Tuesday, February 17, 2009

How to Save a Fistful of Money - Stephan Brackertz

Everybody is looking for ways to save money these days. But where can we find large savings opportunities? Try your service-parts supply chain. Specifically, look at transportation.

Transportation represents a sizeable cost category, about 40%-50% of our supply chain costs. It is also often home to poor cost management. Our NASPC supply chain cost benchmarks shows that the highest cost companies pay up to three times as much for transport as the lowest cost companies. And this is not just a function of business model. Carlisle’s transport rate benchmarking shows that shipment cost per kilogram varies by a factor of 150% – 300% for the same weight and same route. Hmmm.

That is a stupefying result, because economists would tell us that “perfect competition” should characterize this industry (transportation is a commodity, there are many competitors, companies are efficient, and profits for transport companies should be low). This is puzzling considering we hear stories about exploited Eastern European truckers driving 20 hour shifts and poorly maintained trucks that amount to driving time-bombs. How is it possible then that we are paying too much for transport and transport companies are getting fat?

The answer lies in industry structure and transport management.

On one hand, the industry players are smart. In the 70s and 80s, transportation consolidated to create 5 big transport and courier companies worldwide. They told us that global reach provides one-stop shopping and that size means lower costs. We (and other industries) built these companies up to a powerful oligopoly with strong negotiating power. Heavy equipment companies have surely heard the argument that they need to pay more due to their “smaller size”.

The transport oligopoly is also smart. Rather than competing strongly on price, they have created an environment of intransparency that makes it virtually impossible to compare prices – almost as bad as the cell phone industry 1 . In the jungle of cell phone plans it is close to impossible to compare prices. Transport companies have created a myriad of different pricing schedules including variables like geography, weight, order type, and delivery speed. They quote us on rate per kg, per load meter, per cubic meter, and per drop. Of course, when transport companies calculate these “simple” quotes they add a safety cushion in order to maintain these rates at least for a while. Our service-parts are riding on that comfortable safety cushion every day.

On the other hand, we OEMs are at fault for not performing transportation management as forcefully as we should have. We have not been monitoring and measuring as much as we should. If we outsourced transport, we have “unlearned” our competencies over time. We do not ensure that transport companies have aligned incentives. If transport companies are paid on a formula of “per X shipped”, why would they want to reduce X? The simplistic method of having the carrier quote the rate (per kg, per drop) also makes us do stupid things rather than thinking about the true economic cost of transportation. For example, if we are quoted per kg, we try to max out on the other variables that are not part of the formula we are billed on (distance, drops, frequency). Transport companies know this and in defense add an even greater safety cushion to their rates.

Well then, how can we save costs? We have both an operational and a strategic lever. Here’s what works…

On the operative side we can:
  • Perform real carrier management: Set-up a dedicated group – hire crack transport analysts from the industry that are willing to rock the boat.
  • Put metrics in place: Start really measuring transport carrier performance (on-time delivery, transport damage, false invoices).
  • Perform freight audits: Audit what you are being charged compared to what the carrier negotiated rates say. You may be surprised by what you find.
  • Figure out your true costs: Use transport simulation tools to identify what you should be paying.
  • Renegotiate rates: Negotiate carrier rates down. Use benchmark data to back up your case. Use brute force where needed.
  • Align incentives: Renegotiate incentives with carriers so that there is an incentive for them to reduce costs (e.g. share the savings).
  • Tell the carrier what to do: OEMs have to do the in-house analysis of savings potentials and tell the carrier what to do (there can be incredible savings from simply correcting poor consolidation).
  • Introduce competition: If you have only one transport company, introduce a hungry underdog in a market/region.
  • Go to open book: Go to open book accounting with cost plus compensation, or set up a transport joint venture giving you visibility to true costs.
  • Review your transport mode policies: For example, are you using airfreight for referrals or sheet metal where it is not necessary?
  • Leverage synergies between inbound production volume and outbound service-parts: Understand if you can use the return haul capacity of our outbound dealer transportation to transport inbound volume from suppliers.
On the strategic side we can:
  • Question your transport service level: Work backwards from end-customer and dealer needs to service level implications.
  • Question your order types and associated terms & conditions: Use conjoint research and dealer value proposition simulation to design new terms.
  • Question one-size-fits-all: Consider segmenting service level by customer, part criticality, by order type, by country.
  • Simulate the future: Use simulation to reach a more holistic optimization of transportation (e.g. strategic stock deployment, inventory levels, RIM).
  • For heavy equipment: Consider rolling transport cost back into the order terms of the parts. Centrally administer transport for all distributors / dealers (global vs. local optimization)

In truth, however, we don’t like touching the supply chain too much. We like status-quo. We hesitate. Our supply chains are big and complex, there are risks in changing. There will be objections such as “never touch a running system.”
However, with a good plan, even the biggest task seems possible. An example:

The Frankfurt airport is one of the world’s largest airports and it is operating at its capacity limit. In 2006 it recognized a need to renovate one of its landing strips. The only way to do it without crippling the airport was to renovate piece-by-piece during the night. Each night the last plane would land at 21:00. Then, a construction crew of 70 vehicles tore apart 2,200 square meters of tarmac, cleared it out, and repaved to airport standards – all in time for the first flight to land again at 06:00 the next morning. As if this wasn’t challenging enough, the newly paved surface also had to have cooled to 70 degrees Celsius to allow flights to land. The nightly 9-hour working window only had a tolerance of about 10-15 minutes. Over a period of 38 nights, 90,000 square meters of tarmac were renovated. The operation was a success.

Maybe we are being too conservative. Maybe there are ways to change the supply chain piecewise? With a pilot project, or bit-by-bit… This particularly seems to be possible for transportation management.

1 Harvard Business Review June 2007: Companies And The Customers Who Hate Them

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