June 14, 2010
News


Or, what happens when the big gorilla grabs all the bananas?

Wal-Mart Stores recently started an initiative to take control of the inbound transportation of products from its vendors to its own distribution centers and, in some cases, direct to its own stores.

As reported by Bloomberg, Kelly Abney, Wal-Mart’s vice president of corporate transportation, indicated Wal-Mart would take over deliveries of inbound freight where they can reduce costs.

The fight for control of inbound freight is hardly new. Most large retailers and consumer packaged goods manufacturers have routinely fought over this for several decades. Typically, the larger of the two “gorillas” will win control of the freight. Wal-Mart’s initiative, however, is different mainly because of the size of its ambition. Its initiative is affecting all consumer packaged goods manufacturers that supply Wal-Mart, which is essentially the same thing as saying every consumer packaged goods manufacturer.

But the initiative raises two interesting questions regarding the role of freight management on a company’s core operations. First, will the addition of inbound freight benefit Wal-Mart? And second, will the loss of control of outbound freight hurt the affected manufacturers? Let’s look at each in turn.

As to whether this will benefit Wal-Mart, the answer is an immediate “yes.”

First, the company will only take on those lanes of traffic it can manage at a lower cost than it is currently experiencing. And with a private fleet of more than 6,500 trucks, Wal-Mart has a lot of new opportunities to fill in its private fleet network.

As any retailer knows, at a distribution center, the outbound lanes to stores generally are high volume, and they are very stable and predictable. Inbound lanes from vendors, however, generally are lower volume and more variable. By picking which inbound lanes to control, Wal-Mart will be able to better balance inbound and outbound flows and build more stable and robust private fleet tours.

Finally, one can view this as a first step by Wal-Mart to begin taking complete control of the company’s inbound freight to include pickup location. Imagine the benefits if they could take control of the transportation all the way back to the point of manufacturing — not just the point of U.S. distribution.

All in all, the additional inbound freight should significantly reduce Wal-Mart’s average cost per load across the network. This assumes, of course, that Wal-Mart’s internal systems and processes are robust enough to handle this increased volume without the need to hire additional personnel.

The second question is whether the manufacturers will be harmed by the loss of outbound freight. The consensus in the business and transportation press seems to be that the manufacturers will face increased costs on their remaining business when the Wal-Mart volume is removed. I believe the answer is not that clear, however. To understand this, we need to look into the underlying economics of truckload transportation.

The pieces of the network Wal-Mart is targeting are, for the most part, long-haul full truckload shipments. Most vendors are moving these loads using contracted, for-hire truckload carriers rather than private fleets.

Truckload, as opposed to less-than-truckload and ocean, is driven by high variable rather than fixed costs. The primary cost drivers are the length of haul and location of the pickup and delivery. In analyses conducted by MIT’s Center for Transportation & Logistics and by the supply chain analytics firm Chainalytics in recent years, we have quantified the impact of these and other underlying factors.

The analyses, part of Chainalytics’ Model Based Benchmarking Consortium, found the length of haul of each shipment explains between 70 and 80 percent of the variability of truckload rates, while the origin/destination, or what we call regional, factors explain between 10 and 15 percent of the rate variability. These regional factors are capturing the additional cost associated with backhaul/front-haul moves.

That is, the cost to move from, say, Chicago to Miami will be lower if the carrier also has a load from Miami back to Chicago. These differences in regional values demonstrate that truckload shipping experiences a high degree of economies of scope. These economies of scope explain why shippers look for continuous moves in their daily operations and use “expressive,” or package, bids when procuring truckload services.

The question, however, is whether removing a lump sum of volume from a network leads directly to higher average transportation costs across the remaining network. If so, this would imply truckload exhibits economies of scale. But in our analyses over the last seven years of more than $10 billion in annual truckload shipments from more than 70 shippers, we have found no indication of networkwide economies of scale in truckload.

Simply put, a firm that buys more truckload transportation does not necessarily see a lower average cost per shipment. This is different from LTL and ocean transportation, where we have identified and quantified the presence of economies of scale. This makes sense because these modes are driven more by fixed costs shared across shipments. The key difference here is that truckload carriers are dominated by economies of scope, not scale.

This means vendors need to look at the specific lanes and locations being affected. We have found economies of scale only exist within corridors (not across a network). The impact is generally felt for those lanes where there are infrequent shipments.

For example, if a vendor has a lane where the volume after removing Wal-Mart’s freight falls from, say, 10 loads a week to one or two a year, then there will probably be a higher cost for shipments on that lane — although there will only be one or two shipments a year on that lane. However, if the lane volume is reduced from, say, 10 loads a week to five loads a week, the impact on a cost-per-load basis is less than a dollar a load.

Of course, there are some mitigating cases. If a vendor uses its own private fleet for these moves, if the lanes are part of multistop truckload shipments, or if the Wal-Mart volume is driving trailer pool size, there might be other impact.

For the general case where the vendor is using for-hire truckload carriers, the effect is more questionable.

The bottom line is that because truckload shipping is driven more by economies of scope than by economies of scale, the impact of losing volume is not always clear. Each vendor needs to examine how its own network will look on a lane-by-lane basis with the Wal-Mart volume removed because this is how the economics of truckload transportation is driven.

Chris Caplice is executive director of the MIT Center for Transportation & Logistics and founder of the MIT FreightLab. He can be contacted at caplice@mit.edu.

Journal of Commerce