Supply Chain Frontiers issue #1. Read all articles in this issue.
Financial options are commonplace but how about trucking options? Researchers at the MIT Center for Transportation & Logistics are exploring the idea of a road transportation option as a way to make the procurement of trucking services a surer bet.
Even with the benefit of innovative technology such as on-line auctions, buying truck capacity is fraught with uncertainty. The result is higher freight costs and supply chain disruptions when shippers struggle to find the right carriers for their goods. A modest improvement in the process could yield big savings. According to Standard & Poors, total U.S. freight transportation expenditure in 2001 was around $ 713 billion, about eight percent of GDP. The truck mode accounts for more than 80% of the total transportation spend.
Shippers devote a lot of time and energy to procuring transportation, said Dr. Chris Caplice, Executive Director, Master of Engineering in Logistics Program at the CTL. Standard buying projects can take anywhere from three to six months and cost in excess of $ 100,000.
All too often these efforts do not pay off as originally planned. Capacity shortages and rising accessorial fees inflate costs, as do product demand fluctuations that make it difficult for shippers to accurately forecast how much carrier capacity they will need.
A case study of a Fortune 500 food manufacturer carried out as part of the CTL research underlines the planning perils that transportation buyers encounter. With annual sales of more than $ 5 billion, the manufacturer procures over $ 150 million worth of full truck capacity annually. It uses about 400 carriers across its highly scattered distribution network. The enterprise conducted an auction to streamline its procurement process, and did everything right. Carriers were provided with detailed data beforehand and the shipper formulated a strategy that identified target savings. Then demand suddenly soared. A key customer ramped up production causing week-to-week lane surges of more than 200 %. The smaller carriers were overwhelmed, causing the shipper to turn to larger providers at a higher rate that eroded the savings won from the auction process.
According to Caplice this real-world example highlights an important issue: while the savings from a transportation auction may look good on paper, they may not actually be delivered when the loads are tendered. In this case the disjoint was market-driven, but it could be that the carriers do not bid accurately and are unable to unwilling to accept the loads they won.
Another possible hiccup is the relative complexity of some bids. In the early 1990s package, or bundled/combined value, bids were introduced "so that carriers could exploit their economies of scope," Caplice explained. This is important because a constant challenge for tracking companies is ensuring that drivers and equipment are positioned optimally throughout their networks. By including multiple lanes in a single bid trucking companies are better able to plan and deploy resources ? theoretically at least.
A CTL study of 14 combinatorial transportation auctions showed that reality does not always gel with the theory. For example, the study found that only 28 % of the carriers participating in the sample auctions submitted package-type bids, and most of these were quite small ? the mean was 5.7 lanes per bid ? and relatively simple. More tellingly, only 58 % of the package bids that won were actually tendered. Although the savings can be as much as 40 % "package bids rarely win because they are fragile, one lane can knock them out," Caplice said.
Such failures cause loads to be rejected, forcing shippers to spend more time and manpower on searching for alternative carriers. An analysis of a single freight facility carried out by the CTL research team showed that out of 2,948 loads accepted there were 822 turndowns--a ratio of one in four loads rejected! The cost of these turndowns was estimated as more than two percent of the spend.
Building more flexibility into the system is one way to make the procurement process better able to handle the uncertainties of day-to-day operations. This is where the concept of a trucking option comes in.
An option is a right, but not an obligation, to buy or sell something. In the financial world this could be stock or a bond, and the instrument has a pre-agreed shelf life and price. In the trucking version the shipper could commit to buying a certain amount of a carrier's capacity over a given time period, and pay for it whether it not is uses that capacity. In return, the trucker guarantees to provide additional surge capacity at the negotiated contract rate should the shipper have to deal with an unexpected spike in demand.
The concept is in its infancy, and the CTL research is looking at the commercial viability of such an instrument. One of the issues under investigation is when a trucking option is an appropriate choice. Said Caplice, this depends on a number of variables such as the difference between available contract and spot rates, the lane, facility and region involved, and the traffic volumes. Another question is whether transportation management systems can handle such a sophisticated transaction. "The concept falls apart when the (TMS) system cannot deal with it," he pointed out.
Even so the trucking option is a promising idea. "Options may be a good way to lock-in surge capacity," Caplice noted. An intriguing notion is the trading of these instruments. "You could sell a trucking option on a high-volume power lane," he said, "this is something we are thinking about."
The MIT Center for Transportation & Logistics is establishing a special transportation research group, and one of the projects the group will look at is the development of trucking options. Companies interested in joining the group should contact Chris Caplice at: Caplice@mit.edu, tel: 617 258 7975.