Using FreightMath™ To Maximize Price Impact
FreightMath™ is a set of methodologies developed by KSM Transport Advisors (KSMTA) to assist carriers in refining their revenue model and freight network, resulting in enhanced profitability. This article, and subsequent posts, will provide insight into some of the base FreightMath measures and processes to assist carriers on their journey toward higher profits.
Since deregulation in 1980, the freight market has been in a state of perpetual flux subject to the availability of drivers and trucks and the underlying health of the economy. Depending on the power dynamic between shippers and carriers in general, and any given carrier and its shippers, each carrier has an ever-changing opportunity to address pricing with its customers.
In the current market, shippers are attempting to price future economic unknowns into the loads hauled today; this is to the shippers’ advantage as the future contains several headwinds. Some in the media support this dystopian future vision that the trucking industry is on the verge of collapse. Some carriers are succumbing to this pressure and significantly lowering rates, but our clients are not. In fact, many of our clients continue to earn rate increases.
Shippers have a prime directive of delivering their goods through the supply chain with specific operating and service metrics at the minimum cost possible. The recent high transportation prices demanded by the market have not, for the most part, been passed through to consumers. Likewise, the media gets paid (in large part) based on clicks which fosters sensationalism, whereas trucking companies are paid by selling freight and their time to shippers.
Carriers need to understand the macro markets within which they operate. They need to block out the noise and focus on their metrics, their market position, and their customers’ needs to survive and prosper in this information-rich environment. In short, carriers need to focus on their profitability levers and act accordingly.
The first step in understanding how a carrier can/should price its services is to understand its variable costs and gross margin both on a per load and per day basis. The following exercises are most applicable to those carriers in the OTR irregular route market segment.
Step 1 – Calculate Standard Cost per Mile
The first step is to calculate gross margin. The other calculations that follow are to establish a standard cost per mile. The standard cost per mile includes only variable costs and, as such, does not include fixed or administrative costs. The variable costs as a trucking company include:
- Driver Compensation – Direct wages, per diem, benefits, and workers’ compensation.
- Owner Operator and/or Lease Purchase Compensation – All compensation paid to owner operators and/or lease purchase drivers. The main compensation methods in this category are base compensation per mile, or percentage of linehaul, as well as the amount payable for fuel surcharge.
- Fuel – The direct cost of diesel, as well as additives, including DEF.
- Truck Maintenance – All parts and labor related to maintaining tractors, including tires. To get accurate data in this area, it’s important to track and separate labor and parts for tractor and trailer maintenance by repair/work order (RO).
- Trailer Maintenance – All parts and labor related to maintaining trailers. This cost category also includes tires.
- Insurance – Premium payments as well as deductibles (including any self-insured retention). Insurance policies in this category include: auto liability, physical damage, cargo, and excess liability coverage. Any minor accident damage should also be included in this category as opposed to tracking it as a maintenance cost.
- Other Variable Costs – This final catchall includes things such as driver road expenses, motels, truck/trailer washes, and tolls.
Once all the general ledger (GL) accounts are identified for these categories, calculate the standard variable cost per mile using these values. To do so simply take the dispatch miles associated with the same time interval for which the above costs have been captured. Calculate a YTD value as well as a value for the most recently closed month.
A carrier with both company drivers and owner operators should weight the appropriate costs by the applicable miles driven by each group. In this circumstance simply prorate driver and owner-operator compensation by the dispatch miles associated with each driver group. Then apply the percentage of company driver miles to fuel and tractor maintenance expense. All other costs should be unweighted (simply divided by the sum of company and owner operator miles). A standard cost per mile can now be used to approximate profitability for all loads.
If a carrier is ambitious and did a historical look back at 2021 – and maybe even 2020 – it will undoubtedly notice a steep rise (inflation) in these expenses. A similar trend will be seen adding in fixed costs (truck and trailer financing and depreciation) and administrative overhead (non-driver wages and benefits). Specifically, rapid inflation in driver compensation, equipment, and fuel has established a new threshold for what rate per mile is acceptable for the average lane. Using this data to educate customers on the ‘new normal’ is important to opening a dialogue on upcoming contract events and ad hoc requests for price adjustments.
Step 2 – Calculate Gross Margin per Mile/Gross Margin per Day
Gross Margin per Mile
With the standard variable cost per mile established and the loaded and empty miles associated with each load known, calculate the gross margin for each load.
- Empty Miles – The unloaded dispatched miles from previous delivery to the pickup destination.
- Loaded Miles – The dispatch miles from pickup to delivery destination points. It’s important to use a common mileage calculation method for this such as PC Miler Practical Miles.
- Total Miles – The sum of the two mileage categories above.
- Standard Cost per Mile – Already calculated above.
- Revenue – This includes the linehaul, FSC, and any accessorial revenue generated per mile.
(Revenue * Total Miles) minus (Standard Cost per Mile * Total Miles) = Gross Margin per Mile
Gross Margin per Day
A core component of FreightMath is understanding the value of each load to the overall network. The base calculation uses margin per day as the foundation. Using the inputs above, add in the element of time. Time is simply the duration between E-call on the previous load to the E-call on the current load. Essentially, it is matching up the logic above, applicable to the empty and loaded miles, but expressed in hours and minutes.
- Dwell Time – The time in hours associated with the unloaded miles from previous delivery to the pickup destination.
- Loaded Time – The time in hours associated with loading, detention, transit, and unload times between pickup and delivery of the load in question.
- Load Standard Cost – Standard cost per mile multiplied by all the empty and loaded miles associated with the load.
- Load Revenue – This includes the Linehaul, FSC, and any accessorial revenue generated per mile.
((Load Revenue – Load Standard Cost) / (Empty Time + Loaded Time) * 24) = Gross Margin per Day
Step 3 – Rank Customers and Lanes
Once the gross margin per day is calculated for every load, rank customers and lanes. Use the gross margin per day methodology since it does not require any weighting. For customers, simply rank from high to low including broker Bill To’s. Similarly, using origins and destinations, rank lanes using a sufficient aggregation. For example, if a carrier only has a couple of loads originating out of Marietta, GA, it may want to consolidate with all Atlanta area loads for an area called GA-ATL. With a sufficient density, this exercise can be very enlightening for carriers.
Step 4 – Take Action
As a starting point, decide what actions to take to improve profitability. No matter how disciplined and diligent a carrier, there are always opportunities to improve customer profitability. Use $0.10 per total mile at any given time as the amount to unlock through this process. The clearest path to identifying the low-hanging fruit is to rank customers by lane, and for each lane, by gross margin per day. Include three additional columns in this table:
- The effective rate per mile for that customer/lane.
- The average effective rate per mile for the entire lane.
- An external benchmark, such as DAT contract rate (i.e., a 30-day average).
- Lane average differential – #2 minus #1. The value could be positive or negative. If negative, this means there is a pricing disparity versus lane average.
- External Benchmark Differential – #3 minus #1. Again, this value could be positive or negative but represents a signal of how a carrier is pricing its services versus the overall market. For an external benchmark to be credible, there needs to be sufficient density. Depending on the index used, a carrier may have to adjust the market size using 3-digit zip clusters commonly referred to as a KMA (Key Market Area).
Once a Price Impact Action Table is created, add two final columns to the mix: 1.) Price Opportunity, and 2.) Opportunity Value. The price opportunity is simply calculating the largest differential for each lane/customer pair. For example, if the lane average differential is $0.32 and the external benchmark differential is $0.21, add a column that includes an If-based formula to grab the larger of the two. Finally, the last column is multiplying the historical miles for the time period selected by price opportunity. This is more of a psychological tool than a practical one. It reinforces the amount of margin left on the table – margin that would have flowed directly to the bottom line in a perfect world.
Trucking is not a perfect world, nor is it a perfectly efficient market. Carriers know their customers better than anyone else and also know that timing is important. Because of this, use an ‘actualization’ table such as the one below in order to set a realistic target over the next 6-12 months. This method will better match action to reality.
It’s easy to get distracted by all the external noise in the industry. Knowing the incentives behind the media’s reporting and shipper requests removes the psychological barriers to taking action. If the economy enters a recession, carriers have a choice – to participate or not. Choosing not to participate means making many tough choices, and more importantly – taking action.
To further explore your company’s FreightMath and understand how to make it work for your success, please complete this form.
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