Opinion: Costing success in transport

By: Kim Hassall


Transfer pricing will help to keep your operation benchmarked and relevant

Opinion: Costing success in transport
The concept of applying a transfer price can be a very useful technique

 

This is the fifth of a 12-part series on freight/logistic pricing schemes, drawn from over 100 domestic and international pricing/costing strategies that have been compiled over a 20-year period. Some of the more important and novel concepts will be examined in this article series.

What is a ‘transfer price’ in a logistics operation and how does it work?

The concept of applying a transfer price can be a very useful technique, especially for an operational division that is costed as part of a larger operational group and does not have its own specific revenue stream from operations.

An example could be a large contract parcels division that runs pickup, linehaul and delivery, as well as a warehousing division, storing large volumes of client product requiring future sorting and despatch.

Although each of the distinctive business units’ operations should be costed on specific ‘activity’ or ‘efficient allocative’ basis, how should these 1PL (a first party logistics provider, an internal transport service) internal freight services be actually priced?

The first step may/should be to know the full cost of the specific company operations.

The ‘attributable’ costs of the operations, which will include a proportion of common/joint facility costs, could be used initially as the cost of the transport division’s operations.

A BRIEF TRANSFER PRICING CASE STUDY

Figure 1 and Table 1 reflect the implementation of a transfer price to a target company’s transport and delivery services.

At the beginning of 2016, a range of internal practices for this corporate 1PL were being charged at an allocated price, which was only marginally lower than a fully outsourced contact price.

Why slightly lower?

Well, instead of a full profit being charged on internal operations, a reasonable return on capital for assets deployed and a proportion of depot charges were allocated instead.

This is using the benefits of an internally run road-freight operation, especially if borrowing costs are low, in this case for a large processing and delivery company.

As an aside, back in the late 1980s, Australia’s two largest freight companies, neither of which were listed entities, were borrowing money at 1.75 per cent less than their listed counterparts, and so their return on capital could be targeted at a slightly lower transfer price per unit of activity.

Transfer price impact.JPG

The allocation of a transfer price at the beginning of 2016 actually acted as a catalyst. The high unit operational costs for Company A needed to come down, otherwise full outsourcing was the threat to the internal business unit.

So, what actually happened at the end of 2015 that brought about the cost savings, represented by the drop that was reflected in the lower 2016 cost index at the end of that year?

Transfer pricing 2.JPG

WHAT DROVE COMPANY A’S COSTS DOWN?

The transfer price assignment focused on many of Company A’s freight operational practices. 

Not only were the road operations being priced, which had not been common practice previously, but many other operational practices came into focus.

The changes that were made to freight operations were:

1. Firstly, a depot rationalisation was undertaken, and vehicles and drivers were redistributed to a smaller depot network. This achieved two things, lower allocated overheads and vehicle rationalisation

2. Secondly, transport duties to and from customers became more rigorous and ‘free’ ad-hoc services to clients ceased, in favour of paid ad-hoc or specials services

3. There was greater use of basic scheduling software for regular services and this had measurable initial benefits

4. Lastly, a review of vehicle economic life allowed certain vehicle configurations to be used for longer periods, thus gaining some capital savings, though these were offset by slightly lower resale values. However, there was a net capital benefit.

These bundle of benefits helped drive the transport unit costs down by 3.7 per cent after 12 months.

This benefit would then be somewhat offset in the future by the company’s corporate EBA. However, this transfer pricing initiative did keep the internal freight task’s cost lower than a benchmarked 3PL price for at least a few more years.

After the transfer pricing initiative, what perhaps could be the next step in cost reduction strategies?

Finding that optimal insourcing versus outsourcing balance is worth considering, but this will be dependent on several corporate operational variables.

If this insourcing/outsourcing consideration is a second company cost-reduction step, then an initial transfer price implementation might be a less-than-disruptive first round consideration before any outsourcing is implemented.

Even so, a transfer price can initially achieve a lot and is a very important tool in the arsenal of logistic/freight pricing strategies.

Dr Kim Hassall is chair CILT-Australia and director of the Industrial Logistics Institute

12 FREIGHT PRICING STRATEGIES SERIES

Part 1: Network link (density) pricing

Part 2: Moving club pricing

Part 3: PAYGO

Part 4: Price escalations

 

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