The Basic Logic of Freight Terms
The following discussion may be remedial for part of our audience, so please allow me to apologize up front for the following simplified treatise on freight terms. I carry the scars of many a skirmish from my time in the logistics trenches where people who should have understood the nuances of freight terms did not. So for the benefit of those who may not know about the freight terms I will quickly explain.
There a 3 sets of freight terms used typically here in the United States.
- FOB origin - Collect: Loosely translated as the title of ownership of the freight transfers at the seller stock and the buyer arranges and pays the freight cost. (In modern INCOTERMS this is EXW – Ex-Works).
- FOB destination -- prepaid and add (PPD&ADD): where title of ownership transfers at the buyer's stock, the seller arranges and pays the freight and charges the buyer for the freight on the invoice. (There really is not an INCOTERM for this very popular term).
- FOB destination – prepaid (PPD): where the title of ownership transfers at the buyer stock, the seller arranges and pays for the freight and the freight cost is a rolled into the price of the merchandise. (INCOTERM DDP).
Converting freight terms under the first two examples is easy; just change the purchase terms. In fact, with a PPD&ADD program, IF the buyers has a transportation management team they should evaluate the sellers freight charges against their own costs and decide if making a switch will save money.
But with the 3rd there is a rub: you have to negotiate with your supplier and get an allowance for that freight cost. In many cases vendors shipping under prepaid pricing are providing that transportation service to a large number of customers, small customers, that do not have their own transportation departments. As the retail environment has changed and more and more large chain stores have grown to where they have created their own distribution networks there's been a growing pressure on vendors to change their terms.
When vendors are pressured to give an allowance on PPD terms they will often argue that the removal of that buyers freight volume will drive their transportation costs up, a cost that will have to pass along to the rest of the customers. “It’s not fair to our other customers,” is an argument that I would hear when I was running a logistics organization and we converted terms. My response at the negotiation table would be “where is it written that life is fair?” I referred to this argument as the "socialized freight" argument and that "socialized freight" is almost as bad as "socialized medicine". I would drive on stating “that as a capitalist I don’t understand why my company should have to support the profit line of our competition.”
I would challenge the vendor with the claim that the removal of my freight volume would change the “marked up with margin” rates that the vendor would pay. I suspect that Wal-Mart is facing the same resistance as my past teams did as WalMart Vice President of Corporate Transportation Kelly Abney said he was running in recent articles.
In the long run the buyer really dictates the terms so you could say "resistance is futile" on the part of the vendor. In some cases (far more than you would imagine) the challenges come from within the retailers own organization with friction between the logistics and merchandising teams. In many retailers the merchandise managers don't understand the cost of transportation and sadly enough believe what the vendor's representation tells them over that of their own company’s logistics team. I doubt that that is an issue at WalMart since the merchandise category managers are compensated on the net margin dollars that their product lines produce.
The strategic goal of all of this tactical effort to convert freight terms is traditionally thought as a “buying strength” argument where the large retail company with their superior transportation buying power is able to move the freight at a lower cost than the vendor. The same argument is sometimes used by the vendor that is much larger than the retailer against terms conversion. I have seen more than once that “size” does not equal “pleasure” where large companies costs were higher than the smaller customer.
If the goal of the effort to covert terms is focused on creating additional net profit dollars for the buyers company, the tactic is considering just a singular strategic goal being accomplished; not a high-efficiency tactic following the Drucker rule.
More Freight = Lower Rates is not Always True
As I mentioned above, bigger is not necessary better – more does not automatically mean less.
With more of the inbound freight volume under their control WalMart could be in a position to command better rates from their carriers, but I really doubt that is the strategy they have in mind with the initiative. Wal-Mart is already a huge shipper. The sheer number of shipments that come in and out of the WalmMart distribution centers is staggering. Approximately 315,000 inbound loads are delivered to Wal-Mart distribution centers every month More than 3.7 MILLION ANNUAL inbound deliveries. Of those inbound deliveries approximately 115,000 per month are shipped freight terms Collect, about 37%. The new goal is to convert the other 200,000 inbound loads per month.
Stop and think about the number of inbound loads Wal-Mart already controls. 115,000 loads of month is 1.4 million loads a year. Any shipper controlling that kind of volume already has effectively levered a large buying power pricing position with rates. Would more than doubling the freight volume create more significant rate reductions just because of size? I think the idea that by muscling up even more volume to hammer rates may be a little presumptuous. There must be other strategies being addressed with this effort.
Other Strategic Goals?
There must be additional net profit dollars to be gained with WalMart converting the rest of its inbound over to collect freight terms. Wal-Mart invested in multiple supply chain management software platforms, including Transportation Management Systems (TMS), EDI, Dock & Yard Management (YMS) and with help for MIT is busy knitting these platforms into a enterprise system. Converting terms requires a substantial long-term analysis and negotiation effort. Managing the movement of over 450,000 truckloads a month requires a substantial trained and experienced staff. This will not happen overnight and there is not an easy task in any of these efforts.
You could make the argument that with proper systems and processes that Wal-Mart will build a large enough critical mass to drive higher levels of efficiency into the freight management task. But just because something is bigger does not necessarily drive more efficiency into the operation. We industrial engineers understand this very well under the law of diminishing returns. At some point the additional effort needed to manage all of that freight movement effectively may require more input per-unit been managing only half of the total freight movement. The return on the freight “margin” and the rate negotiation strength is not enough to offset all of these investments – so there has to be more returns.
I suspect that there's even more savings, even more efficiencies brought to the entire supply chain when WalMart takes complete control of the transportation network. And I believe that these efficiencies will provide WalMart with the ability to deliver on a host of other strategic results that they have promised the world.
We will delve into these efficiencies next week in this space.
What is your take on this take on WalMart's plan to control all its inbound freight? Let us know your thoughts at the Feedback button below.
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