Logistics Procurement: When to Optimize for Cost vs. Stability
When you talk to sourcing professionals, one of the procurement challenges that will repeatedly be raised is logistics. The transportation of materials and supplies to production locations, and the delivery of finished products to customers.
Logistics is extraordinarily complex. It involves many moving pieces, multiple carriers, and multiple geographical locations. As always, there is pressure to keep costs to a minimum, but that must be weighed against the disruption to business that would result if there’s insufficient shipping capacity available.
In this blog, we’ll explore when category managers should optimize logistics procurement for price, and when it would be better to optimize for stability.
The Goal of Logistics Procurement
Logistics can involve a wide range of transportation modes including truck, train, airplane, boat, and others, and cover a wide range of industries, such as food and beverage and packaging. To simplify the conversation, let’s stick with trucks as our unit of measurement.
The goal of logistics procurement then becomes twofold. First, ensuring there is enough space available on enough trucks to ensure material, supplies, and services can be transported between facilities to support on-time production. Second, there must be sufficient truck capacity to transport finished products to customers, on time.
It’s not quite that simple, of course. There are a lot of moving pieces. You must make certain that the right trucks are available at the right time at the right location. Cost is also a big variable. Transportation costs can easily account for 10% to 20% of production costs, so spending effectively on logistics can make a huge difference in profitability.
The Challenge of Forecasting the Demand for Trucking
The procurement team is usually responsible for putting logistics contracts up for bidding. Doing so involves being familiar with the carriers in a region. It also requires an understanding of how much truck space will be needed in each region. Ideally, being able to accurately estimate how much truck capacity will be required in each region plus having multiple carriers bidding on the contract results in competitive bidding and better pricing.
You can probably see the many potential issues that are bound to arise. Will the procurement team be capable of accurately forecasting the unit level sales numbers needed to estimate the required truck capacity? For most manufacturing companies, this is difficult. As a result, the procurement team needs to figure out the relative cost of buying redundant capacity (stability) versus the risk of buying too little (focus on cost).
A common strategy is to negotiate frame contracts with several large carriers in a given region. The assumption is that these frame carriers will fulfill the estimated transportation demand. Smaller secondary carriers are used as the safety choice to pick up the slack should orders spike and exceed the estimated demand.
Here’s where things get even more complicated for the procurement team. It’s far too easy to lose track of how many trucks each carrier has in each region. That can lead to procurement assigning large, frame contracts to a carrier that lacks the capacity to fulfill the orders in a particular region. When orders are placed with these carriers and they turn them down due to insufficient capacity, secondary carriers must be tracked down and paid a premium for transportation.
The result is stress and the high likelihood of additional costs and delays. In a worst-case scenario, logistics challenges can result in customers turning to competitors who can deliver their order on time.
Optimization to the Rescue
The solution to the problem is optimization. This means either optimizing carrier forecasts for cost savings (at the risk of being caught short) or optimizing for stability (at the risk of overpaying or being stuck with excess capacity).
The best tools for choosing whether to optimize for cost stability are data, reporting, and predictive sourcing . Go back through five years of quarterly logistics estimates and determine whether your forecast for required carrier capacity was accurate. If those numbers were consistently on the number, then it means you rarely had to scramble at the last moment to find a secondary carrier for an emergency delivery. In this case, it makes sense to optimize for cost.
The Cost of Overly Conservative Forecasts
After doing a deep dive on the historical numbers, many procurement teams discover that they have consistently been conservative in their carrier forecasts.
If your carrier forecasts are frequently too conservative, that means your company is regularly paying extra for secondary carrier costs. Which cuts into the bottom line. Even worse, delivery issues caused by having insufficient carrier capacity booked may be costing your company sales. Customers who can’t count on reliable delivery times and costs will soon look elsewhere.
If you discover a pattern of overly conservative carrier forecasts, that’s a clear sign you should be forecasting for stability instead of cost.
The Next Step
The process of optimization — and choosing whether to optimize logistics procurement for cost or stability — depends on access to data. Comparing quarterly forecasts to actuals and even knowing critical details like the capacity of individual carriers in different geographical regions requires procurement software that can capture this data.
Arkestro can help with your next logistics RFP. We have templates available that will ensure you are optimizing logistics and not overpaying. To create your templates and to get a one-on-one walkthrough, click here.