Exposing the Biggest Hidden Supply Chain Cost of a New Facility

When deciding between locations for a new facility, most companies embark upon supply chain network studies that thoroughly evaluate each potential geography. Property leases, labor costs, and administrative costs are all important factors in weighing the differences between geographies. However, one extremely important cost is often calculated using incomplete or inaccurate data: transportation. 

This is surprising because inbound and outbound transportation make up the lion's share of the distribution costs in a supply chain network. For food and beverage production, these transportation costs account for a whopping 85% of all distribution costs; even for high tech companies, they add up to 60%. In many instances, transportation costs outweigh both fixed and variable facilities costs and inventory carrying costs.

When managers do factor in transportation costs when planning new facilities, they often rely on generic distance-based costs calculated as simple cost-per-mile estimates. This is problematic because these estimates ignore key factors like equipment type, service levels, fuel and accessorial charges. They are also limited to internal data, load board data, carrier quotes and third-party trends.

Only contract rates matter

Emergencies, oversights, and other unexpected events can occur that occasionally lead to shippers turning to the spot market to move freight, but most shipments should go out under negotiated contract rates. This makes contract rates the metric to consider when planning facility location. Distribution centers and other physical facilities represent long-term investments and it is wise to forecast the trajectory of transportation rates into the future. Contract rates roughly move with inflation with the average increase being two to four percent a year. Incorporating this long-term trend and conducting sensitivity analyses on how brittle a solution is in the face of changing transportation costs leads to better decision making. 

One of the most predictable things about the freight market is that carriers are reactive to changes in demand and adjust capacity on lanes accordingly. This makes a thorough understanding market rates quite effective at planning transportation costs for facilities. Don't worry so much about small, unpredictable inputs that can swing rates — they almost always achieve equilibrium and move with the rest of the market over time. Spot rates are impacted immensely by these short-term inputs and that is what makes them such inaccurate predictors of long-term transportation costs.

 Accurate transportation costs must eliminate bias

When initially looking at new geographies for distribution centers, manufacturers usually lack insight into the actual contract rates of shipping out of that location. National cost-per-mile estimates are averages that are often not true reflections of a specific location and asking a broker to price out lanes is inadequate because quoted rates are poor indicators of what could be successfully negotiated. Carriers that quote rates also may not even really operate in the market, or they may provide a quote that is based on their current capabilities versus what capacity could look like if they scaled to meet large new demand.

The most meaningful freight rate data reflect true transportation market dynamics including origin and destination effects by geography. This data is difficult for individual companies to capture, but it is available through freight rate benchmarking services. When enough data is available and advanced analytical techniques are applied, a model can be created that generates accurate estimates for contract rates on all candidate lanes. Utilizing a model helps eliminate bias and is a true reflection of actual prices that will be paid — but this requires many more data points than any single company can gather on its own.

It is also a good practice to use the same source of rates for all lanes (candidate and existing) in the network that is being investigated to drive consistency and reduce bias. Do not utilize modeled rates in one location and actual rates paid in other locations because those actual rates include premiums and discounts that might not be duplicated in the candidate locations. Reducing bias requires using the same source of modeled rates across the entire network.

It is possible to get much more accurate insight into transportation rates than many companies realize, and it's an endeavor worth pursuing for a cost that makes up such a large percentage of continual operational expenditure. Investing the time and research into uncovering this cost today can save money every single day in the operation of a new facility over its entire lifespan. When planning a new facility, don't neglect to factor in the cost of shipping to and from it. 

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