Cost confusion

Jan 01, 2006 10:30 PM  By

Logistics is hardly the stuff of controversy, but a session on logistics costs at this year’s meeting of the Council of Supply Chain Management Professionals (CSCMP) threw the audience into, if not quite a tizzy, a state of agitation. At issue was the presenter’s contention that logistics costs decreased considerably in 2005 — despite soaring fuel prices. Following the CSCMP event, the trade press picked up the buzz, expressing puzzlement at this apparent contradiction. But according to the session presenter, William Drumm, president/CEO of Establish/Herbert W. Davis and Co., there is no contradiction. Below, in an exclusive interview with Multichannel Merchant/O+F, he explains why.

More than 70% of the companies in your survey were able to reduce their logistics costs this year. How were they able to do that in the face of higher fuel prices?

Transportation costs don’t change in a linear way along with fuel costs. If gasoline or diesel fuel prices double, that doesn’t mean transportation costs double, because fuel accounts for only 25%-30% of transportation costs. So even if fuel [costs] were to double — which they did for a week or two — [transportation costs] would return to near-normal levels. I predicted that at the CSCMP conference, and I’m very happy to see that I’m right!

Why aren’t fuel and transportation costs directly related?

If you were running a truck and it cost you $1.00-$1.50 a mile, maybe $0.25-$0.35 of that is fuel related. Now let’s say fuel went up by 50%, then instead of the cost being $1.00-$1.50, it would be $1.12-$1.62. It’s not going to go up directly proportional to the increase in fuel because driver wages didn’t change, the depreciation on the tractor-trailer didn’t change, and the insurance, tolls, and taxes didn’t change.

Another reason fuel and transportation costs are disconnected is that when you look at the transportation cost that a company incurs, it changes when the company changes its tactics. If they decide to ship a lot more by truckload and a lot less by LTL, or if they decide to have more warehouses closer to the customer, then they’re going to spend fewer transportation dollars even though they’re spending more money on fuel.

How does this translate into lower logistics costs overall?

Logistics costs as a percentage of sales have decreased because the product is more valuable. Companies may spend the same dollars or even more dollars on transportation, but they’re getting more dollars for the product that’s in the truck. As a result, transportation costs as a percentage of sales can go down even when transportation cost drivers are going up. That’s because the value of the product went up faster than the transportation costs did. It’s very difficult for people to get their arms around this concept. I explained this ad nauseam at the CSCMP conference, and some of the audience comments I got back on the evaluation forms were “This doesn’t make sense. Fuel prices are going up and transportation costs are going down. He must be wrong!”