The Long and Winding Road to Cube and Density-Based Pricing
Freight pricing has been an interest of mine for many years, particularly the pricing of less than truckload freight. This somewhat ambiguous category encompasses shipments weighing typically between 100 and 10,000 pounds. A white paper entitled The Path to Density-Based Pricing: Connecting Domestic LTL Pricing to the Global Supply Chain, published by SMC3 in September, 2008, places the current status of LTL pricing in the United States in context.
The Current LTL Pricing Structure in the United States
“Over the past two decades, globalization of the supply chain, industry consolidation and competition in the freight transportation marketplace have brought sweeping changes to the less-than-truckload (LTL) industry. In this era of dramatic change in our nation’s business climate, there is one system that has not experienced any fundamental alteration – the industry’s traditional classification-based rating structure. . . . A holdover from the railroad era of the early 20th century, the classification-based pricing system is confusing to the non-expert, costly to implement, and difficult and burdensome to manage. Furthermore, some argue that it produces pricing that bears little relationship to actual transportation costs and that it hinders the LTL industry’s ability to compete against air freight and parcel carriers. . . .
The United States is the only country using a freight classification-based pricing system for LTL shipments; the rest of the world uses density measurements to drive transportation pricing. While many recognize the shortcomings of class-based pricing and have weighed the advantages of moving toward a density- based pricing methodology, real barriers to change remain. For one thing, freight classification has been the industry standard for more than 70 years. Changing this entrenched system would require nothing less than an industry paradigm shift. . . .
Pricing for international oceanic and air freight has long been based on cube and weight calculations. The rest of the developed world, including Canada, Mexico and European countries, uses density measurements to set transportation prices. The United States is the only country where a segment of the trucking industry uses a class-based rate system as the basis for trans¬portation pricing.”
A couple of years ago I became aware of a new LTL pricing methodology entitled “Cube Based Pricing.” At the time, it struck me as a clever way of simplifying the complex National Motor Freight Classification system, of creating a system that correlates the pricing of LTL freight directly with the space occupied on a trailer and of bringing the pricing of LTL freight in the United States (and to a lesser degree in Canada) more in line with how freight is priced in many parts of the world.
I wrote a piece on this topic (see Cube Based Pricing – The Scoop on the new LTL Pricing System, published Oct. 1, 2007) that became the most frequently read posting on this blog. To this day, that blog continues to receive a significant number of readers on a monthly basis. Clearly the piece struck a chord with thousands of shippers and carriers.
Cube and Density Based Pricing
Since there was so much interest, I thought it would be enlightening to revisit this topic to see how far Cube Based Pricing has progressed over the past two years. This blog will explore the current status of two similar LTL pricing methodologies, Density Based Pricing (DBP) and Cube Based Pricing (CBP). Under a density-based system, dimensional weight measurements combine the physical volume and the weight of a shipment to determine shipping costs. Density is computed by dividing the weight of an item by the product of its dimensions in length, width and height, which determines its volume. The typical unit of density measurement is pounds per cubic foot in the English system, and kilograms per cubic meter in the metric system. Cube refers to the cubic space occupied on a trailer and this pricing approach reflects essentially the same set of parameters.
While there are likely a number of companies developing and refining a version or one or both approaches, I will focus specifically on the DBP product from SMC3 and the CBP product from the Visibility Group. Both companies are based in Atlanta, Georgia. To prepare this blog I reviewed the most recent sales collateral from both companies on these topics and interviewed Danny Slaton, Senior VP, Business Development, SMC3 (www.smc3.com) and Hank Mullen, President and Lynnette Guess, CEO, The Visibility Group (www.thevisibilitygroup.com/). Here is what I learned.
Both companies have been hard at work on developing and refining their respective products. Neither product has gained any level of market acceptance although both products are being used on a very limited basis. Danny Slaton indicated that 7 – 8 carriers are using the pricing tool, primarily for import / export. In his view, “the pricing methodology will gain traction as global trade increases and companies require the cost of shipping LTL freight from Beijing to Toronto. As more companies seek to link their global ERP system to their TMS system and these systems are linked to emerging weighing and measuring technologies, the data points required for density formulas will be commonplace. This convergence of technologies will further enable the adoption of DBP”.
Hank Mullen’s take was similar to Danny’s. There are no carriers or shippers that are using CBP exclusively. However, Hank is seeing companies use their NMFC pricing system and their CBP systems in parallel. Commmented Lynnette Guess, "when we developed Cube Based Pricing, we saw the need for a transition model whereby a carrier and shipper can map dimensional attributes to existing freight pricing. We developed this transition model to allow the shipper to provide dimensional data and for the carrier to analyze this data. Our thoughts were that this analysis would lead to a pure Cube Based Pricing system that is simple and efficient." This is allowing shippers and carriers to compare their LTL rates under both methodologies to see how and where the rates vary. Hank also mentioned that there is some interest among a group of 3PL’s since they are less comfortable with the intricacies of NMFC pricing and are seeking ways to facilitate their LTL pricing functions.
The reasons for the slow adoption were outlined very clearly in an e mail received from Jim Graham, Director of TBB Logistics. Here is what Jim had to say.
“While the cost of some technology changes would slow down or prevent some from wanting to make the change, the real obstacle is FEAR. Fear both with the shipper and carriers, and the fear comes from the feeling, belief or knowledge they will be harmed by the change. . . . (The fear has come from) . . . . the transformation of goods to be less dense. . . . (This) . . . . has continued to build support by shippers in holding on to the classification process.
Fear one for the shipper
You see this fear every time a product is changed from one class in the NMFC to a density. Shippers have enjoyed the stable class for their product and now they are subject to a higher class because their product is less dense. Shippers know their products have become less dense and therefore would be subject to higher costs if they had to pay on a density only basis. . . . The simple fact is products have become much smaller and lighter, but the NMFC process has been slow to actually move to more density classes. Some of this slow reaction time was the hesitation to upset shippers who already saw the NMFC as nothing but a carrier committee to collectively raise charges. . . .
Fear two for the shipper
Again, going back into history, shippers . . . . would use much more packaging because they recognized their freight was going to be stacked on other freight, . . . . the carrier’s equipment was rarely “air ride” smooth, and with heavier products it needed to be more secure. Also, the ‘outer packaging’ was (designed) to protect the ‘inner-packaging’ and goods. Several things have happened -- As freight became lighter and costs of packaging went up, shippers did not continue to invest in the best packaging. Also, it became popular to have the ‘outer packaging’ advertise the product, so it can go directly from the shipping pallet to the shelf or the customer’s vehicle. This has led directly to the shipper requiring the carrier to (state) ‘do not double stack’ their product. The (SMC3) white paper talks about a pallet of 48 x 40 x 48 being around 54 cubic feet, but in today’s shipping dock you see considerable freight with the ‘do not stack’ cone, the one package on top so the surface is not level, or pallets exceeding 48 inches. With this going on, the shipper is really taking up 48 x 40 x 96 – 108 cubic feet. While there are a few carriers that have rules in place to adjust for this, most shippers have found ways to skirt these rules and are taking up much more space than the actual shipping form. Under a density program they would have to pay for this space in some manner, which would increase their costs.
Fear for the carrier
The transition of the process from the class to the density rating system places the carriers in a position of losing revenue over a considerable amount of time. Shippers who would benefit from the change would make the move quickly, and thus the carrier would see less revenue from these accounts. Those shippers who perceive or know their freight charges would go up would be hesitant to move and would continue to pressure the carrier(s) to rate their shipments under the current class/rate process. Until the field is completely level (all carriers moving to density rating and shippers given little choice), you have carriers working under both systems and not seeing the benefit of shippers sharing equally in paying for the space used.
The move to a density system will take place much quicker and smoother if there is a way for the transformation to . . . . be ‘revenue/expense neutral’ for the carrier and shipper for an 18 to 36 month period, and during this time and at least 24 months after transition, there is equilibrium of demand and supply. Then market forces can begin to adjust to the actual purchase of space for distance. If either side has the upper hand, then movement will be very difficult.”
7 Steps to Density Based Pricing
In the SMC3 white paper referenced above, 7 items are listed as requirements to bring about the change that so many shippers are carriers are seeking. They include:
1. A Change Management Process to bring about a methodical, gradual change.
2. A Consensus among Shippers and Carriers that this will result in greater efficiency over the long term.
3. A Standardized Methodology with Clear Rules to ensure Uniformity.
4. Revenue Parity that does not unduly Reward or Punish Shippers, Carriers or Third Parties.
5. A Shipment Handling Methodology to account for Over-dimensional or Hazardous Products.
6. Automated Business Processes that account for Density and Cube across the Supply Chain.
7. Enabling Technologies (e.g. forklift scales) that simplify and speed the implementation process.
The Canadian Experience
While this all sounds good, domestic LTL freight in Canada and some cross-border freight has for years been rated using a density based pricing methodology. What can we learn from the Canadian experience? To answer this question I spoke with Laura Tizzard of L.T. Traffic Services. This is what she had to say.
“Although there was less application of a classification system, there once were commodity-based tariffs in place (in Canada) to cover all products and shipping lanes domestically. The only “rate quotes” that existed were simple agreements as to the amount of discount a customer might qualify for. . . . Carriers were forced to work on a level playing field and the competition between carriers was based more on service and value added products than on rate structures.
Now, there is no standard tariff being applied. There are only rate quotes specifically named for a shipper with rates negotiated between the shipper and carrier. . . . Many carriers are now attempting to develop their rates based on a “cost plus” structure. For TL carriers it is a fairly simple process of establishing pickup, handling, linehaul, and delivery costs per load. However for LTL carriers the process becomes much more complicated and difficult to measure. Each measure of those cost categories is dependent upon how many different shippers contribute to the load and how many different products are involved. The make-up of every load is different, the structure difficult to predict and dependent on customer delivery deadlines. If carriers had the time and space available to hold freight and plan their loads for greatest profit and efficiency that would be nice, but the reality is that consignees no longer carry large inventories and shipper products are sent as needed. Carriers have to move the freight when they receive it in order to meet the delivery requirements to satisfy consumer needs.
Canadian LTL carriers now need to measure the space occupied by each shipment in order to distribute the costs throughout the load and measure the profitability of each component. To that end they are using DBP and CBP price structures. Although some shippers may not see cubing reflected in their invoicing, they are in fact paying based on the density of their product.
While the 7 items suggested by SMC3 would be ideal and something to strive for, the reality of achieving that standard and consensus among shippers and carriers has not been reflected in the Canadian trucking industry. After deregulation, pricing became a free-for-all largely dependent on what the other guy was offering. Shippers went along with the new pricing because they witnessed the competition and received lower rates. At the time, shippers felt they were finally getting a deal but now find it difficult to measure themselves against their competition. They truly have no way of knowing if they are getting the ‘best’ deal or whether their competitor has achieved something they have not. Perhaps now is the time to bring back a standard that shippers can measure themselves against.
However, whether the ‘tariff’ is based on class, commodity description, or density factors is not the real issue. All of those methods simply give the product a category or name. The real issue is what rates or prices are connected to those product categories. As long as shippers insist on discounts and want a better rate than their competitors, and as long as carriers are willing to comply and give never-ending discounts, then the tariff (whatever it is based on) will at some point become irrelevant.”
The Long and Winding Road
Clearly, the road to Cube and Density Based Pricing will be long and winding. These are significant hurdles to overcome. While the move to these types of pricing systems is inevitable, it will take time and a major collaborative effort between shippers, carriers and the companies designing these tools to make the move a reality. The other challenge, in light of the highly competitive nature of the U.S. economy and the culture of freight rate discounting, will be to see whether one or more of these tariffs can at least serve as basic LTL rate benchmarking tools over time.