Catapult Whitepaper: Understanding Freight Rates in the Global Supply Chain

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1 Catapult Whitepaper: Understanding Freight Rates in the Global Supply Chain

2 1 Introduction Shipping today requires a global mindset. Modern logistics is no longer a matter of managing a small portfolio of local carriers with phone calls and manual processes. Supply chains are complex, international operations that connect suppliers and delivery networks all over the world. A particular challenge for any global supply chain is how to best utilize the many transportation modes - and understand the way freight rates are determined for each. Every method of shipping is very different in terms of how rates are calculated. This is an important point since most international shipments require at least two separate modes to complete even the simplest delivery. Luckily, there are some similarities across modes that serve as a good baseline for understanding freight costs in general. It is not surprising that how far something needs to ship, along with its quantity, go a long way in determining freight costs regardless of the transportation mode. Like anything else, rates are also determined by supply and demand because carriers are in business to optimize profits and maximize margins. Freight rates tend to be very cyclical and react in consistent ways with the overall economy. It s typical that as rates rise, carriers add supply (in the form of more trucks, planes, and ships) which increases capacity and eventually lowers rates. In the current ocean cargo market there is a huge surplus of capacity and rates are at near historic lows. Conversely, due to a strong job market in the U.S., truckload rates are high as a shortage of drivers has increased labor costs, decreased capacity, and as a result limited supply. Any optimized global supply chain must include a firm control of costs, which is not possible without a rigid control of freight rates. To that end, the following is a breakdown of the main shipping modes (land, sea, and air) with an explanation of how each is calculated, as well as other considerations affecting rates. Distance and weight affect operating costs (and therefore rates) by increasing everything from the labor expense of drivers time to the amount of fuel and wear and tear on equipment. Another factor is the time available for a delivery to be made, which compresses everything that happens with a shipment. Less time means fewer options and greater pressure, with less margin for errors. These constraints translate to higher costs. Time and weight can work together in a positive way to lower rates. More time and a larger volume of freight mean lower per unit shipping costs. For example, shipping in larger quantities like full truckload is more efficient than a typically smaller air freight or LTL shipment. In other words, economies of scale are important in logistics.

3 2 Any optimized global supply chain must include a firm control of costs, which is not possible without a rigid control of freight rates.

4 3 Land Almost no delivery can happen without a truck helping at some point, making trucking rates central to most any shipment for obvious reasons. This mode of transportation as it relates to global shipping primarily includes truckload, less-than-truckload (LTL), and small parcel. As a general rule, rates for land shipments are pretty simple relative to other modes. Truckload rates are generally a flat amount or a rate per mile with an adjustable fuel surcharge added. LTL rates in the U.S. are calculated off a negotiated tariff that considers distance, weight, and freight class. Most other parts of the world quote LTL (aka groupage) as a flat rate per shipment. Small parcel is usually a zone to zone rate, based on weight and transit time. This can also vary by country. There are many factors at play in the current marketplace affecting land rates. For one, over the road shipping is very labor intensive. The aforementioned low unemployment level in the U.S. has created a driver shortage which has pushed trucking rates higher. Conversely, during the recession 8 years ago freight rates were very low, and when the economy was weak, capacity was greater and unemployment much higher. The U.S. Trucking Industry s Growing Driver Labor Issues Have Limited Capacity and Increased Rates Average Driver Age: 49 years old Percentage of women drivers: 5.8% Annual Driver Turnover Rate: 90% 2015 Driver Shortage: 48, Estimated Shortage: 48, Estimated Shortage: 175,000 Source: American Trucking Association

5 4 A particular time of year can create predictable peaks and valleys for freight rates in certain regions. For example, the seasonality of produce shipping during peak harvest out in a region like the southern U.S. creates greater demand at certain times of year pushing up rates by 25% or more during that period. The world s logistics infrastructure requires trucks to do most of the picking up and delivering of shipments even when it s an ocean or air freight carrier handling the middle part. This means it s the trucking companies who deal with all the common dock related problems. Detention, special delivery requirements, OS&D issues, and other accessorials are all costs incurred at these times. Accessorials such as these are important costs to understand and negotiate like any other component of a freight rate tariff. Sea Ocean cargo is the least cost option for covering long distances and international moves. It is also the most complicated to manage from a rate and contract perspective. Ocean freight rates are still primarily a function of distance and weight but cube and transit time also impact costs to a large extent. Ocean rates start out pretty simple as shippers generally pay a flat port to port rate per container (or a part of it) as a base rate - but then come fees and other costs. Ocean carrier contracts can be subject to a list of over 1,700 different surcharges, many of which can change weekly or more often. To the frustration of shippers and freight forwarders, many of these additional fees are applied seemingly at the discretion of the carrier. Here are 10 of the most common surcharges applied by ocean carriers: Terminal handling fees (origin/destination) Peak Season Surcharge (PSS) General Rate Increase (GRI) Security charges (carrier, origin/destination) Panama and Suez Canal surcharges Bunker Fuel (technically not a surcharge, but may or may not be included in rate) Inland Fuel Surcharge Documentation fees (origin/destination) Currency Adjustment Factor Chassis fee Port Congestion Fee

6 5 All this combines to make ocean cargo rates hard to calculate accurately without proper technology and industry experience to make sense of the many moving parts. Given the global and political nature of ocean shipping, and the fact there are always multiple countries involved, ocean shipping is the most regulated mode of shipping. These factors together expose ocean shipping to boom and bust periods, the impact of which is reflected in the extreme rate fluctuations common to the industry. Adding to the complexity, world trade and the global economy are especially impactful on rates as most ocean shipping is international. Ocean Shipping from Source to the U.S. Market Is Very Efficient On a Per Item Basis Television $1.00 each Vacuum Cleaner $1.00 Coffee (1kg) $0.15 Scotch Whiskey (bottle) $0.15 Can of beer $0.01 Air Because of its high per unit cost compared to other shipping modes, air freight is often considered the shipping option of last resort. The global air freight network is built for speed and reliability, but not for situations where shippers are looking to minimize costs. Whereas trucks are generally accessible on short notice and can go anywhere a road will take them, air freight is severely limited by flight schedules and space on the planes. It requires tight coordination across the board to execute an air freight shipment successfully. While international air freight is subject to many of the same import/export and documentation regulations as ocean freight, rates are much simpler and not impacted by the same list of fees and surcharges. Air freight costs are typically calculated and billed based on chargeable weight. This is most often calculated using an industry standard formula that accounts for the weight and cube of a particular shipment. Cost per kilogram is the common unit of measure for calculating total shipment costs and include applicable fees, plus delivery and pick up from the shipper and consignee. Facts on Airplane Freight Capacity Most Common Air Craft Used: Freighter Available Space: 26,000 cubic ft. Source: imo.org Pallet Space: up to 35 pallet containers, up to 10 ft. tall Range: up to 9,000 nautical miles Source: Boeing.com

7 6 Like ocean shipping, air freight pricing is a function of capacity and demand. But air freight does not face the same large capacity shocks like those brought on by bigger and bigger megaships being added in the ocean industry currently. The air freight market has perhaps benefited most from the current low cost of oil since fuel accounts for a high percentage of an airline s operating costs much higher than truckload or ocean carriers. Interestingly enough however, because airlines have such extreme risk exposure to the price of fuel, many take measures to hedge their risk to fuel spikes with financial instruments. This hedging has actually muted much of the benefit to the carriers during the recent oil price downtrend. Conclusion These points illustrate the importance of shippers and freight forwarders remaining diligent when it comes to freight rates and contract management. This includes both how they negotiate rates and manage tariffs. Shipping rates are often the most important cost component in the global supply chain. It is the daily routing decisions of choosing the best carrier to optimize cost and service that accumulate into a company s total logistics spend. Understanding how freight rates operate and are influenced by the global marketplace is vital to an optimized gl

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