LOGISTICS

AND
SUPPLY CHAIN
MANAGEMENT
TRANSPORTATION
MANAGEMENT
Transport economics and pricing are concerned
with the factors and characteristics that
determine transport costs and rates

This helps to develop an effective logistics

strategy and to successfully negotiate transport
agreements
I Economic factors
Transport economics is influenced by seven factors.
Distance:
This factor directly contributes to variable
cost, such as labor, fuel, and maintenance
The cost curve does not begin at the origin
because there are fixed costs associated with
shipment pickup and delivery regardless of
distance
The cost curve increases at a decreasing rate
as a function of distance
This is reflected from the fact that longer
movements tend to have a higher percentage
of intercity rather than urban miles
Intercity miles are less expensive since more
distance is covered with the same fuel and
labor expense as a result of higher speeds and
also because frequent intermediate stops
typical of urban miles add additional loading
and unloading costs
Volume:
Like many other logistics activities, transportation
scale economies exist for most movements
Transport cost per unit of weight decreases as load
volume increases
This occurs because the fixed costs of pickup and
delivery as well as administrative costs can be
spread over additional volume
Small loads should be consolidated into larger loads
to take advantage of scale economies
Density:
This factor incorporates weight and space
considerations
These are important since transportation cost is
usually quoted in terms of cost/price per unit of
weight
In terms of weight and space, an individual vehicle is
constrained more by space than by weight
Once a vehicle is full, it is not possible to increase
the amount carried even if the product is light
Actual vehicle labor and fuel expenses are not
influenced by weight, higher density products allow
relatively fixed transport costs to be spread across
additional weight
As a result, these products are assessed lower
transport costs per unit of weight
Stowability:
It refers to product dimensions and how they affect
vehicle space utilization. Odd sizes and shapes, as
well as excessive weight and length, do not stow
well and typically waste space
Density and stowability are similar, but it is possible
to have products with the same density that stow
very differently
For example, while steel blocks and rods have the
same density, rods are more difficult to stow
because of their length and shape
Handling:
Special handling equipment may be required for
loading or unloading trucks, railcars, or ships
Also, the manner in which products are physically
grouped together (e.g., taped, boxed, or palletized)
for transport and storage affects handling cost
Liability:
This factor includes product characteristics that
affect risk of damage and the resulting incidence of
claims
They are susceptibility to damage, property damage
to freight, perishability, susceptibility to theft,
susceptibility to spontaneous combustion or
explosion, and value per money unit
Carriers must either have insurance to protect
against possible claims or accept responsibility for
any change
Shippers can reduce their risk, and ultimately the
transportation cost, by improved protective
packaging or by reducing susceptibility to loss or
damage
Market:
A transport lane refers to movements between origin
and destination points
The vehicles must find a load to bring back (“back-
haul”) or the vehicle is returned empty
(“deadhead”)
Ideal situation is for “balanced” moves where
volume is equal in both directions
Demand directionality and seasonality result in
transport rates that change with direction and
season
II Cost structures

Cost allocation is primarily the carrier’s concern

But, since cost structure influences negotiating
ability, the shipper’s perspective is important as well
Variable costs:
These are costs that change in relation to some level
of activity
It includes direct carrier costs associated with
movement of each load
Typical cost components include labor, fuel, and
maintenance
It is not possible for any carrier to charge below its
variable cost and expect to remain in business
Fixed costs:
These do not change in the short run and include
carrier costs not directly influenced by shipment
volume
Expenses associated with fixed assets must be
covered by contribution above variable cost on a per
shipment basis

Joint costs: These are expenses created by the

decision to provide a particular service
For example, when a carrier elects to haul a
truckload from A to B, there is an implicit decision to
incur a “joint” cost for the back-haul from B to A
Either the joint cost must be covered by the original
shipper from A to B, or a back-haul shipper must be
found.
Common costs:
This includes carrier costs that are incurred on
behalf of all shippers or a segment of shippers
These are often allocated to a shipper according to a
level of activity like the number of shipments
handled
III Pricing strategies

When setting rates to charge shippers, carriers can

adopt one or a combination of two strategies
This combination approach trade-offs between the
cost of service incurred by the carrier and the value
of service to the shipper
Cost-of-Service strategy:
The carrier establishes a rate based on the cost of
providing the service plus a profit margin
This represents the base or minimum transportation
charge and is for low-value goods or used in highly
competitive situations
Value-of-Service strategy:
Rate is charged based on perceived shipper value
rather than the cost of actually providing the service
A shipper is probably willing to pay more to transport
high-value goods
Combination strategy:
This establishes the price at some intermediate level
between the cost-of-service minimum and the cost-
of-service maximum
Managers must understand the range of prices and
the alternative strategies so that they can negotiate
appropriately
IV Rating
Actual pricing mechanisms used by carriers are built
on the key strategies discussed above
Class rate:
The price to move a specific product between two
locations is referred to as the rate
The rate is listed on pricing sheets or computer files
known as tariffs
All products transported by common carriers are
classified for pricing purposes
The first step is the classification or grouping of the
product being transported

The second step is the determination of the precise

rate based on the classification of the product and
the origin-destination points of the shipment
Classification takes into account the characteristics
of a product or commodity that will influence the
cost of handling or transport

Product with similar density, stowability, handling,

liability, and value characteristics are grouped
together into a class
In addition, two additional charges are common
The minimum charge represents the amount a
shipper must pay to make a shipment regardless of
weight
Minimum charges cover fixed costs associated with a
shipment
A surcharge is to cover specific carrier costs
It is used to protect carriers from costs not included
in published rates
Commodity rates:
When a large quantity of a product moves between
two locations on a regular basis, it is common
practice for carriers to publish a commodity rate
These are special or specific rates published without
regard to classification
The terms and conditions are usually indicated in a
contract between the parties
Today most rail freight moves under commodity rates
Exception rates:
These are special rates published to provide shippers
lower rates than the prevailing class rate

The purpose is to provide a special rate for a specific

area, origin-destination, or commodity when either
competitive or high-volume movements justified it
When the exception rate is published, the
classification that normally applies to the product is
changed

Such changes may involve assignment of a new class

or may be based on a percentage of the original class
Special rates and services
Freight-All-Kinds-rates
Local, joint, proportional, and combination
rates
Transit services
Diversion and Reconsignment
Split delivery
Accessorial services
Demurrage and detention
Drivers of Transportation Decisions

Transportation cost structure

Economies of distance & scale
FTL versus LTL
Product and demand characteristics
Value density
Demand characteristics
Customer requirements ( Delivery time)
Relative Ranking* of Transportation
Mode by Performance Measures

*1 is most favourable & 5 is least favourable from shipper point of views

* * Delivery time variability in absolute terms
Impact of Mode of Transportation on
Supply Chain Performance Measures

Freight cost:
Lot size: Differences in required shipment sizes
translate to differences in cycle stock related
inventory.
Delivery time: pipeline inventory and safety
stock carried in supply chain is a function of
lead-time in transport
Delivery time variability: safety stock carried in
a supply chain is a function of the variability in
lead time in transport, and
Losses and Damages

Total cost = Fright cost + Cycle stock inventory carrying cost +

Pipeline Inventory carrying cost
+ safety stock inventory costs + Cost of losses and damages
Choice of Mode of Transport:
Illustration
Product : Printer
High End Standard Low end
Value/unit ( Rs.) 20,000 15,000 10,000
Inv. Carrying cost/unit/year 4,000 3000 2000
Mean Demand/week (units) 100 100 100
SD of demand /week(Units) 30 30 30

Option Sea Air

Lot size (units) 400 100
Freight/unit (Rs.) 90 360
Lead time(weeks) 4 1

Target service level: 98%

Cost Comparisons for Different Modes of
Transport Under Stable Demand*

Impact of Value Density

Optimal Decision : For high end :
Air. For standard and low end : Sea
* Assumption : SD of demand = 0 ( No demand uncertainty)
Cost Comparisons in Situation of Demand
Uncertainty

Impact of Value density and Demand Uncertainty

Optimal Decision : For high end and standard: Air.
For low-end: Sea
Value Density
It is the ratio of rupee value to its weight
It shows the importance of transportation costs
in the overall product cost
It also allows the firm to examine the trade-off
between inventory and transportation cost
High-value density products
faster and more expensive modes of
transport
Few bulky products (cycles and water storage tanks)
has the transportation cost captured by the physical
volume rather than the weight
Air freight industry
Volumetric weight is used
Freight charge is based on the physical weight or
the volumetric weight, whichever is higher
1 m3 = 166 kg of volumetric weight
Demand characteristics
It captures the volume of demand and the nature
of uncertainty
Higher volumes of demand allow firms to work
with bigger batch sizes
Higher demand uncertainty affects the amount
of safety stock carried
For longer lead time products, high amount of SS
is needed for products with high demand
uncertainty
Sabare International
Turnover was 3.75 billion dollars (2006-07)
Manufacturer and exporter of home furnishing
textiles
Serves major retailers like Wal-Mart, JC penny
and Kmart in the US
For pillows the transportation cost is a dominant
component of the cost because of the bulky
nature of the product
Rather than manufacturing pillows in India, it
has set up a state-of-the-art manufacturing
facility in Atlanta for pillow filling and bedding
Despite the higher cost of labor, Sabare is able to
save substantial transportation costs in serving
the US markets
Hub-and-spoke model
All the destinations in the region are inter-
connected through a central hub
All operations are centralized at the hub
This permits economies of scale in operations
For 50 cities, 1225 routes are required in point-
to-point model whereas 49 routes in hub-and-
spoke model
 This simplicity comes at some cost
Example
Courier company
Hub is at Nagpur
Bangalore and Chennai are 331 km apart
But all parcels between them will be routed
through Nagpur (2132 km)
The packets are charged at the same rate
irrespective of distance travelled
This model is modified by creating regional hubs
instead of one central hub
This helps in avoiding movement across long
distances for nodes that are geographically close
to each other
Adequate infrastructure, of course, is needed at
each regional hub
Cross-docking at Toyota Kirloskar
The company works with a fine-tuned
transportation strategy for its inbound logistics
The supply is received through milk runs from
Gurgaon, cross-docked to trucks going to the
Bidadi plant in Karnataka
Double cross-docking is practices, one at
Gurgaon and another at Pune
It helps maintain lower inventory at the plant
It protects from transportation reliability
problems
All parts from all the suppliers from the north
and the west come in on a daily basis
Failure of one truck will disrupt supply for a
maximum of one day