At the depths of the Great Recession, a barrel of crude oil cost $40. Last Friday, the number closed at over $104 U.S., with no relief in site. Michael Irvine of the Kent Group, a petroleum consulting firm expressed the view that it's not only the situation in Libya that's causing the spike in crude. " It’s not as much related to the Middle East as many people would think, but more fundamentally on the basis of global crude oil demand having increased steadily for many months now. Demand for crude oil globally is at, or higher than the pre-recessionary levels."

There is a direct inverse correlation between increases in oil costs and economic activity. According to new report on CBC News, for every $10 increase in the cost per barrel of crude oil, GDP decreases by 0.5% over the next 2 years. Journal of Commerce Economist Mario Moreno estimates that U.S. consumer spending growth, excluding gasoline and other energy, is reduced $11 billion, or one-tenth of a percentage point, for each 17 cents that average gasoline prices for all grades rise above $2.90 a gallon. If average gasoline prices reach $4 a gallon in the U.S., he forecasts consumer spending on non-fuel purchases would fall $60 billion or 6.5 percent.

Higher energy prices also reduce consumer confidence, a key component of sustained economic growth. A 4 percent rise in gasoline prices from December to January contributed to a drop in the Reuters/Michigan consumer sentiment index of 72.7, down 1.8, in mid-January.

Of course energy prices are not the only costs on the rise. Prices for other commodities such as copper, steel and aluminum have also been receiving an updraft. Recently there have numerous reports of dramatic increases in food prices, notably wheat. Some experts have suggested that the inability of people to feed their families in Egypt was a large contributor to overthrow of the Hosni Mubarak and has been a key factor in the turmoil in other countries in the region. Other reports indicate that U.S. housing prices may have hit bottom. This suggests that continuing cost increases in food, energy and housing may curtail or even derail economic growth.

This places freight transportation companies and shippers in a tough spot. For many years carriers have adopted fuel surcharge formulas that bear some relation to fluctuations in the cost of crude oil to help offset the rise in fuel costs. While there are some industry standards (e.g. Freight Carriers Association of Canada), there is a significant variance between the individual surcharges levied by each carrier and the energy efficiency of different modes and carriers within modes.

On the other hand, shippers are not shy to negotiate these fuel surcharges. Under pressure, some carriers will roll their surcharges into their freight rates or waive them on occasion to secure particular pieces of business. The key issue for carriers is to maintain the momentum of the energy conservation initiatives (e.g. speed limiters, SMARTWAY, switch from national to regional truckload focus) that were put in place when a barrel of crude oil spiked to $147 in the mid 2000’s.

Shippers need to focus on the basics of freight management. This includes packaging optimization to reduce cubic space occupied, consolidating freight to take advantage of lower cost modes of transport, network design, local versus offshore sourcing and managing lead times/mode switching (e.g. truck to rail) when feasible. Shippers should also be doing their due diligence on their transportation providers, checking on their fuel efficiency (e.g. miles per gallon) and energy saving initiatives.

All eyes will be on the ISM Purchasing Managers Index that has shown positive growth for the past 21 months, to determine if the economic growth curve that we have been on can be sustained through this period of upward pressure on energy costs. The big question is how high will crude oil costs go in the coming weeks and months?

This has been a challenging winter. In addition to the earthquakes and tsunamis in New Zealand and Japan, harsh winter storms throughout North America have been disruptive to the smooth flow of people, goods and services for many companies. Looking back over the past few years, hurricanes, volcanic eruptions and tornadoes have also made life difficult for supply chain professionals.

It may be several weeks or months before the full impact of the tsunami in Japan, from an economic or supply chain perspective, is understood. As the world’s third largest economy, the images of cars and houses being swept along by powerful waves signal that there is widespread damage. The closure of airports and ports could have significant consequences.

Of course, disruptions to supply chains can come from factors other than weather or natural disasters. Quality control problems, piracy and export restrictions are just some of the factors that can come into play. To make matters worse, most of these disruptions are unpredictable in timing and scope.

Each shipper has to make an assessment of the potential risks to their supply chains. According to Patthira Siriwan, senior project manager for supply chain development in North America for Damco, the combined logistics brand for A.P. Moller-Maersk, supply chain risks can be categorized into five groups: operational, social, natural, economy and political/legal. Damco defines supply chain risk management as “attempts to identify risks and quantify their commercial financial exposures as well as mitigate potential disruptions at each node and lane in the supply chain”.

Supply chain risk models can vary from the rudimentary to the sophisticated. In the case of the latter, complex “what if” analyses can be performed. This allows the shipper to identify potential trouble spots and map out alternative supply chain strategies. In a recent article in the Journal of Commerce, Siriwan indicated that shippers tend to focus on “factors with the biggest impact on their supply chain, such as on-time performance, supplier lead time variability and carriers by origin or trade lane”. Shippers need to perform some sort of probability analysis on the impacts of each potential disruption, with a particular focus on alternative vendors, carriers, origin points and ports and destination ports.

Looking ahead to the balance of 2011, there are some major (predictable) risks that could drive up supply chain and transportation costs. These include the impact on fuel costs as a result of unrest in the Middle East. Rising labour costs in China could have the result of driving up manufacturing costs or extending lead times if China’s Insourcing initiative (moving manufacturing inland to lower cost locations) takes hold. This may cause some companies to look at other Asian countries as they contemplate making alternative sourcing arrangements. Then there is the fallout from the natural disasters in Japan that are still to be determined.

Each company needs to assess the potential risks to their company for each of the five elements outlined above. As a minimum, shippers should be evaluating alternate modes and carriers to make sure they have a range of quality options in place. In addition, each of these options should be tested under “real world” circumstances with actual freight to see if they are viable and dependable in a time of need.

Over the past few years, inbound freight management has taken hold like a new weight loss diet, particularly among Canada’s leading retailers. As I visit our clients on an ongoing basis, this subject is one of the hottest topics of discussion. Many of Canada’s leading retailers including Shoppers Drug Mart, Home Depot, Loblaw Companies and Wal-Mart, have all picked up the baton and have been running with it with varying degrees of success. Inbound freight programs are also being implemented in other industry verticals including fast food (e.g. Tim Horton).

The attraction to these big players is easy to understand. The large freight volumes these companies control provide them with leverage in carrier negotiations. They also create opportunities to reduce costs through more effective loading and transportation processes (e.g. delivering full truckloads of LTL freight versus multiple deliveries of LTL freight, providing backhaul for a private fleet). Through aggressive and effective management, large retailers can achieve significant reductions in freight costs.

For vendors to these large retailers, these initiatives create challenges and opportunities. They permit or push shippers with limited expertise in managing freight transportation, and modest volumes, to step aside and allow their more experienced and powerful clients to take control of their inbound freight. Vendor acceptance removes the responsibility for late deliveries and customer fines.

Of course, this all comes at a price. Inbound freight management is a profit centre for these retailers. The differential between the carrier freight allowances paid to shippers and the cost of the transportation paid out to the retailers’ designated carriers flows right to the retailers’ bottom line.

The range of acceptable vendor responses to these programs varies from one company to another. There are some major implications in giving up control of outbound volumes to large customers. First, the shipper may face higher freight costs and lower margins on this block of business. Second the shipper is faced with retaining control over a reduced volume of freight. Less leverage can mean higher freight costs on the remaining volume. Third, it may become costly to maintain a viable transportation department when their task is to manage a much depleted volume of freight.

This leaves vendors that have the option to participate or not with some key decisions.

1. To Retain or Give Up Control of Outbound Freight

The starting point for shippers faced with this option is to have a strong handle on their freight and supply chain costs. Shippers that don’t have accurate and detailed cost breakdowns for transportation, freight handling and warehousing will be hard pressed to perform a quality cost comparison. They will be challenged to develop an accurate business case to compare the options of compliance versus retaining control.

Before doing the costing analysis, each shipper needs to look at structuring a series of viable supply chain scenarios. A Toronto-based shipper has the option of transporting all goods from a central location across Canada or shipping to warehousing facilities close to the customer’s DC’s (e.g. Montreal, Calgary) and delivering locally. In the case of the latter scenario, the shipper needs to calculate the cost of public warehousing and assess their ability to consolidate and transport loads to DC’s in a timely manner versus maintaining ongoing deliveries of LTL freight. In other words, there is a need to construct a variety of scenarios under which to maintain the status quo, adjust their supply chain to more cost effectively comply with the customer’s requirements while maintaining control of long haul movements or simply turn over control (of the status quo) to their customers.

As mentioned above, relinquishing control can have significant financial consequences. Therefore, some shippers are actively evaluating strategies to make it more difficult for the retailer to take control. One of our clients labels this his “poison pill” strategy.

2. Create a Stronger Leveraging Strategy

Shippers are realizing that if they give up control of their outbound freight to certain large customers, they must make their remaining freight more attractive so they can prevent their freight costs from escalating. This can involve rethinking their carrier sourcing strategy. Many shippers have historically taken a regional allocation strategy in awarding their freight. For their Canadian freight, they would select a primary and backup carrier for Atlantic Canada, Quebec, Ontario – GTA, Ontario – non-GTA and Western Canada. For each region there may be LTL and truckload carriers selected. In the case of Western Canada, an intermodal and over the road carrier might be chosen. Carriers specializing in each of these segments would be awarded business.

Shippers are now revisiting this approach and taking a more consolidated or core carrier approach. To create greater leverage, suppliers are now looking at carriers that provide multiple modes of service (e.g. expedited, regular over the road and intermodal, LTL and truckload) and serve multiple regions. This allows them to create larger bid awards, thereby keeping costs down.

3. Create your own Inbound Freight Program

Another way to create additional leverage is for shippers to take control of their own inbound freight. Rather than taking a silo approach with inbound freight (included in the landed cost of inbound freight) controlled by the Purchasing Group, there is value in adopting a more holistic view of transportation. Taking control of inbound freight allows for the creation of round trips and adds more volume to freight RFP’s.

4. Ship Collect

For smaller shippers with no expertise in freight management, one option is to shut down the Transportation department and ship everything collect. Another option is outsource the management of the total supply chain to a logistics service provider.

In the consumer products area, inbound freight programs are gaining widespread adoption. Shippers seeking to maintain their bottom lines need to assemble quality data and assess their options in a very methodical and thoughtful manner.

Wolfe Trahan & Co. is a Wall Street research firm that has a strong focus on freight transportation. Each quarter they survey several hundred American shippers in a variety of industries and create an extensive report that documents their findings.

The Q1 2011 report, issued in March, summarized data collected towards the end of the fourth quarter 2010. Excerpts from the report were captured in a recent Supply Chain Digest On-Target Newsletter. Among the highlights, shippers are expecting freight rates to rise significantly over the next 12 months with the overall average in the range of 6.5 percent (including fuel). This reflects increases in both shipping volumes and freight rates. They also see the supply/demand pendulum swinging back in the carriers’ favour. Shippers predict the highest rate increases over the next 12 months in intermodal, followed by ocean shipping, truckload carriage, and rail.

Capacity has been a hot topic over the past year. Despite the recent improvements, however, a strong 77% of respondents expect to see very tight or somewhat tight truckload capacities over the coming year. Wolfe Trahan says this is the highest number seen on this measure since mid-2004, and notes that was followed by a multi-year pricing upswing for the carriers and a mini-"capacity crisis" in 2005-06. The company believes some of the concern about TL capacity stems from what shippers perceive as the potential impact of new U.S. government regulations, specifically CSA 2010 and proposed new changes to current Hours of Service rules. The report found an amazing 92% of shippers were opposed to changing the current maximum driving time of 11 hours down to 10, as the U.S. Federal Motor Carrier Safety Administration is considering right now.

Shippers expect truckload rate increases before fuel surcharges to average 3.1% over the next 12 months. On the LTL side, the vast majority see the market right now as "balanced"; with only 6% perceiving tight LTL capacity.

As a result of the combined impact of tighter truckload capacities and higher rates, shippers expect a rather significant increase in the percent of their freight volumes that will go intermodal. Thirty-eight percent of shippers are looking to move more freight via intermodal versus over the road truckload, up from 30% in Q3. Another 16% said they had already moved freight from truck to intermodal over the past year. This was the largest shift from truck to rail since mid-2008. About 36%, however, said they would not move any freight away from trucking because intermodal shipping did not meet their business or transport needs.

Other highlights of the report include:

• Thirteen percent of shippers have already fully integrated CSA 2010 BASIC safety rankings into their carrier selection process, and another 72% say they will do so in the future, leaving just 15% in total who did not indicate they planned to do so. Additionally, 66% of shippers said they had entered into discussions with current carriers which were flagged with alerts from the safety reporting system.

• Thirty-eight percent of shippers say they have seen parcel shipment costs rise as a result of the new approaches to dimensional weighing (DIM) taken by UPS and FedEx at the beginning of the year, including 11% saying the result was at least a 5% increase in parcel shipping costs. Twenty-six percent of respondents, however, say they have been able to negotiate no changes to those formulas.

• Shippers see ocean freight rates decelerating. On average, respondents expect ocean rates to increase 2.7% this year, down from expectations for a 3.9% increase in rates last quarter. Wolfe Trahan says spot rates have declined of late 27% from their 2010 peaks.