Surcharge survival strategies

Mike Coronado thought he and his staff had the fuel surcharge problem licked. Back in November when they were drafting their business plan for 2008, Coronado, who is director of distribution for The Container Store, and his colleagues put a lot of They analyzed their surcharges for the last five years, sifted through the data looking for patterns, and then made careful month-bymonth projections for the upcoming year. But in the end, it wasn't enough. Just months into the new year, it became clear that their projections were falling well short of reality. "As good as it was, who would have projected a 53-percent fuel surcharge?" asks Coronado.

The Container Store is not alone. With diesel fuel prices spiking above $4 a gallon, shippers from coast to coast are getting walloped by fuel surcharges. Nearly 88 percent of the DC VELOCITY readers who responded to an online survey in April reported that their surcharges had increased in the past three months. The respondents said they were paying fuel surcharges of 24 percent above current freight rates on average. (For more on the survey results, see the sidebar titled "sharing the pain.")

But while shippers may feel they are paying exorbitant sums, some carriers say that fuel surcharges aren't keeping pace with their actual costs. "Ironically, few believe that fuel surcharges are fair or equitable right now," says Jim Butts, senior vice president of transportation for C.H. Robinson, a non-asset-based third-party logistics service provider. "Shippers feel they are paying too much in freight costs in general, and fuel surcharges are a large component of that. And carriers feel that revenues don't seem to be keeping [up with] rising fuel prices."

No one denies that soaring surcharges are adding up to substantial money, however. "It's not like we're $50,000 over plan; we're talking $600,000 to $800,000," says Coronado. "It's a huge number. So it's something that we as an entire company are focused on."

But however much companies like Coronado's focus on the problem, the question remains: Is there anything shippers can actually do about fuel surcharges? Or is the only option what one wiseacre survey participant suggested: "Pray a lot."

sharing the pain

If you're feeling the pain of rising fuel surcharges, you're not alone. In an online survey conducted among DC VELOCITY readers in April, 88 percent of the 206 respondents reported that they had seen increases in their fuel surcharges in the previous three months. On average, respondents said they were paying fuel surcharges of 23.8 percent above current freight rates.

Among other findings, the survey indicated that there's little uniformity in the way fuel surcharge programs are structured. Close to half (52 percent) of the respondents reported that their fuel surcharges were adjusted on a weekly basis. Another 35 percent said their surcharges were adjusted monthly, and 12 percent said adjustments were made on a daily basis. Only 18 percent of the respondents said their fuel surcharge programs contained a cap.

One obvious way to control fuel surcharge costs is to reduce shipments. And in fact, 24 percent of the respondents reported that they had deliberately cut down on the number of shipments they made in order to rein in fuel surcharge costs.

Asked what other techniques they were using to control freight costs (and by extension, fuel surcharges), respondents cited a variety of strategies. The most popular answers included consolidating loads or implementing an internal efficiency program (28 percent), and negotiating prices or shopping around for better rates (18 percent). Other responses included changing routes, redesigning the supply chain network, using software, and passing on the costs to customers.

Not all of the respondents were equally enterprising in their responses to the problem, however. A full 20 percent admitted that they were doing nothing at all to control their surcharge expenses.

Time to renegotiate?
As is often the case, the answer depends on whom you ask—and how far you're willing to go to solve the problem. Most observers agree that it's unlikely that shippers will be able to convince carriers to renegotiate their surcharge programs, regardless of what they might have done in the past. "Once upon a time, when it came to fuel surcharges, companies were willing to negotiate, and you could set your fuel surcharge," recalls Doug Bell, distribution center manager for General Paint, a Canada-based paint manufacturer and retailer. "Of course with the volatility of fuel nowadays, I doubt there's a carrier out there that's comfortable doing that."

But that's not to say surcharge programs are set in stone. In fact, Gary Girotti, vice president of the transportation practice at analyst firm Chainalytics, urges shippers to review their existing agreements with carriers to make sure they're in line with industry standards. For example, he says, there are probably truckload carriers out there that are still using an older method of calculating surcharges— that is, they're calculating them as a percentage of the total freight cost rather than pegging surcharges to the current price of diesel (see sidebar for a look at how fuel surcharges are calculated). If so, their customers have legitimate reason to ask to have their agreements revised. If you haven't gotten off a percentage basis for truckload shipments, says Girotti, you should, because the cost of freight has little to no bearing on how much fuel is needed to haul a particular load.

Girotti also urges shippers to make sure that their "escalators"— the price points at which surcharge provisions kick in—are reasonable. For example, a typical agreement might call for the shipper to pay the standard base rate of $1.20 per gallon and then pay an additional penny for every 5- to 6-cent increase in the per-gallon price of diesel. "If you have a 6-cent escalator, you are probably paying about right," he says. Girotti notes that during 2004-2005 when carrier capacity was a problem, some carriers convinced shippers to drop their escalator point from 6 cents to 5 cents, arguing that the new requirements for low-emission engines were making them less efficient. "But there's no data to support that," he says.

Go to market
If renegotiating fuel surcharges isn't feasible, renegotiating freight rates might be. In fact, several survey respondents reported that they had renegotiated their freight rates this year and that it was well worth the effort. "As the economy slows down, discounts have increased. It helps offset the fuel surcharge," wrote one survey respondent.

Girotti says that Chainalytics has helped 15 to 20 of its clients with their rate negotiations this past year. "All are getting double-digit savings in [the form of] rate reductions," he says. Those lower rates have taken some of the sting out of rising fuel surcharges.

While there is still time to take advantage of lower rates, this wave may be running out."Given the amount of carrier failures that are happening in the market," says Girotti, "we're starting to see a rate bottoming, where the carriers aren't going to be able to go much lower."

Whether they're preparing to renegotiate an agreement or simply getting ready for the next round of regular contract negotiations, shippers will face complicated tradeoffs between rates and surcharges. Although some shippers have tried negotiating lower base rates or escalators, Chris Caplice, who is executive director of the Massachusetts Institute of Technology's Center for Transportation & Logistics, warns that this strategy can backfire. Research conducted by Caplice and Chainalytics shows that shippers that pay lower fuel surcharges generally end up paying higher line-haul rates.

Rethink your operations
Even if they can't negotiate lower rates or surcharges, there are still plenty of other things shippers can do to control costs. To begin with, they can look for ways to reduce the number of shipments they make. In fact, nearly one-quarter of the respondents to DC VELOCITY's survey are cutting back on shipments in order to rein in fuel surcharges. "You can't control the cost of fuel," says Coronado, "but you can control the number of truckloads that you're processing."

Coronado reports that in the last few years, The Container Store has developed a number of techniques for cutting back on shipments. For example, it has implemented a program that has reduced the number of trucks returning to its Dallas DC from stores by 50 to 60 percent. It has also begun using a transloading partner to consolidate shipments of its Elfa shelving units from Sweden. "What we have been able to do is to reduce the number of containers from Sweden to the United States, which has had a dramatic impact on freight costs," says Coronado. The retailer is also using a new demand forecasting and demand truck scheduling program that has enabled it to ship products on a just-in-time basis and do a better job of determining precisely which products a given store needs.

Electronics manufacturer Philips has also found that consolidating shipments can take a big bite out of freight costs. "Five to 10 years ago, it wouldn't be unusual to have two and three and four shipments going out the same day to the same customer, shipped independently of each other," says John Brooks, the company's director of distribution and transportation. Over the last couple of years, Philips has worked to combine order drops to distribution centers, consolidate loads, and reduce the number of shipments to customers.

"A lot of customers prefer once a week or twice a week to receive deliveries from companies like ours," Brooks says. "So we have worked to really put them on more of a scheduled shipping process, and that's helped with transportation costs as well as minimizing the impact of rising fuel prices."

Butts of C.H. Robinson urges shippers looking to control freight costs to consider whether there are ways they can help their carriers hold down expenses. These could include reducing deadhead miles, cutting down on dwell time, or simply making sure that dispatchers provide drivers with clear information and directions. The more efficient the carrier's operation, the lower the shipper's costs.

Along with consolidating shipments and working to improve efficiency, a number of shippers are re-evaluating their modal choices. Girotti is an advocate of this approach. He's urging his clients to take a closer look at intermodal. In the past, shippers tended to shy away from intermodal because of its reputation for inconsistent service. Now, however, the cost advantage is too big to ignore, he says. In addition, a drop in imports from Asia has freed up capacity, which has enabled the railroads to bring service levels up a notch.

Still others are rethinking their entire supply chain networks. Several survey respondents said they were changing their routes, sourcing closer to home, or evaluating DC locations. "We're starting to look at, instead of reducing distribution centers, do we need to have more distribution centers because the closer you are to the customer, the lower your transportation costs," says Brooks.

Wrong answer!
Despite the many options available to them, it appears that when it comes to the problem of soaring surcharges, a sizable number of shippers have opted for the prayer route. A full 20 percent of the survey respondents, for example, said that they were doing nothing to counteract rising freight costs.

In Coronado's opinion, this is the wrong answer. "You just can't throw your hands up and say, 'There's nothing we can do about this,'" he says. "There is nothing we can do about the fuel surcharges. But in your supply chain, you can really take a look at what you do … each and every day and see whether there are opportunities for improving efficiency."

making the calculations

So how are fuel surcharges determined? The details will vary depending on the carrier and the type of service— truckload or less-than-truckload (LTL). But in general, the process works as follows.

For truckload freight, surcharges are typically tied to the current price of diesel—usually the national average weekly retail on-highway diesel price published each Monday by the Department of Energy. Oftentimes, carriers establish a "peg" or base rate and then charge shippers a set amount for every X cents-per-gallon increase in the current average price. For example, an agreement might call for the shipper to pay the standard peg rate (which is around $1.20 per gallon) and then pay an additional penny for every 5to 6cent increase in the price per gallon. A peg rate of $1.20 may seem arbitrary, especially considering that diesel fuel routinely runs over $4 per gallon these days. But fuel surcharges were created back in the 1990s and that's a fairly accurate reflection of the price of diesel back then, says Gary Girotti, vice president of the transportation practice at analyst firm Chainalytics.

For less-than-truckload (LTL) service, fuel surcharges are typically based on a percentage of the total freight cost, rather than on mileage. With LTL hauls, freight moves through a network of terminals, which means there's often little correlation between the shortest route for a given shipment and the distance it actually travels.

As diesel prices soar, there are signs that some truckload shippers are rethinking their surcharge programs. For example, Chris Caplice of MIT's Center for Transportation & Logistics reports that he's recently seen an uptick in interest in tiered fuel surcharge arrangements. A tiered system might work as follows: When the price of fuel rises above the peg rate of $1.20, a shipper would pay, say, an additional penny for every additional 5 cents per gallon until the price per gallon hits $4. Then the shipper would pay an additional penny for every 6cent increase in the per-gallon price of diesel. There aren't many companies using a tiered program right now because it requires significant management time and information systems to administer, says Caplice. Yet he believes more companies will be looking into this option as fuel prices continue to rise.

About the Author

Susan K. LacefieldEditor at Large
Susan Lacefield has been working for supply chain publications since 1999. Before joining DC VELOCITY, she was an associate editor for Supply Chain Management Review and wrote for Logistics Management magazine. She holds a master's degree in English.More articles by Susan K. Lacefield

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