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By Stelios Stylianakis
Country General Manager
TNT Express (Cyprus) Ltd.
Optimising transportation costs requires the consideration of a number of factors. There is clearly a general trade-off between speed of transport and corresponding transportation costs. For example, sea transportation is much cheaper than by air. Consequently, transit times and respective costs, as well as corresponding demand issues must be clearly understood before selecting the corresponding service. There is also a trade-off between ordering high quantities less often (low transportation costs per unit, but high stock holding costs), as opposed to smaller quantities, more often (using faster transportation means). Let’s try to over-simplify the issue.
Trade-off between transportation costs and stock holding costs
Holding more stock than needed is subject to a number of less obvious costs over a specific time period, the most important of which are the following:
a) Stock obsolescence cost = Total Cost of Obsolete Stock (i.e. the value of stock written off in the P&L);
b) Financing costs (cost of capital held up in stocks) = Average Stock X Cost of Capital;
c) Warehousing Cost (rent, opportunity cost: utilising that space differently, salaries, etc).
When a company takes action to reduce its stock levels (by ordering smaller quantities more often), then the total of those three elements of holding costs is reduced. This reduction as a % of Cost of Goods Sold (COGS) can be compared to the additional transportation cost % (as a percentage of COGS) for the different alternatives examined. As long as this cost reduction % is higher than the additional transportation cost %, then it clearly pays off to order less and more often. It goes without saying that a minimum stock level must be kept to satisfy urgent demand.
These days, there is another critical factor that should be considered. The current inability of our banking system to support local business makes financing a very scarce resource. In other words, it is not only about financing cost, it is about availability of financing per se. Consequently, most companies cannot afford to buy large stock quantities and what they can do is simply to choose the right transportation method, given the financing limitations (as opposed to deciding on optimum stock levels).
Transit Time Considerations:
There is often a less obvious element in transit times, which may be omitted. Surely, this may result in costly stock outs and customer dissatisfactions. Transit times then, must be assessed properly.
First of all, the value of Time Definite Services (as opposed to every other type of transportation service), must be clearly understood. A time definite service enables consistent transit times through daily scheduled departures. This basically means that no matter which day the shipment is available for departure at origin, the transit time to destination is always the same. This is so important for proper planning of stock levels and for the avoidance of costly stock outs.
Furthermore, there might be cases where a more complicated solution may actually prove either cheaper, or faster, or both. For example, a flight from a particular city to LCA may take a few hours but if there are only two flights per week, total transit times can be anything between 1-4 days. However, if road transportation is scheduled daily and a truck from the particular city can reach within 1 day an airport where regular flights to LCA exist, then the combination of road and air transportation could actually be a more effective and speedy solution.
Finally, one must ensure that the transit-time alternatives assessed actually correspond to similar service levels. Sometimes companies obtain port-to-port quotations and transit times and wrongly compare it with door-to-door service. Clearly, even in bigger cities (with own international airports or ports), the time to pick up a shipment and take it on time to the airport or port (in order to depart as per schedule) is significant (similar arguments apply to corresponding costs). Equally, the time to clear a shipment at destination (if needed) as well as the time to deliver it at the door of the receiver must also be taken into consideration.
Conclusions:
Calculating the trade-off between transportation costs and stock holding costs is relatively straight forward. Evaluating different transportation options must be done with care, ensuring meaningful comparisons between solutions exhibiting similar service levels (especially when it comes to transit times and associated costs). There is no need to pay a premium for faster transportation when you do not really need the products as soon as possible but, make sure you understand the service you buy, especially when you do need the products as soon as possible!
If uncertain, ask for help… but make sure you ask those that can, and are willing to help.
