing is illustrated in the premium overnight freight market. When FedEx first
introduced overnight delivery, there were few competitors that could provide comparable
service, so it was perceived by shippers as a high-value alternative. They were willing to pay
$22.50 for overnight delivery of a single package. Once competitors such as UPS and the United
States Postal Service entered the market, rates dropped to current discounted levels of $5 to $10
per package. This rate decrease more accurately reflects the value and cost of this service.

Combination Pricing: The combination pricing strategy establishes the transport price at an
intermediate level between the cost-of-service minimum and the value-of-service maximum. In
practice, most transportation firms use such a middle value. Logistics managers must understand
the prices and the alternative strategies so they can negotiate appropriately.

4. Rates and Rating

The previous discussion reviewed key strategies used by carriers to set prices. Building on this
foundation, this section presents the pricing mechanics used by carriers. This discussion applies
specifically to common carriers, although contract carriers utilize a similar approach.

Class Rates: In transportation terminology, the price in dollars and cents per hundredweight
to move a specific product between two locations is referred to as the rate. The rate is listed
on pricing sheets or on computer files known as tariffs. 'The term class rate evolved from the
fact that all products transported by common carriers are classified for pricing purposes. All
product legally transported in interstate commerce can be shipped via class rates. Determination
of common carrier class rates is a two-step process. The first step is the classification or grouping
of the product being transported. The second step is the determination of the precise rate or price
based on the classification of the product and the origin destination points of the shipment.

Classification: All products transported are typically grouped together into uniform
classifications. The classification takes into consideration the characteristics of a product or
commodity that will influence the cost of handling or transport. Products with similar density,
stowability, handling, liability, and value characteristics are grouped together into a class,
thereby reducing the need to deal with each product on an individual basis. The particular class
that a given product or commodity receives is its rating, which is used to determine the freight
rate. It is important to understand that the classification does not identify the price charged for
movement of a product. It refers to a product's transportation characteristics in comparison to
other commodities. Motor carriers and rail camers each have independent classification systems.
Products are also assigned different ratings on the basis of packaging. Glass may be rated
differently when shipped loose, in crates, or in boxes than when shipped in wrapped protective
packing. It should be noted that packaging differences influence product density, stowability,
and damage, illustrating that cost factors discussed earlier enter into the rate-determined process.
Thus, a number of different classifications may apply to the same product depending on where it
is being shipped, shipment size, transport mode, and product packaging.

One of the major responsibilities of transportation managers is to obtain the best possible rating
for all goods shipped, so it is useful for members of a traffic department to have a thorough
understanding of the classification systems. Although there are differences in rail and motor
classifications, each system is guided by similar rules; however, rail rules are more
comprehensive and detailed than those for motor freight. It is possible to have a product
reclassified by written application to the appropriate classification board. The classification
board reviews proposals for change or additions with respect to minimum weights, commodity
descriptions, packaging requirements, and general rules and regulations.

Rate Administration: Once a classification rating is obtained for a product, rate must be
determined. The rate per hundredweight is usually based on the shipment origin and destination,
although the actual price charged for a particular shipment is normally subject to a mini- mum
charge and may also be subject to surcharge assessments. Historically, the origin and destination
rates were manually maintained in notebooks that had to be updated and revised regularly.
Today, rates are provided in diskette form by carriers and the administration process is typically
computerized.

Historically, the published rate had to be charged for all shipments of a specific class and
original destination combination. This required frequent reviews and maintenance to keep rates
current. Following deregulation, carriers offered more flexibility through rate discounts. Now
instead of developing an individual rate table to meet the needs of customer segments, carriers
apply a discount from class rates for specific customers.

Commodity Rates: When a large quantity of a product moves between two locations on a
regular basis, it is common practice for carriers to publish a commodity rate. Commodity rates
are special or specific rates published without regard to classification. The terms and conditions
of a commodity rate are usually indicated in a contract between the carrier and shipper.
Commodity rates are usually published on a point-to-point basis and apply only on specified
products. Today, most rail freight moves under commodity rates. They are less prevalent in
motor carriage. Whenever a commodity rate exists, it supersedes the corresponding class or
exception rate.

Exception Rates: Exception rates, or exceptions to the classification, are special rates published
to provide shippers lower rates than the prevailing class rate. The original purpose of the
exception rate was to provide a special rate for a specific area, original destination, or
commodity when either competitive or high-volume movements justified it. Rather than publish
a new tariff, an exception to the classification or class rate was established. Just as the name
implies, when an exception rate is published, the classification that normally applies to the
product is changed. Such changes may involve assignment of a new class or may be based on a
percentage of the original class. Technically, exceptions may be higher or lower, although most
are less than original class rates. Unless otherwise noted, all services provided under the class
rate remain under an exception rate.