Freight costs often represent a significant percent of a manufacturer or retailer’s expenses. While many companies have highly qualified CFOs and VPs of Logistics or Transportation, the management of freight costs is often sub-optimized. This appears to be a result of a lack of collaboration between these executives with each having a different set of metrics and perspectives. Here is my take on why this is happening.
Business Strategy versus Transportation Strategy
CFOs are focused on the strategic direction of the business, on earnings, cash flow and return on invested capital. They are under pressure to reduce the amount of inventory tied up in supply chains. To a CFO, lean inventory means “reduction in working capital tied up in inventory.”
VPs of Logistics and Transportation are preoccupied with efficient supply chains. Leaner inventories mean smaller production lots and faster transportation, which can command premium rates since they preclude the use of cheaper, longer-transit modes, and may even require paying a premium for expedited freight. On the inbound side, this can cause plant or production line shut-downs due to lack of raw material or parts. On the outbound side, it can lead to empty shelves or the loss of a customer and its associated revenue stream.
Inventory is a component of working capital. Investors look at the levels of capital tied up in the supply chain – the lower the better. However, if you take your inventory, and therefore working capital, too low, your profit margin may suffer.
Different Perspectives on the Strategic Importance of Transportation
CFOs are intimately involved in evaluating new business strategies. Business acquisitions can lead to production overlaps and duplicate supply chains. Expansion to a new market may require the costly creation of supply lines that don’t exist. Reducing order-to-delivery cycle time to achieve a competitive advantage means faster, more expensive modes of transport.
Too often, however, transportation is an afterthought in these evaluations, despite the fact that freight costs can significantly impact the viability of new business ventures. Evaluating the payback on new business strategies requires an accurate read on transportation costs, which can account for a good chunk of a manufacturer or retailer’s operating costs. This demands that the CFO have a more granular understanding of these costs and how they are determined. Unfortunately, a lack of clear communication between logistics and finance can result in an incorrect financial evaluation and adverse financial consequences.
Another area where CFOs and VPs of Transportation may differ is whether or not to outsource the logistics function. Outsourcing transportation to a logistics company – one that provides the required people, carrier capacity, warehousing and IT systems – helps convert fixed costs to variable costs. The asset-light approach to transportation may also help reduce personnel costs, lower SG&A expenses, reduce or eliminate insurance costs, improve return on assets, gain fast access to extra capacity to support unplanned or future growth or facilitate the reduction in capacity in case of a business downturn.
However, the decision to outsource transportation demands a certain level of expertise in the selection of an outsource provider, and in putting controls in place to ensure customer service levels are maintained. Also, the true costs of a dedicated fleet may not be fully allocated. For example, the outsourced fleet doesn’t always have its own insurance and may just be piggy-backing on the corporate insurance policy. Finally, if the transportation function is outsourced, will the company retain a minimum level of management expertise to provide proper oversight?
To sum up, reductions in working capital related to inventory carrying costs should be balanced against the potential for increased freight charges and lower customer satisfaction levels caused by stock-outs. CFOs need to work closely with their logistics colleagues to figure out what level of in-house and outside assets will best serve the company’s needs. To make this decision, it’s critical to understand the total cost of owning transportation-related assets, such as a truck fleet or software system and the value-added from carrying a full-time professional and administrative staff. CFOs need to collaborate with their transportation counterparts to understand the true cost of transportation and the impact of these costs on the viability of various business strategies.
