Below is an abstract of “Fuel Surcharge: A Shipper’s Perspective,” a GEP whitepaper. Click here to download the complete paper.
An Uncontrollable Cost – that is the general consensus amongst companies on fuel surcharge. The volatility in fuel prices over the past few years has not help to alleviate the issue either. This article provides an overview on fuel surcharge and suggests strategic and tactical measures to get a handle on the spend.
Fueling the Problem
The US Energy Information & Administration (EIA) expects the world liquid fuel consumption to increase by 1.5 million billion barrels per day in 2011. The problem is further compounded by the disruption of oil supply and unrest in Middle East and North Africa regions contributing to higher oil prices. In the past, excess capacity and competition had prevented a large portion of these costs from being passed from carriers to shippers.
With less-than-truckload (LTL) freight carriers implementing complex variations of fuel surcharge rates based on weight of the goods, distance travelled and other factors, shippers today can no longer afford to ignore the issue and need to proactively seek out opportunities to achieve savings by establishing a greater control on fuel surcharge expenditure. GEP suggests a two pronged approach consisting of both strategic and tactical measures to mitigate this rise in costs.
1. A Solution Framework Addressing Fuel Surcharge
Figure 1: Solution Framework for Fuel Surcharge
1.1 Strategic Measures
By collaborating with the carriers, a shipper can analyze and determine ways through which they can ensure appropriate shipment charges and thus achieve a lower fuel surcharge cost.
1.1.1 Understand shipping characteristics
Develop a profile of your outbound and inbound shipping for three years. Many times there are assumptions made which prove flawed and change the actual versus budgeted costs. The carrier will have their own data collection forms but these are the types of data the carriers will use to develop your pricing proposal and estimate their profitability. By analyzing these data, you may also determine the opportunities for improvement.
Strategic Measures Tactical Measures
Figure 2: Developing a Shipping Profile
Once the shipping profile is in place the approach would be to analyze existing carriers, identify their strengths and most efficient lanes, and then match-up with the shippers existing distribution pattern to achieve efficient freight cost and lower fuel surcharge cost.
1.1.2 If Suitable, Negotiate an FAK Rating
Shippers should negotiate FAKs (Freight All Kind) rating. FAK negotiations allow for shippers and carrier to agree on either a single commodity classification to be used, or tiers of classifications to be used for their product. Companies that ship different classes of freight can better negotiate a set class with a carrier irrespective of the actual class of the freight are. FAKs are a sure method to offer huge savings as freight is frequently reclassified by a freight carrier, resulting in higher pricing adjustments.
1.1.3 Use Pool Distribution
Another effective strategy to ensure fuel efficiency is “Pool Distribution”. Taking advantage of significant volumes, shippers and carriers can work together to create “pool distribution” points, where shipments are “pooled” to a carrier's distribution center, then shipped out from the center to the final destination. This method can help the carrier and shipper avoid expensive line haul and break-bulk costs.
1.1.4 Use Regional Carriers
Using Regional carriers is an effective strategy because they operate more efficiently and have less overhead. Thus, they can be extremely competitive when it comes to pricing. They often have fewer surcharges and rules than national carriers. There usually exists a win-win relationship between the regional carrier and the shippers as the carrier benefits by increasing lane density, the shipper benefits by reducing its overall expenditure.
1.1.5 Leverage Regulatory Measures
In January 2008, the Surface Transportation Board removed anti-trust immunity from the freight classification and rate bureaus to collectively set freight classification and LTL rates, which both determine your final cost. This ruling encourages competition. The last year of jointly-determined rates was 2007. Typically, carriers pay a fee to subscribe to standardized base rates and shippers typically pay a fee to use these base rates.
1.1.6 Ensure Carrier Fuel Economy
Shippers need to work with the carriers to specify equipment designs that promote fuel efficiency. As much as drivers may disapprove, governing speed may be an effective fuel economy device. Paying careful attention to preventive maintenance such as oil changes, tire pressures, and use of the right lubricants and additives offers gains in fuel economy of about one percent. Reduce engine idling by increasing throughput for loading and, and providing facilities for drivers to wait for loading and unloading. Pay drivers by the activity and not by the hour, incenting them to hustle.
1.2 Tactical Measures
In depth analysis of the Pricing models of carriers directly to ensure that carriers are not making undue profits though fuel surcharge programs
1.2.1 Ensure Due Diligence
Before negotiating pricing with the carriers it is important to understand the value of your business to the incumbent as well as other carriers. Try answering the following questions:
1. Will your business qualify as a national or key account?
2. What are the local market conditions and competition for volume?
It is important to study the carrier management reports as well as year to date package volume, billings (revenue) by month this year and last year. Another key data point is the revenue per package shipped from which the carrier will judge their profitability.
1.2.2 Leverage Price Indices
The DOE publishes indices for five regions: East Coast, Midwest, Gulf Coast, Rocky Mountain and West Coast. Since 1994 the average difference (basis) between the National Average and the Gulf Coast has been about 5-cents per gallon. In other words, the Carrier's actual fuel cost per gallon in a region may be quite different than the national average index. To avoid this, tie fuel surcharge schedules to appropriate regional price indices.
1.2.3 Counter Profits from Fuel Surcharge
If shippers accept carrier-offered fuel surcharge programs blindly without investigating the underlying elements such as actual miles per gallon, they end up inflicting higher prices on themselves. If a shipper can leverage his volumes then the company's surcharge can be applied on a 'per mile' basis instead of being expressed as a percentage of the line haul transportation charges.
1.2.4 Cap Fuel Surcharge for Long Term Contracts
Depending on their capacity carriers will agree to a cap on fuel surcharges; i.e., if the cost of fuel reaches a certain level and beyond, the carrier will cap the fuel surcharge for shippers willing to negotiate long term contracts. This will give additional cost certainty. Also having a fuel-hedging strategy arrangement with the carrier shall lower the overall average fuel spend.
1.2.5 Auditing is important
Just like auditing line haul costs on freight invoices, it is also important to audit fuel surcharges. Assuring that you have a quick payment discount is one easy and automatic method of cost reduction. Routine auditing of your invoices is critical to ensuring that you are invoiced correctly and that the carrier is performing to contractual service levels. It is conceivable that an audit of your invoices might identify invoice errors of 4% or higher in the carrier's favor.