7.5 The Economics of Transportation

Transportation vehicles (e.g., trucks, railcars, airplanes, and containers) can only carry so much weight. To illustrate this point, let's take a closer look at how weight affects trucking. By law, the weight a tractor-trailer combination can carry is limited. In the U.S., the typical "big rig" can weigh 80,000 pounds. When you subtract the weight of the tractor and the trailer, you end up with about 45,000 pounds for freight. Once you hit your weight limit, something we refer to as "weighing out," you need to split the load across two trailers, use specialized equipment, or petition for a special permit to carry a heavier load. Each option increases your costs. In addition to the capacity issue, remember that heavier shipments require more energy, and fuel, to move. Fuel is usually the second highest operating cost for a carrier.

Figure 7-6 illustrates the weight-based cost/price curves for a truckload (TL) carrier and a less-than-truckload (LTL) carrier. Let's take a closer look at the cost curves:

• Truckload Costing: Because TL carriers dedicate an entire trip to a single customer's freight, they charge a flat rate for a given distance. This is true whether you ship 30,000 pounds or 45,000 pounds. You are buying the entire trailer. Of course, heavier loads burn more diesel fuel, but the carrier factors this reality into the flat rate.

• Less-than-truckload Costing: Because LTL carriers use the trailer's capacity to handle multiple customers' freight, they charge a variable rate based on how much your shipment weighs. You pay for the portion of the trailer's capacity that you use. LTL rates, however, start with a flat minimum charge. The minimum is based on the fact that regardless of how much your shipment weighs, the carrier incurs pick-up and delivery costs. Once you exceed the minimum charge, your rate goes up, but at a decreasing rate (this is known as the tapering principle). The carrier and you both benefit from economies of scale gained with shipments of increasingly greater weight.

Which shipping option should you use? At about 15,000 pounds, the two cost curves cross. That means that for lighter shipments, you should use LTL and for heavier shipments, you should use TL. As you compare your options, do the analysis to calculate the precise breakeven point.

Transportation vehicles can only hold so much volume before they are full. Once you fill a trailer, referred to as "cubing out," you need to split your load across two trailers. Figure 7-7 shows the volume-based cost/price curves for a truckload (TL) carrier and a less-than-truckload (LTL) carrier. These curves should look familiar because the cost/price story is essentially the same as for weight.

• Truckload Costing: TL carriers charge a flat rate because you are buying the entire trailer. The carrier doesn't care whether you fill the entire trailer or just a little corner.

• Less-than-truckload Costing: LTL carriers charge a variable rate because they're concerned with how much space you take up in the trailer. The more space you use, the less space is available for other customers. The LTL carrier charges you a minimum fee for small shipments. Once the amount of space you require surpasses a minimum, price increases, but at a decreasing rate—just like with weight.

Which shipping option should you use? For smaller shipments, use LTL; for larger shipments, use TL. You do, however, need to crunch the numbers to find the precise breakeven point.

Our preceding discussion highlights two tradeoffs you need to remember:

• LTL Opportunity Costs: Your consumption of a trailer's weight and space capacity reflects an opportunity cost for an LTL carrier that will be passed along to you.

• Weight versus Cube: What do carriers—whether TL or LTL—sell? Answer: Their capacity to move product. In other words, they sell either weight or cube. If you are shipping cotton, you will "cube out" the trailer before coming close to the weight limit. If you are shipping beer, you will "weigh out" the trailer before coming close to filling the trailer. Carriers set their prices to maximize their revenue based on the tradeoffs between weight and cube.

Distance affects transportation rates differently from weight and volume. As a rule, as distance increases, costs, and the rates you pay, go up. However, don't expect a really cheap price if you simply want to move a load across the street. The carrier will charge a minimum fee for pick-up and delivery. Figure 7-8 shows how different types of carriers account for distance.

• Truckload: TL carriers charge a flat minimum rate for short distances. As distance increases, the price will increase at a decreasing rate. Note that distance is the first driver that influences TL costs and rates.

• Less-than-Truckload: LTL carriers charge a flat minimum rate for short distances. As distance increases, the price will increase at a decreasing rate.

• Zone-based Small Package: UPS and FedEx charge in a stepwise fashion as distances increase.

• Conventional Parcel: U.S. Postal Service charges a flat rate regardless of distance—across town or across the country. If this seems like a good way to lose money, you're right.

Carriers consider factors beyond weight, volume, and distance when they assign products something called a "freight classification" that helps set shipping rates. Table 7-3 identifies common product- and market-related factors that shape freight classifications and the prices you pay for transportation service. You can count on one thing: Anything that systematically drives costs up increases rates.

• Product Factors - Consider stowability, meaning, can the items be stacked or nested such that vehicle space can be better utilized? Ease or difficulty of handling is also critical. So too is the level of liability that the carrier assumes with any loss or damage affects. Value, fragility, and level of hazard all impact liability. High freight classifications penalize you for increasing carrier costs. You should expect to pay more if your product has a low density, poor stowability, is hard to handle, and makes the carrier responsible for risk.

• Market Factors - Market-related factors come in two shapes and sizes: Factors that affect costs and factors that affect bargaining power. Let's first look at factors that affect costs:

  • Regulation: Complying with regulations—whether they focus on safety or pollution—increases carriers' costs. They pass these cost increases on to you.

  • Location: Some places cost more to deliver to than others. For instance, in urban settings, congestion and regulation can make a carrier's life miserable—and expensive. By contrast, remote rural areas often mean the carrier will end up moving an empty trailer back to its next load. Empty backhauls raise costs—and prices.

    International shipments also tend to be more expensive—and not just because of longer distances. You have to understand complex import/export rules, fill out more documents, and pay numerous duties and other fees when your shipment crosses international borders.

  Now, let's consider factors that influence bargaining power.

  • Competition: If only one carrier serves your market, your bargaining position is weak and you can expect to pay more. When this happens, you are said to be a "captive shipper."

  • Balance of Freight Flows: When an equal amount of freight flows back and forth between two points, carriers can earn revenue coming and going. The result: Both fronthauls and backhaulsTerms that indicate the freight flows back and forth between two points. A move from A to B is the fronthaul. A move from B to A is the backhaul. are full—and rates are lower. When an imbalance occurs—like when a large trade imbalance exists—carriers have to make enough money on the fronthaul to cover all of the empty miles (called "deadhead miles") on the backhauls.