On Total Supply Chain Costs vs Freight Rates
Disclaimer: This is not a quantitative analysis, but rather an opinion piece reflecting the perceptions and opinions of Sea-Intelligence management team, as expressed by the author. These pieces will become a regular feature, alongside our other, highly data-intensive products and publications.
Author: Bjørn Vang Jensen
In my last piece, I mused on the ongoing ocean freight negotiations. To be clear, air cargo negotiations are also ongoing, or about to begin, and in any other year, I’d have been knee-deep in those, too, at this point. Or perhaps, this year, neck deep. Because this is not, as I wrote last week, one of those easy years, in any freight mode.
Is that bad? Well, it depends on how you are measured, how mature your company is in terms of managing its supply chain, and also on your appetite for an adult discussion which is long overdue. And it’ll be hard, and you’ll have and/or (swiftly!) acquire enemies, and you might not even survive it. But is needs to be had.
But isn’t that the very nature of a fight (er, excuse me, “adult discussion”)?
In my opinion, it is not a bad thing at all, because, as a supply chain professional, this is one of those rare years when you are given an opportunity to voice what the former Vice President of the US, Al Gore, called an “uncomfortable truth”.
And that uncomfortable truth is this: Your freight costs are frequently (albeit not always!) a microscopically small part of your total supply chain costs. Feel free to dispute this but do be careful to have your arguments and your numbers really, really well prepared before you do! I’m not saying that I’ll dispute your numbers, or your argument; I’m challenging you to do it to yourself. That’s precisely what makes it uncomfortable, and discomfort drives reflection, hopefully followed by insight and progress.
Yes, there are commodities that might be exceptions, where ocean freight is a very large part of the Cost Of Goods Sold (COGS). But without wishing to in any way denigrate those commodities, which do play an important part in the world economy, in the context of this year, they are in the minority.
That’s just the way it is. There is a reason why, these days, if something is going from China to the US West Coast, the cost of ocean transport is anywhere from USD 2,500 to 7,000 per container, while something moving in the opposite direction still argues whether it should pay USD 250 or 225. Same cost of transport, same distance, same vessel, same container, same IT, same terms, same everything.
And that reason has a name: Contribution to Repositioning. In good years, when equipment is plentiful, and vessels are anyway half-empty, a carrier may as well make something towards the cost of moving that box back “home”.
But this is not that year. There is no equipment, and the potential profit from being able to use that box east-bound (or west-bound to Europe) ASAP is impossible to resist, for most carriers. And given that a normal TP westbound CY-CY rate probably doesn’t even pay for the initial crane move in Long Beach, let alone the one in China, then, in the words of Clint Eastwood, this year you’ve got to ask yourself, “do you feel lucky?”
Luck counts. But letting it all ride on Red, as it were, is probably not the smartest way forward this year, as much it might well be in other years.
This does, however, present us, as professionals in this field, with a rather pressing problem/question: If we accept (and we do) that most commodities do contribute positively to the overall economy (because otherwise, they would have long since ceased to exist, no matter which direction they move in, and no matter what their end-use is), then how do shippers justify doubling or tripling the freight cost year-over-year?
In this context, it doesn’t matter whether your freight is east-bound or west-bound, or for that matter whether your goods move between Asia and Europe or Asia and the US, again, in either direction. The numbers and contribution to the COGS themselves may differ, but the recent percentage changes in pure freight costs may not.
As always, a number of potential hypotheses present themselves:
- “Some sort of price gouging is taking place”. We’ve already dealt with that, in a recent issue of the Sea-Intelligence Sunday Spotlight, and we have found it to be untrue, at least in the sense that we cannot find evidence that carriers have deliberately removed capacity in order to drive up rates. The current situation is purely driven by supply and demand, specifically under-supply, and while that is unfortunate from a shipper’s standpoint, facts are facts.
- “The freight rates were always profitable”. That’s an extension of hypothesis # 1, and since we believe this to be untrue, then clearly, so is this. With the exception of a few trades, it’s been a long time since carriers made real money. Again, no apologies as a buyer, but – again, again – facts are facts.
- Companies are measuring individual supply chain cost elements, rather than end-to-end costs, in the process creating – by default – sub-optimization. As a company, you must look at the whole picture. Otherwise, you end up in the situation described by Benjamin Franklin:
“For the want of a nail the shoe was lost,
For the want of a shoe the horse was lost,
For the want of a horse the rider was lost,
For the want of a rider the battle was lost,
For the want of a battle the kingdom was lost,
And all for the want of a horseshoe-nail.”
There will no prizes awarded for guessing where I come down on this, but, unfortunately, the problem only starts there. Because many companies separate logistics management from supply chain management, which reminds me of one of those anecdotes I always like to throw into these pieces:
In the early 2000’s, I was sitting on (yet another) conference panel, this time in Kuala Lumpur. Sitting next to me was a very distinguished scholar from a very distinguished university, a giant among men in the field of supply chain management, an old teacher of mine, and someone for whom I have nothing but boundless admiration.
And he was asked a very simple question from a member of the audience:
“Dr. NN, can you articulate the difference between logistics and supply chain management?”
And the unforgettable reply:
“Well, for the last 20 years, I’ve been driving up Highway YY to the university, and at a certain point, nearly every morning for all those years, I’ve passed a truck going in the opposite direction. When I first encountered him, the livery on his truck read, “Fred Smith Transport”. I noticed, at some point in the late 90’s that the livery now read, “Fred Smith Logistics”. Now, when he and I wave to each other, his livery has changed again. It now reads, “Fred Smith – Your Partner in the Supply Chain”.
“But it’s still Fred driving that truck”.
I don’t think I really need to belabor the point, but just in case: No matter how you slice and dice it, there is no supply chain without logistics, nor the other way around.
In fact, there is no such thing as a “supply chain”, if you define a “chain” as something linear, where one link connects to the next, and to no others (chain mail armor doesn’t count, don’t even try!). It has a beginning and an end. If such a thing really existed in the world of logisticians, it would indeed be a beautiful thing to behold – for a nerd like me, anyway - but it doesn’t.
What we really have are supply webs, and those are very, very different. Go ahead and mentally picture a simple chain versus a spider-web. The latter is how your, and virtually any other, company, actually functions!
What makes a web so different from a chain? Simple: If everything were formed into chains, the cost at every change in link would be (relatively speaking, anyway) easy to measure. A web, on the other hand, depending on its density and structure, by definition represents an immense increase in complexity, and a corresponding level of increased complexity in determining what happens when you tinker with it.
People are rarely afraid of cutting a chain in order to swiftly insert a stronger link. Actually, smart people try to fit in the new link before cutting the old one, but that’s a subject for another piece. But place one single cut anywhere in a web, and results can very quickly change in ways - and in locations - you never imagined!
This could be - and indeed has been – the subject of entire books; for now, however, suffice it to say that you have immense opportunities within that web for optimizing your company’s costs, far beyond freight costs alone, and this would be an excellent opportunity to take that fight. Think:
- PO management costs
- Supply chain management IT costs (or indeed lack thereof, which is worse!)
- Warehousing costs (and how many warehouses you have vs. how many you need)
- Inventory financing costs (oh, you thought those were just balance sheet lines?)
- Demurrage and detention costs
- Warranty- and reverse logistics costs
- Insurance costs
- Brokerage costs
- Inland transport costs
- Minimum order quantities (see “inventory carrying costs” above)
- Consolidation-, LCL-, air cargo-, premium ocean freight- and courier-costs
- The cost of employing armies of people to manage all those inefficiencies (careful: This is where you might encroach on someone else’s empire and incur serious wrath…)
An international player within the Fortune 500 would expect the sum of all these costs to add up to something like 10% of its top line. If you’re a globalized company, then 7-8% is considered world-class. Report anything below that only if you’re prepared to prove it to some very skeptical analysts.
Sadly, however, very few companies, in my experience, have ever even attempted to measure it, or have given up early on.
Why? Because that information is almost never readily available. Not because anyone has ever actively tried to hide it, but because the supply chain has, at least until recently, never been a priority in all but a handful of companies.
As a result, all, or nearly all, of the costs mentioned above sit inside a little catch-all bag many companies like to call “landed cost”, comprised of raw material cost + conversion cost + “all those other ones”. Freight sits somewhere in there, too, as well it should, but since it is usually negotiated separately, and is therefore far more visible (at least once a year), it sometimes gets a disproportionate amount of attention.
Freight, while important to all those of us who have made our living in this field, is, frankly, almost an afterthought! That’s not to say that freight doesn’t have an impact. If that’s the impression you’re left with, then I’m equally disappointed in you and in myself. All costs matter!
But the fact is that if you have chosen to move large parts, or indeed all, of your supply base to the other side of the world, then freight costs are not your prime concern. Freight availability, however, very much is!
After all, if you are trying to sell your wares in Manchester, that’s highly unlikely to happen if they’re still sitting quay-side in Shanghai.
Do feel free to disagree. I absolutely LOVE discussion. That’s how progress is made, after all, and I do not hold a patent on the truth. But if you do, then please be as ready to be challenged as I am. Because I’ve never in my life walked away from a discussion, if I thought it was worth taking, and I aim to keep it that way.
Next week, we will be taking a look at the Forrester-Effect on global supply-webs. You have a whole week to Google it.