Lowering a company's freight costs, in an economy where fuel surcharges are the norm, is next to impossible - or is it? Well, while most businesses seemed resigned to their fate, other enterprises are more aggressive in their efforts to reduce their incoming and outgoing shipment costs. These companies continually try to lower the costs of incoming shipments of raw materials, while mitigating the costs on outgoing shipments of finished goods. So, what must your company do to emulate their strategies?
Reducing Your Freight Costs
To help you with this exercise, I've included a list of six steps to reducing the burden of freight. The third step includes a sample excel sheet that allows you to measure the savings accrued from larger volume purchases, versus the costs of holding inventory for longer periods.
Measuring your inventory carrying costs, against purchasing more to drive down prices, is an essential part of maximizing your economies of scale and reducing your per-unit freight costs on incoming shipments. After all, freight is a critical cost of inventory.
A product's costs of goods sold (COGS) includes the costs to get raw materials, parts and consumables into a company's warehouse. This is ultimately why inventory stock-outs are so expensive and why they must be avoided; they force companies to rush parts in and out of their warehouse, while covering huge expedite fees on rush deliveries. So, what are the six steps to reducing your freight bills?
1. Be Aware of the Hidden Costs of Overseas Shipments
When it comes to overseas shipments, making sure you only pay for one delivered price to your door, is often the best course of action. This implies that the cost of delivery and insurance is covered by your supplier. The myriad of freight and INCO terms can literally keep you up at night. Some of them include: CIF,CIP,DAF, Ex-Works, FOB, DDU, DDP, DEQ, etc,. To learn more about these terms, please refer to the INCO-TERMS website here.
Now, if you deal with overseas, container, and or port-to-port shipments, then get to know these terms like the back of your hand. You must know where your company’s liabilities are with respect to insurance coverage on each of these terms. I’ve seen firsthand the huge amounts of wasted money from my clients who had no idea what these terms meant. In some cases, they lost the complete value of the shipment.
Now, I won’t go through each one of these terms and explain them – I wouldn’t be able to. However, you have to make sure your interests are protected at all costs.
2. When Possible, Separate Freight From Delivered Pricing
When it comes to overseas shipments, there is merit to having a supplier cover all the costs to your door, and in return, providing you one price for the product. In this case, it’s a DDP (Duty Delivery Paid) shipment: You pay one price – the duties, taxes, clearance, is all covered in the price and is the responsibility of your supplier. However, where possible, especially with shipments within the same country, try and have the freight separated from the price of the product your company purchases.
While accounting loves to have one clean bill, there is a cost to that delivered price and it can be more expensive for your company. If your vendor is providing you a delivered price, you can be 100% sure you are paying a surcharge on the freight. It’s a service your vendor is offering your company and it costs them to support it. As such, it's a guarantee they are charging extra and making a profit off the service.
You might not be able to get lower freight costs on your own. You might just find that even with your vendor's delivered pricing, it’s still better with them regardless of their mark-up. However, you must know. You might have better freight costs, and if you do, then you’ve successfully lowered a key cost of your inventory.
3. Measure Carrying Charges Versus Higher Volume Purchases
The one conundrum companies always face is how to measure the per-unit freight costs of taking more per shipment against the burden of carrying that extra inventory. Essential to this process is to understand your monthly carrying charges. Most companies agree that it’s usually around 3% per month. So, every month you hold inventory, add 3% to that cost. Here is some information about how to measure carrying costs versus larger volumes.
Use the following example to drive down your purchase costs:
- If the savings accrued in freight and price from your vendor (for higher volume purchases) are greater than your monthly carrying charges of 3%, then you’ll come out on top.
- Your company should be able to reduce your costs of incoming shipments by a minimum of 5% if you double your volume. You should see a higher percentage if you go even higher.
- We’ve provided two scenarios here: One is for your customer providing a 9% price discount. Another is for a 10% price discount for doubling your purchase volume. Your price discount could easily be higher - depending upon your strengths in negotiation.
- Both the 9% and 10% discount means you’ll now hold inventory for more than one month. We’ve assumed it will now be three months before depleting the stock and having to purchase more.
- We’ve moved the analysis from purchasing and holding inventory on a month-to-month basis, to holding inventory for a full quarter.
- The net gain, or savings, is the yellow shaded area. This is simply the original cost of ownership of $58.71 minus the new cost of ownership after the end of the 3 months.
Here’s the sample excel sheet if you want to download it: Download Sample-Excel-Sheet-Freight-Reduction
The above video summarizes the same strategies outlined in the above table (Step 3). It demonstrates how your company can measure its carrying costs of inventory against making larger volume purchases. You can learn more by going to: Inventory Carrying Costs Versus Higher Volume Purchases
4. Make Your Efforts Measurable
It’s one thing to go ahead and set forth plans to reduce your freight costs, but it’s another thing entirely to commit yourself to tracking your success and improving on your efforts. Now, I strongly suggest you take the time to write down the following:
- Start with your most recent year-to-date freight costs and work out your monthly average before starting your initiatives.
- Track your savings quarterly. For instance, our 9% and 10% example is based on higher volume held for three months at 3% per month.
- The goal is to reduce the per-unit freight cost of incoming parts, and to make sure that your inventory carrying charges aren’t too high in the process. If successful, you'll lower your product's COGS and increase gross profit.
- Do the analysis by product line. Doing the analysis by product line will increase the gross profit margin of that line. You need to track the following as part of your initiative.
- Price reduction from vendor for purchasing more.
- Per-unit freight reduction from shipping more.
- Monthly carrying charges or “ownership cost” as seen above in the example from point 3 in this list.
5. Avoid Stock-Outs and the Double Freight Bill
Remember, encountering a stock-out means you'll cover an expedite fee from your vendor to rush a shipment in. However, that's not the only costs you'll have to cover. After all, if you’ve let your customer down because you didn’t have the inventory, then you’ll have to cover delivery to their location. Avoid the double whammy from inventory stock-outs. They are killers.
The double freight bill is just one cost of an inventory stock-out. However, there are others. The video above outlines these costs in detail. You can learn more about the high costs of low inventory by going here.
6. Create a Bidding War for Your Container Freight
If your company is involved in container or truck shipments, and you’ve become concerned with the costs, then it’s time to ratchet up the competition for your business. Now, be careful, don’t go with the cheapest option – it’ll come back to haunt you. Just make sure to save money if possible from one shipment to the next. This isn’t always easy, especially with fuel surcharges always a threat. However, I’ve seen it done first-hand and it does work. It’s all about mitigating your costs as much as possible.
In doing this, I set up one customer of mine with their junior logistics coordinator actively going out to five or more companies for bids on each and every delivery. He was successful and it became his full time job. Getting a surcharge, and negotiating it down somewhat, is still a savings. Yes, you got a higher price, but it could have been even higher. Again, it’s all about mitigating costs – as much as possible.
When looking to reduce freight costs on incoming and outgoing shipments, be sure to set measurable objectives, ones where success or failure can be tracked and measured accordingly. In addition, make sure to analyze the burden of carrying additional inventory versus the potential savings of purchasing more and the reduction in per-unit freight costs from the higher volume.
Also, don't be afraid to make your business worth bidding and competing for. Doing this will make sure your suppliers are always doing their best to bring the most value to the table. The pressure will force vendors to compete for your business. Over time you'll align yourself with a stronger, more cost-effective carrier.
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