While growing revenues may be the more exciting part of running a transport business, understanding and managing your costs—whether you are a large fleet operator or an owner/operator—can be just as critical to business success.
And cost control can be particularly important where there is a significant degree of competition from other trucking firms, which may be keeping rates in check, according to David Colledge. The president of Colledge Transportation Consulting spoke at BCTA’s recent Managing Profitability Conference in Surrey, B.C. and outlined how to get a handle on costs.
The impact of vigilant cost management is directly evident on the bottom line.
“If you can improve your operating margin by just five cents per kilometre and you operate a truck 200,000km a year, it adds $10,000 to your bottom line. And if you operate a fleet of 50 trucks the savings would amount to half a million a year,” Colledge pointed out.
Truckers have long bemoaned the better than 20% profit margins of the Canadian Class 1 railways while trucking companies are fortunate to make, on average, five to seven cents on the dollar. Colledge, whose transportation costing experience began in the rail sector, used railways as an example of how to do cost management right.
Nothing wrong with learning from the competition.
“The railways have transformed the arcane science of railway costing into something of an art form. They have in place very sophisticated costing frameworks. But it is the way they apply these frameworks not only to manage costs but to make pricing decisions on whether to accept or reject incremental business that I think is the most interesting,” he said. “It was amazing to me the level of detail that was put into their ‘activity based’ costing system. Unit costs were computed to five decimal places.”
There are several different methodologies which can be used to establish the relationship between costs incurred to provide a transportation service. Colledge explained the most common techniques used by the railways.
This method is used where the variability of costs is already determined. A unit cost is developed for a certain activity. For example, yard locomotive fuel for switching operations would be determined based on the total yard diesel fuel divided by yard diesel unit miles. In a trucking context, it might be line haul costs divided by linehaul truck kilometres.
This method is used for specific cost items where it is implied that the costs are 100% variable. For example, train crew costs that can be developed from crew trip ticket data by train run for specific geographic areas and the application of wage rates from union agreements. For trucking, driver hours can be obtained from logbooks and applying the relevant wage rate per mile or per hour. It is also possible using this method to develop specific costs for linehaul labor and terminal labor that would be applicable to TL and LTL operations.
This approach is used where the cost variability is unknown. It is applied to multiple years of data to smooth out “lumpy” costs and to determine which costs are variable and which are fixed. An example could be in-house truck maintenance shops or maintenance of terminals. This approach is important when it comes to allocating certain common or overhead costs, such as terminal operating costs.
“In reality, a costing system would be a combination of these three methods,” Colledge said.
There are two types of costs, of course, which make up total costs: variable costs and fixed costs.
These vary with changes in traffic volume with a relevant range. They generally include labor costs, fuel and materials. The variability of the costs depends on the time horizon: as the time horizon is extended, more costs tend to become variable.
These do not change with changes in traffic volume. For the firm as a whole, these costs will continue in the short run even if the firm stops producing. Fixed costs typically include such items as capital costs associated with plant and equipment, administrative salaries, insurance and some taxes.
“The notion of variable and fixed costs is also important when traffic density (or volume) is considered. If the annual traffic volume is low, there is a smaller base over which to spread fixed costs and the average cost per tonne or per unit of cargo is higher,” Colledge explained. “This would be important for LTL carriers operating a network of terminals.
After he provided a thorough explanation of costing techniques and types of cost, Colledge outlined three steps to cost development.
Determine the physical resource or work units consumed in the shipment of goods from origin to destination. Several factors influence the costs for any particular movement being analyzed, including: route miles; equipment type and ownership; payload and equipment tare weight; average travel speed; wait times and origin/destination to load/unload cargo; and waiting time at intermediate transfer points. The payload and tare weight affect fuel consumption rates and fuel costs.
The work units are developed based on the available details of the specific situation as well as accepted industry averages. It is also very important to determine whether there is a return revenue movement. If there is no backhaul opportunity, the full round-trip cost should be assigned to the headhaul movement.
After determining work units, the next step in the costing experience is to apply these output parameters to unit costs. In a truck operation, truck miles would be applied to an average cost per truck mile, which could be specific by route. The level of detail can be whatever management deems important and wishes to differentiate. Costs can also be determined for different lines of business, such as general freight, heavy haul, etc. This is important because different operating divisions involve the use of different types of equipment and would each have somewhat different cost and competitive conditions at play.
There may also be specific miscellaneous and overhead costs to be added. The overall output from the cost mode includes vehicle-based costs such as tractor payments, fuel, tires, maintenance, licences and insurance, driver-related costs and fringe benefits and other costs items such as dispatching, terminal and warehousing costs.
Your costing system, of course, will only be as good as the data fed into it.
“A good costing system depends on having good data,” Colledge said. “This is essential to develop accurate costs that can be used by management to make pricing and operational adjustments in response to changing market conditions and opportunities.”