Is “buying too low” a costly strategy?
Shippers frequently ask us about the timing of truckload procurement exercises. The answer we give often shocks people, because it’s so counterintuitive.
You might think that striking deals with carriers when the market is “down” results in great long-term savings. Not necessarily so. At least, we don’t think so.
It’s kind of like the stock market. Too often, day traders and other investors try to time the market and buy when they think it’s low. Research shows that is not a winning strategy, either.
Our research shows that when shippers negotiate rock-bottom pricing with carriers, they rarely end up capitalizing on those rates in the long haul. Certainly, a shipper can enjoy immediate savings that reflect the dynamics of the market at that particular moment. We can likely all agree on that.
However, this discussion is about when to bid. Too often, we see shippers who don’t want to conduct a bid procurement exercise when the market shifts and prices increase. The rationale is usually something along the lines of, “if I bid now, my carriers will take an increase.”
We agree that it’s possible, but we think a different scenario may be more likely.
Depending on your agreements, your specific procurement strategy and the overall marketplace, a shipper’2013-05-22 19:24:30’s Tier 1 carriers may very well have little to no incentive to accept tenders. As a result, the shipper is forced to move down to Tier 2 carriers — or lower. The shipper typically has to pay more, spend more time managing freight and endure significantly lower service levels.
Clearly, this is not always the case — but we think it is more often than not. If there is a sustained shift in the market place, shippers must address rates or potentially suffer through problems relating to capacity, cost and service levels.
It is perhaps one of the strongest arguments for why you need a TMS and business intelligence tools. As one of our senior process engineers says, “If you can’t measure it, you can’t manage it.”
Here’s why we think this is true:
Route Guide Leakage. Truckload contracts are quite different from most other acquisitions of products and services. In most agreements, there is a stated price and a quantity to be purchased and the agreement is executed over time. But with truckload agreements, while there is an agreed price, there is no guarantee of acceptance. If the agreed price is too low, it can affect the carrier’s decisions. Simply stated, if another shipper is paying more, carriers are likely to make their equipment available to them first. So, the shipper has a great rate, but little opportunity to capitalize on it. This forces the shipper to move to Tier 2 or 3 carriers, which adds cost and service level risk to the process. This phenomenon is often referred to as routing guide substitution or routing guide leakage.
Variability in Shipper Networks. Think about how much your network changes over the course of a year. Your suppliers, products, customers and output from factories and distribution centers are typically affected by economic conditions and changes in company strategy. As a result, the volume in specific lanes can change dramatically. This causes a loss of alignment between the shipper’s network and the carrier’s network. In a strong relationship, where the shipper and carrier are both satisfied with the agreement that’s in place, our research shows that carriers are more likely to adjust their capacity and their equipment allocation to accommodate changes in the shipper network. If the carrier is not happy with the pricing in place, what incentive do they have to accommodate the shipper?
Variability in Carrier Networks: Carrier networks are no more stable than shipper networks. Carriers continuously add and subtract customers; and the lanes they service for these customers change constantly. This variability creates new imbalances in carrier networks. From a pricing and availability standpoint, this can work in the shipper’s favor – or to their detriment. But trying to time this variability and capitalize on it is a losing proposition over time. The only way this can ultimately work in favor of the shipper is if there is a contract in place that motivates the carrier to strategically manage that variability. A contract with a rock-bottom price does not provide the right incentive for the carrier.
What About Spot Markets? OK, so shipper and carrier networks constantly change. And amid that constant change, there is a steady stream of opportunities to capitalize on exceptionally low rates or excess capacity. So, what about making spot buys? While a transactional approach should give you market rates on average, it creates other challenges:
- Lack of Commitment: With no long-term commitments to rates or volume, carriers have little incentive to provide exceptional service. You will be in transactional relationships, not strategic ones.
- Higher Transactional Costs: While the “price” of a transactional relationship might be lower, the real cost of a strategic carrier relationship is typically much better for the shipper. For example, simply using established systems to tender loads, pay carriers and track freight results in tremendous real savings.
- Lower Quality: In a strategic carrier relationship, there are tools and processes for managing quality (on-time delivery, etc.). Transactional carrier relationships typically lack the necessary tools, processes or incentives for quality control.
- Unwanted Price Variability: Just like in other markets — whether it’s oil, steel or wheat — spot market pricing is more volatile than long-term pricing. This makes budgeting nearly impossible.
What is the Right Answer? So, we’ve built a case for not trying to time the market — or capitalize on spot buys. Then, what do we recommend?
We believe in a process called Strategic Truckload Procurement.
OK, it’s not the most creative name. But we believe the thinking behind it is solid — and it results in deep savings and exceptional service levels over time.
Strategic Truckload Procurement is based on mutually beneficial relationships between a shipper and its carriers. Instead of simply driving for the lowest price, it seeks alignment between the shipper network and the carrier network. It also seeks alignment between the shipper’s and carrier’s business goals — and business outcomes.
Alignment over a sustained period of time is beneficial for the carrier and the shipper. If both parties can collaborate on a full-year plan using forecasts and modeling tools, there is a much greater chance of better chance of developing a win-win strategic relationship.
This strategy results in a fair price that provides the carrier with an incentive to accept loads and provide tools, processes and dedicated services that result in higher quality outcomes.
And while one year seems to be the right interval for alignment and price negotiation with carriers, we believe that sticking with carriers from year-to-year (where it makes sense) is critical. We also believe partnership is still part of the puzzle. Re-alignment with carriers — not constant carrier turnover — drives real savings.
While this research is encouraging, it’s not the final word. Our current plan is to research this topic more aggressively during the next 15 months. We plan to employ students from MIT to more fully research these concepts during the 2010 to 2011 school year. The result is to transcend perception and discover what really works for shippers