Marketing channel and logistics management CHAPTER 2.doc

CHAPTER TWO
TRANSPORTATION MANAGEMENT
Transportation represents the most important single elements in logistical costs for most
firms. Freight movement typically absorbs two-thirds of the logistics expense. For this
reason, the logistician should have a good understanding of transportation matters.
The five basic transportation modes are Rail, Highway, Water, Pipeline, and Air. The
relative importance of each mode can be measured in terms of:
 System mileage,
 Traffic volume,
 Traffic revenue, and
 The nature of traffic composition.
Modes of Transportation
The mode of transport describes the type of transport used.The freight transportation
structure consists of the rights-of-way, vehicles, and carriers that operate within five basic
transportation modes. A mode identifies a basic transportation method or form. The five
basic transportation modes are: Rail, Highway ( road ), Water, Pipeline, and Air. Each
mode has different characteristics, and the best in any particular circumstances depends
on the type of goods to be moved, locations, distance, value and a whole range of other
things.
A. Rail Transportation
Rail transport is most commonly used for heavy and bulky loads over long land journeys.
Trains can maintain a consistent, reasonably high speed, and can link with other modes to
carry containers and bulk freight.
Rail Transport uses freight trains for the delivery of merchandise. Freight trains are usually
powered by diesel, electricity and steam. Rail is suited for bulk shipment of products like
fertilizer, cement, food grains and coal etc. From the production plant to the warehouses.
The capability to efficiently transport large tonnage over long distances is the main
reason railroads continue to handle significant intercity tonnage.
Railroad operations have high fixed costs because of expensive equipment, right-of-way
and tracks, switching yards, and terminals. However, rail enjoys relatively low variable
operating costs. The development of diesel power reduced the railroads' variable cost per
ton-mile, and electrification is providing further reductions.
Advantages of Rail transportation:
 it is relatively faster than road transport.
 it is suitable for carrying heavy goods in large quantities over long
distances.
 cost effective.
Limitations of Rail transportation:
 it is relatively expensive for carrying goods over short distances.
 it is not available in remote parts of the country.
 It provides service according to fixed time schedule and is not flexible for loading
or unloading of goods at any place
BY: Asaminow G.@DKU Marketing Distribution and Logistics Management CH-2 1
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B. Highway Transport:
Highway transportation has expanded rapidly since the end of World War II. To a
significant degree the rapid growth of the motor carrier industry has resulted from speed
and ability to operate door-to-door.
Motor carriers have flexibility because they are able to operate on all types of roadways.
Nearly one million miles of highway are available to motor carriers, which is more mileage
than all other modes combined
Road is the most widely used mode of transport and is used – at least somewhere – in
almost all supply chains. Its main benefit is flexibility, being able to visit almost any
location.
Road Transport Advantages:
 It is a relatively cheaper mode of transport as compared to other modes.
 It is a flexible mode of transport as loading and unloading is possible at any
destination. It provides door to door service.
 It helps to carry goods from one place to another, in places which are not connected
by other means of transport like hilly areas.
Limitation of Road Transport
 Due to limited carrying capacity road transport is not economical for long distance
transportation of goods.
 Transportation of heavy goods or goods in bulk by road involves high cost.
C. Water Transportation
Water is the oldest mode of transport. The original sailing vessels were replaced by steam-
powered boats in the early 1800s and by diesel in the 1920s. A distinction is generally
made between deep water and navigable inland water transport.
Both rail and road transport have the obvious limitation of only being used on land. Most
supply chains use shipping to cross the oceans at some point, and over 90% of world trade
is moved by sea.
Water transport uses ships and large commercial vessels that carry billions of tons of cargo.
Water transport is used primarily for the movement of large bulk commodity shipment and
it is the cheapest mode for carrying such load. Water transport is particularly effective for
significantly large quantities of goods that are not perishable in nature and for cities or
states that have water access.
Advantages of Water transportation:
 It is a relatively economical mode of transport for bulky and heavy goods.
 The cost of maintaining and constructing routes is very low most of them are
naturally made.
 It promotes international trade.
Disadvantages of Water transportation:
 The depth and navigability of rivers and canals vary and thus, affect operations of
different transport vessels.
 It is a slow moving mode of transport and therefore not suitable for transport of
perishable goods.
 It is adversely affected by weather conditions.
 Sea transport requires large investment on ships and their maintenance.
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D. Pipeline
Pipelines are a mode of transportation used primarily for the movement of crude petroleum,
refined petroleum products, natural gas, and other fluids in the form of gas, liquid, or
slurry. They operate on a continuous basis, 24 hours a day, 7 days a week, with high fixed
costs for construction, right-of-way, control stations, and pumping capacity. Once
constructed, pipelines have low variable operating costs and are limited in flexibility in
terms of the commodities that can be transported.
Advantages of Pipelines:
 Efficient for moving large quantities over long distances.
 Low variable operating costs once constructed.
 Environmentally friendly compared to other transportation methods.
 Reliable and consistent in terms of delivery.
 No need for return trips or empty containers/vehicles.
 Can transport oil, gas, water, sewage, and some other products like pulverized coal
in oil.
Disadvantages of Pipelines:
 Limited flexibility in terms of the commodities that can be transported.
 Slow speed of transportation (typically less than 10 km per hour).
 Inflexible routes, only transporting between fixed points.
 High initial investment required for building dedicated pipelines.
 Vulnerable to leaks and environmental hazards if not properly maintained.
 Only suitable for carrying large volumes of certain types of fluids.
E. Air Transportation
The newest but least utilized mode of transportation is airfreight. Air freighting is
commonly used by companies who work with short lead times, or advanced service levels.
Air transportation is best suited for small, high - value items or time sensitive emergency
shipment that have to travel a long distance. Air carries normally move shipments that have
high value but light weight.
Advantages of air transportation
 It is the fastest mode of transport
 It is very useful in transporting goods to the area, which are not accessible by any
other means.
 Reduce lead time and Improved service levels.
Disadvantages:
 It is relatively more expensive mode of transport.
 It is not suitable for transporting heavy and bulky goods.
 It is not suitable for short distance travel.
Generally, an enterprise has three alternative ways to obtain transportation capacity.
A) Private--a private fleet of equipment may be purchased or leased.
B) Contract--specific contracts may be arranged with transport specialists to
provide movement service.
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C) Common carriage--an enterprise may engage the services of any legally
authorized transport company that offers point-to – point transfer at specified
charges.
From the logistical system viewpoint, three factors are of primary importance in
establishment of the transport service capability:
 Cost
 Speed, and
 Consistency
The cost of transport accrues from the actual payment for movement between two points,
plus the expenses related to owning in-transit inventory. Logistical systems should be
designed to minimize the transport cost in relation to the total system cost. However, this
does not mean that the most inexpensive method of transportation is always desirable.
Speed of transportation service is the time required to complete a movement between two
locations. Speed and cost are related in two ways:
1. Transport specialists capable of providing faster service will charge higher rates.
2. The faster the service, the shorter the time interval during which materials and
products are captured in transit.
Consistency of transportation service refers to the variance in time for a number of
movements between the same locations. In essence, how dependable is a given method of
transportation with respect to time? In many ways, consistency of service is the most
important characteristic of transportation.
2.1 Basic Transport Economics & Pricing
Transport economics and pricing are concerned with the factors and characteristics that
determine transport costs and rates. To develop an effective logistics strategy and to
successfully negotiate transport agreements, it is necessary to understand the economics of
the industry. A discussion of transportation economics and pricing required coverage of
three topics:
 The factors that influence transport economics
 The cost structures that influence expense allocation.
 The rate structures that form the foundation for actual customer charges.
2.1.1 Economic Factors
Transport economics is influenced by seven factors. The specific factors are distance,
volume, density, stow ability, handling, liability, and markets. In general, the above
sequence reflects the relative importance of each factor.
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Distance—is a major influence on transportation cost since it directly contributes to
variable cost, such as labor, fuel, and maintenance. The following figure shows the general
relationship and illustrates two important points.
1) The cost curve does not begin at the origin because there are fixed costs
associated with shipment, pickup and delivery regardless of distance.
2) The cost curve increases at a decreasing rate as a function of distance.
This characteristic is known as the tapering principle, which results from the fact that
longer movements tend to have a higher percentage of intercity rather than urban miles.
Generalized relationship between distance and transportation
Volume—like many other logistics activities, transportation scale economies exist for
most movements. This relationship, illustrated in the following figure, indicates that
transport cost per unit of weight decreases as load volume increases. This occurs because
the fixed costs of pickup and delivery as well as administrative costs can be spread over
additional volume. The relationship is limited to the maximum size of the vehicle (such as
a trailer). Once the vehicle is full, the relationship repeats for the second vehicle. The
management implication is that small loads should be consolidated into larger loads to take
advantage of scale economies.
Generalized relationship between weigh and transportation cost/pound.
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Price per pound

Density—the third economic factor is product density, which incorporates weight and
space considerations. These are important since transportation cost is usually quoted in
terms of dollars per unit of weight, such as amount per ton or amount per hundredweight
(cwt). In terms of weight and space, an individual vehicle is constrained more be space
than by weight. Once a vehicle is full, it is not possible to increase the amount carried even
if the products is light. Since actual vehicle labor and fuel expenses are not dramatically
influenced by weight, higher density products allow relatively fixed transport costs to be
spread across additional weight. As a result, these products are assessed lower transport
costs per unit weight.
In general, logistics managers attempt to increase product density so that more can be
loaded in a trailer to better utilize capacity. Increased packaging density allows more units
of product to be loaded into the fixed cube of the vehicle. At a certain point, not additional
benefits can be achieved through increased density liquids such as beer or soda ‘weighs
out” a highway trailer when it is about half full. As such, the weight limitation is reached
before the volume restriction is met. Nevertheless, efforts to increase product density will
generally result in decreased transportation cost.
Generalized relationship between density and transportation cost/pound.
Stowability—refers to product dimension and how they affect vehicle (railcar, trailer, or
container) space utilization. Odd sizes and shapes, as well as excessive weight or length,
do not stow well and typically waste space. Although density and stow ability are similar,
it is possible to have products with the same density that stow very differently. Items with
standard rectangular shapes are much easier to stow than odd-shaped items. For example,
while steel blocks and rods have the same density, rods are more difficult to stow because
of their length and shape. Stow ability is also influenced by the shipment size; sometimes
large numbers of items can be “nested” that might otherwise be difficult to stow in small
quantities. For example, it is possible to accomplish significant nesting for a truckload of
trash cans, while a single can is difficult to stow.
Handling—Special handling equipment may be required for loading or unloading trucks,
railcars, or ships. Furthermore, the manner in which products are physically grouped
together (e.g., taped, boxed, or palletized) for transport and storage also affects handling
cost.
Liability—includes six product characteristics that primarily affect risk of damage and
the resulting incidence of claims. Specific product considerations are susceptibility to
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damage, property damage to freight, perishability, and susceptibility to theft, susceptibility
to spontaneous combustion or explosion, and value per pound. Carriers must either have
insurance to protect against possible claims or accept responsibility for any damage.
Shippers can reduce risk, and ultimately the transportation cost, by improved protective
packaging or by reducing susceptibility to loss or damage.
Market Factors—Finally, market factors, such as lane volume and balance, influence
transportation cost. A transport lane refers to movements between origin and destination
points. Since transportation vehicles and drivers must return to their origin, either they
must find a load to bring back (“back-haul”) or the vehicle is returned empty (‘deadhead”).
When deadhead movements occur, labor, fuel, and maintenance costs must be charged
against the original “front-haul” move. Thus, the ideal situation is for “balanced” moves
where volume is equal in both directions. However, this is rarely the case because of
demand imbalances in manufacturing and consumption locations. Balance is also
influenced by seasonality such as the movement of fruits and vegetables to coincide with
the growing season. Demand directionality and seasonality result in transport rates that
change with direction and season. Logistics system design must take this factor into
account and add back-haul movement where possible.
2.1.2 Cost Structures
The second dimension of transport economics and pricing concerns the criteria used to
allocate cost components. Cost allocation is primarily the carrier’s concern, but since cost
structure influences negotiating ability, the shipper’s perspective is important as well.
Transportation costs are classified into a combination of categories.
Variable Costs—are those costs that change in a predictable, direct manner in relation
to some level of activity during a time period. Variable costs can be avoided only by not
operating the vehicle. Aside from exceptional circumstances, transport rates must at least
cover variable costs. The variable category includes direct carrier costs associated with
movement of each load. These expenses are generally measured as a cost per mile or per
unit of weight. Typical cost components in this category include labor, fuel, and
maintenance.
Fixed Costs—are those costs that do not change in the short run and must be covered
even if the company is closed down (e.g., during a holiday or a strike). The fixed category
includes carrier costs not directly influenced by shipment volume. For transportation firms,
fixed components include terminals, right-of-way, information systems, and vehicles. In
the short term, expenses associated with fixed assets must be covered by contributions
above variable cost on a per shipment basis. In the long term, the fixed cost burden can be
reduced somewhat by the sale of fixed assets; however, it is often very difficult to sell
rights-of-way or technologies.
Joint Costs—are expenses unavoidably created by the decision to provide a particular
service. For example, when a carrier elects a haul a truckload from point A to point B,
either the joint cost must be covered by the original shipper from A to B, or a back-haul
shipper must be found. Joint costs have significant impact on transportation charges
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because carrier quotations must include implied joint costs based on considerations
regarding an appropriate back-haul shipper and/or back-haul charges against the original
shipper.
Common Costs—this category includes carrier costs that are incurred on behalf of all
shippers or a segment of shippers. Common costs, such as terminal or management
expenses, are characterized as overhead. These are often allocated to a shipper according
to a level of activity like the number of shipments handled (e.g., delivery appointments).
However, allocating overhead in this manner may incorrectly assign costs. For example, a
shipper may be charged for delivery appointments when it doesn’t actually use the service
(such as when the shipper’s deliveries are unloaded on an “as available” basis).
2.1.3 Pricing Strategies
When setting rates to charge shippers, carriers can adopt one or a combination of two
strategies. Although it is possible to employ a single strategy, the combination approach
considers trade-offs between the cost of service incurred by the carrier and the value of
service to the shipper.
Cost-of-Service Strategy—is a “buildup” approach where the carrier establishes a rate
based on the cost of providing the service plus a profit margin. For example, if the cost of
providing a transportation service is Br. 200 and the profit markup is 10 percent, the carrier
would charge the shipper Br. 220. The cost-of-service approach, which represents the base
or minimum transportation charge, is a pricing approach for low-value goods or in highly
competitive situations.
Value-of-Service Strategy—is an alternative strategy that charges a rate based on
perceived shipper value rather than the cost of actually providing the service. For example,
a shipper perceives transporting 1,000 Birr of electronic equipment as more critical or
valuable than 1,000 Br. of coal since the equipment is worth substantially more than the
coal. As such, a shipper is probably willing to pay more to transport it. Carriers tend to
utilize value-of-service pricing for high-value goods or when limited competition exists.
Combination Strategy—establishes the transport price at some intermediate level
between the cost-of-service minimum and value-of-service maximum. In standard
practice, most transportation firms use such a middle value. Logistics managers must
understand the range of prices and alternative strategies so that they can negotiate
appropriately.
Net Rate Pricing—it is a simplified pricing format. Carriers can replace individual
discount sheets and class tariffs with a single price sheet—and thus make the customer’s
interpretation of the rate-making process much simpler.
Established discounts and accessorial charges are built into the net rates. In other words, the
net rate represents a final price. The goal is to drastically reduce carriers’ administrative
costs and directly respond to customer demand to simplify the rate making process. Carriers
thus hope to win over new shippers and solidify current shipper accounts by taking much of
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the calculation out of finding a price. Shippers welcome pricing simplification because it
promotes billing accuracy and provides a clear understanding of how to generate savings in
transportation.
 Rating
This section presents the actual pricing mechanics used by carriers and it applies
specifically to common carriers, although contract carriers utilize similar concepts.
Class Rates—in transportation terminology, the price in Birr and cents per
hundredweight to move a specific product between two locations is referred to as the rate.
The rate is listed on pricing sheets or computer files known as tariffs. The term class rate
evolved from the fact that all products transported by common carriers are classified for
pricing purposes. All products legally transported in interregional commerce can be
shipped via class rates.
Determination of common carrier class rates is a two-step process:
1. The classification or grouping of the product being transported.
2. The determination of the precise rate (i.e., price) based on the classification of the
product and the origin-destination points of the shipment. Typically, this procedure
is referred to as rate administration.
1.Classification—all products transported together are typically grouped into uniform
classifications. The classification takes into consideration the characteristics of a product
or commodity that will influence the cost of handling or transport. Product with similar
density, stowability, handling, liability, and value characteristics are grouped together into
a class, thereby reducing the wide range of possible ratings to a manageable size. The
particular class that a given product or commodity receives is its rating. The rating is the
product's classification placement, which is used to determine the freight rate. It is
important to understand that the classification does not define the price charged for
movement of a product. It refers to a product’s transportation characteristics in comparison
to other commodities.
Products are also assigned different ratings on the basis of packaging. Glass may have a
different rating when shipped loose, in crates, or in boxes than when shipped in wrapped
protective packing.
2.Rate Administration—once a classification rating is obtained for a product, the
specific rate must be determined. The rate per hundredweight is usually based on the
shipment origin and destination, although the actual price charged for a particular shipment
is normally subject to a minimum charge and may also be subject to surcharges or ancillary
assessments. Historically, the origin and destination rates were maintained in notebooks
that had to be updated and revised regularly.
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In addition to the variable shipment charges on either per hundredweight or a per mile
basis, two additional charges are common for transportation:
 Minimum charges and
 Surcharges.
The minimum charge represents the amount a shipper must pay to make a shipment
regardless of weight. To illustrate, assume that the applicable class rate is Birr 15/cwt, and
the shipper wants to transport 100 pounds to a specific location. If no minimum charge
exists, the shipper would pay Birr15. However, if the minimum charge is Birr150 per
shipment, the shipper would pay the minimum. Minimum charges cover fixed costs
associated with a shipment.
A surcharge is an additional fee designed to cover specific carrier costs. Surcharges are
used to protect carriers from costs not included in published rates. The surcharge may be
assessed as a flat charge, a percentage, or a sliding scale based on shipment size. A
common use of surcharges is to compensate carriers for dramatic changes in fuel cost. For
example, when fuel prices experience steep increases, it is common to see transportation
rates with 10 to 20 percent surcharges. The surcharge approach provides immediate relief
for the carrier for unexpected costs while not building a “temporary” cost into the long-
term rate structure. There are different types of rating: some of these are:
Commodity Rates—when a large quantity of a product moves between two locations
on a regular basis, it is common practice for carriers to publish a commodity rate.
Commodity rates are special or specific rates published without regard to classification.
Exception Rates—exception rates, or exceptions to the classification, are special rates
published to provide shippers lower rates than the prevailing class rate. The original
purpose of the exception rate was to provide a special rate for a specific area, origin-
destination, or commodity when either competitive or high volume movements justified it.
An aggregate tender rate is utilized when a shipper agrees to provide multiple shipments
to a carrier in exchange for a discount or exception from the prevailing class rate. The
primary objective is to reduce carrier cost by permitting multiple shipment pickups during
one stop at a shipper’s facility or to reduce the rate for the shipper because of the carrier’s
decreased management and marketing expenses.
A limited service rate is utilized when a shipper agrees to perform services typically
performed by the carrier, such as trailer loading, in exchange for a discount. A common
example is a shipper load and count rate, where the shipper takes responsibility for loading
and counting the cases. Another example of limited service is a released value rate, which
limits carrier liability in case of loss or damage. Normally, the carrier is responsible for
full product value if loss or damage occurs in transit.
2.2. Transport Decision Making
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Transportation decision making requires the availability of information and the assignment
of knowledgeable, trained individuals to process the information in order to serve the
enterprise’s functional and strategic transportation needs. Information is provided through
a variety of transport documents. Utilization and analysis of the information are the
responsibility of various members of the traffic department.
Transport Documentation
Several documents are required to perform each transport movement. The three primary
types are bills of lading, freight bills, and shipping manifests.
Bill of Lading—is the basic document utilized in purchasing transport services. It
serves as a receipt and documents commodities and quantities shipped. For this reason,
accurate description and count are essential. In case of loss, damage, or delay, the bill of
lading is the basis for damage claims. The designated individual or buyer on a bill of
lading is the only bona fide recipient of goods. A carrier is responsible for proper delivery
according to instructions contained in the document. In effect, title is transferred with
completion of delivery.
According to Charles Taff, the bill of lading has the following three purposes:
1) It serves as a receipt for goods, subject to the classifications and tariffs that
were in effect on the date that the bill of lading was issued.
2) It serves as a contract of carriage and identifies the contracting parties and
prescribes the terms and conditions of the agreement.
3) It serves as documentary evidence of title.
Freight Bill—represents a carrier’s method of charging for transportation services
performed. It is developed using information contained in the bill of lading. The freight
bill may be either prepaid or collect. A prepaid bill means that transport cost must be paid
prior to performance, whereas a collect shipment shifts payment responsibility to the
consignee.
Shipping Manifest—lists individual stops or consignees when multiple shipments are
placed on a single vehicle. Each shipment requires a bill of lading. The manifest lists the
stop, bill of lading, weight, and case count for each shipment. The objective of the
manifest is to provide a single document that defines the contents of the total load without
requiring a review of individual bills of lading. For single-stop shipments, the manifest is
the same as the bill of lading.
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