KEY INSIGHTS 1. Carriers discount their line-haul rates to

compensate shippers for higher than average fuel surcharge premiums.

2. When the price of fuel is above $2.08 per gallon, an increase in fuel surcharge payments is less than offset by a corresponding decrease to the line-haul charge.

3. Shippers that set a low carrier efficiency pay higher fuel surcharge payments and higher per-load transportation costs than do shippers that set a high carrier efficiency for fuel prices above $2.08 per gallon.

By Molly Abramson and Ajit Sawant Thesis Advisor: Dr. Chris Caplice Summary: This project explores how a shipper’s fuel surcharge (FSC) program affects its per-load transportation cost in the United States truckload (TL) transportation industry. We built a cost model using ordinary least squares (OLS) regression analysis to quantify the effect of an FSC program on transportation cost. We controlled for well-known transportation cost drivers including distance, geography, and time of year.

Molly Abramson came to the MIT SCM program after receiving a B.S. in Managerial Economics at the University of California at Davis. Upon graduation, she joined Apple Inc. as a Materials Program Manager in Cupertino.

Ajit Sawant came to the MIT SCM program with an M.M.S. and a B.E. in Electronics from the University of Mumbai. Prior to graduate school, he worked as a Lead Consultant for Infosys. Upon graduation, he joined McKinsey & Company in Boston as an Associate.

Introduction A shipper hires a carrier to transport its product along a lane. Periodically, a shipper will conduct a procurement or bid exercise to select its primary and backup carriers. During a bid exercise, a preselected group of carriers report their lane rates to the shipper. The shipper ranks these rates to form its routing guide. When the shipper has a load that needs to be

transported, the shipper will tender the load to the primary carrier on the routing guide. If the primary carrier rejects the load, the shipper will tender the load to the first backup carrier, then the second backup carrier, and so forth until a carrier accepts the load. A shipper’s per-load transportation cost is made up of a line-haul charge, a fuel surcharge (FSC), and other miscellaneous charges. We excluded these miscellaneous charges from our analysis. The line-haul charge is the contracted rate established during the bid exercise. It covers the carriers operating costs, except for fuel, and includes a small markup for profit. The fuel surcharge is a premium, paid in addition to the line-haul charge, which partially reimburses the carrier for fuel expenditures. How much the shipper pays in fuel surcharge premiums depends on the shipper’s fuel surcharge program and the prevailing price of diesel fuel. Why does the carrier not build the cost of fuel into its line-haul rate during the bid exercise? Fuel prices are volatile. A carrier’s long-term line-haul rate cannot accommodate this price volatility. Instead, the cost of fuel is isolated and shared between the shipper and the carrier. In terms of planning and budgeting, the

Impact of Risk Sharing on Competitive Bidding in Truckload Transportation

shipper also benefits from separating predictable line-haul costs from variable fuel costs. During a bid exercise, shippers report their fuel surcharge programs to carriers. An FSC program is a table which reports how much the shipper will pay to the carrier in FSC premiums at different fuel prices. Table 1 gives a sample FSC program table for a hypothetical shipper.

Table 1. Sample FSC program table

Fuel price between Premium

$1.200 / gallon $1.259 / gallon $0.000 / mile

1.260 1.319 0.010

1.320 1.379 0.020

... ... ...

3.600 3.659 0.400

3.660 3.719 0.410

... ... ...

Suppose that the price of diesel fuel is $3.62 per gallon when the carrier transports the shipper’s load. Using its FSC program table, the shipper determines that it will reimburse the carrier $0.40 per mile for fuel. Three important values characterize a shipper’s FSC program: the peg price, the per-mile premium, and the escalator. The peg price is the fuel price which corresponds to a zero per-mile premium. Here, the peg price is $1.20 per gallon. The per-mile premium is the amount the shipper will pay to the carrier for each mile traveled. Finally, the escalator is the difference between two consecutive fuel prices in the FSC program table. In this table, the escalator is $1.260 – $1.200 = $0.06 per gallon. The escalator determines how quickly the per-mile premium increases. In this case, the per-mile premium increases by one cent for every six cent increase in the price of fuel. We can express this FSC program table in equation form:

!"#-­‐!"#$  !"#  !"#$%&$ = !"#!"#$  !"#$% − !"#

!"#$%$&'(×0.01 1.

If we divide the escalator term by the incremental per-mile premium, we get the shipper’s estimate of a reasonable carrier fuel economy. We call this the shipper’s efficiency value.

!""#$#%&$' =!"#$%$&'(∆  !"#$%&$

=$0.06  /  !"#$0.01  /  !"#$

= 6  !"#$%  /  !"# 2.

Using the efficiency variable, we can approximate the step function given in equation 1 with the following linear equation:

!"#-­‐!"#$  !"#  !"#$%&$ =!"#$  !"#$% − !"#!""#$#!%$&

3.

Research Question FSC programs vary across shippers. Our project evaluated whether a shipper’s FSC program impacted its per-load transportation costs. We hypothesized that the more a shipper paid in fuel surcharge premiums, the less it would pay in line-haul charges. We expected per-load transportation costs to be constant across different FSC programs for a given lane. Methodology We built a cost model using ordinary least squares (OLS) regression analysis to test our hypothesis that lower line-haul charges offset higher fuel surcharge premiums. In OLS regression analysis, a dependent variable is explained by a series of independent variables. Our dependent variable was a measure of the line-haul charge. When carriers set their line-haul rates, they take into account the peg price as reported in the shipper’s FSC program table. These peg prices vary from shipper to shipper. Our dependent variable, called pure line-haul or LH′, was normalized for the effect of different peg prices by calculating what the line-haul charge would have been with a peg price of zero. We calculated the dependent variable, in dollars per load, as follows:

!!! = !"#$%&  !"#$-­‐ℎ!"#  !ℎ!"#$ − !"#  !"#$%&'()& 4.

!!! = !"#$%&  !"#$-­‐ℎ!"#  !ℎ!"#$ −!"#  

!""#$#!%$&×!"#$%&'(

Our model contained an independent variable to quantify a shipper’s FSC premium, as given by its FSC program table, and the peg price adjustment. We called this independent variable total FSC or FSC′ and calculated it as follows:

!"!! = !"#$%&$ + !"#  !"#$%&'()& 5.

!"!! =!"#$  !"#$% − !"#!""#$#!%$&

×!"#$%&'( +!"#  

!""#$#!%$&×!"#$%&'(

!"!! =!"#$  !"#$%!""#$#!%$&

×!"#$%&'(

The FSC program independent variable was measured in dollars. Figure 1 illustrates our dependent LH′ variable and our independent FSC′ variable. Our model also contained independent variables for other transportation cost drivers, including distance, geography, time of year, tender lead time, tender day of week, and an indicator to represent if the carrier was the shipper’s primary carrier or not. In this project, we defined tender lead time as the difference between when the carrier accepted the load and when the carrier transported the load. Results Our main cost model explained the dependent LH′ variable with the FSC′, distance, geography, and time of year independent variables. We represented the time of year with calendar quarters.

We estimated the following equation for pure line-haul:

!!! = 950.73 − 0.63  !"!! + −763.01, 90.60  !"#$%&'ℎ! 6.

!!! = +1.38  !"#$%&'( + −90.85,−11.26  !"#$%&$' + !

The above equation gives the intercept and specific coefficients for the FSC′ and distance independent variables. For the geography and quarter variables, the equation lists a range of coefficients. The FSC′ coefficient of -0.63 indicates that for every $1.00 increase in total FSC spend, there is a corresponding $0.63 decrease in the pure line-haul charge. The FSC ′ independent variable was statistically significant with a p-value of less than 0.0001.The model had a high adjusted R2 of 88.99 percent. Our results did not meaningfully change by adding the tender lead time, tender day of week, and primary carrier independent variables. Our results were also consistent across different assumed fuel prices. So, does a shipper’s FSC program impact its per-load transportation cost? Consider three hypothetical shippers with efficiency values of five, six, and seven miles per gallon. We define the net fuel payment to be the difference between the shipper’s total fuel surcharge payment and the line-haul discount. Figure 2 graphs the net fuel payment for each shipper at different fuel prices.

Figure 2. Efficiency and net fuel payment

-$0.1

$0.0

$0.1

$0.2

$0.3

$0.4

$1.5 $2.0 $2.5 $3.0 $3.5 $4.0

Net

fuel

pay

men

t ($

/ mile

)

Fuel price ($ / gallon)

5 mpg 6 mpg 7 mpg

Per-load cost

FSC premium paid

LH′ DEP. VAR

Peg price adjustment

FSC′ IND. VAR

Contract LH rate

Figure 1. Dependent and independent variables

Efficiency

The x-axis gives the fuel price in dollars per gallon. The y-axis gives the shipper’s net fuel payment to carriers. For fuel prices above $2.08 per gallon, the shipper that assumed a low carrier efficiency paid a larger net fuel payment than did the shipper that assumed a high carrier efficiency. Consequently, the shipper assuming low efficiency had a larger per-load transportation cost than did the shipper assuming high efficiency. Why was the net fuel payment larger for the shipper assuming low efficiency? While this shipper paid higher total fuel surcharge payments than the shipper assuming high efficiency, it also received a larger line-haul discount. When the price of fuel rose above $2.08 per gallon, however, this shipper’s higher FSC payments to carriers outweighed the larger line-haul discount it received from carriers. As a result, the shipper which assumed a low carrier efficiency had higher per-load transportation costs on a given lane. Conclusions This project highlights two important characteristics of the truckload transportation industry. First, the more a shipper pays in fuel surcharge premiums, the less it pays in line-haul charges. Shippers that assume a low carrier efficiency pay higher fuel surcharge premiums but lower line-haul charges than shippers that assume a high carrier efficiency. Second, for fuel prices above $2.08 per gallon, shippers assuming low efficiency have greater per-load transportation costs than shippers assuming high efficiency. Our initial hypothesis was incorrect: a shipper’s FSC program does impact its per-load transportation cost.