The 2020 Mid-Year Economic Update_long

Stem the Tide: Rising Fuel Costs

Direct orders to branches instead of a central facility to avoid compounding costs with internal transfers. A downside to this strategy is that it may challenge in the areas of inventory and staffing.

Analyze Replenishment Practices
Just-in-time inventory replenishment requires more frequent and smaller deliveries. This usually requires the use of LTL, or Less Than Truckload, Miklovic says, which has higher costs because trucks have to travel more complex routes. Fewer but larger shipments allow for full truck rates, based on point-to-point least distance rates.

Distributors should analyze replenishment cycles and minimum-order quantities to decide whether potential inventory increases are justified based on current fuel and transportation expenses on a per-unit basis, Miklovic says.

“Bottom line is there are lots of supply-chain related things any company can do. Some will have minimal impact (on costs) but every little bit helps,” he says. “All the evidence says energy costs will continue to rise and that while there will be short-term decreases, the long-term global economic forecasts support a period of continued high energy costs.”

Summer Forecast
Crude oil prices surged in April and have almost doubled in the past two years, according to the U.S. Energy Information Administration.

Retail regular gasoline prices are projected to average about $2.57 per gallon in 2006 and 2007, 34 cents higher than last year’s average of $2.37 a gallon. The EIA estimates retail diesel will average $2.79 a gallon in the second quarter 2006, and $2.74 in the third quarter.

By September 2006, fuel prices are expected to be lower than last year because of the return of crude oil and natural gas production and refineries affected by Hurricanes Katrina and Rita in 2005. Important note: EIA’s projections do not reflect any new production or refinery outages due to hurricanes. Forecasts indicate another busy hurricane season in the oil and gas rig-heavy Gulf of Mexico.

The EIA projects motor gasoline consumption, which had no growth in 2005, to grow 0.9 percent in 2006 and 1.5 percent in 2007 as a result of continued economic growth and the stabilization of motor gasoline prices. Transportation diesel fuel consumption is projected to show solid growth in 2006 and 2007 of 3.4 percent per year.

Barring significant supply changes, the EIA forecasts gasoline and diesel prices won’t go down, but will plateau to the end of 2007.

A majority of the 166 survey respondents to the online survey have revenues below $250 million a year. More than half have sales under $50 million. Survey responses included distributors from the electrical, building materials, electronic, HVAC, industrial, plumbing and PVF sectors.

U.S. Energy Information Administration


Fuel surcharges based on order size. For example, an $8 charge for orders less than $500. One distributor, which runs a fleet of 10 trucks, said: “We instituted a $1 surcharge per invoice to try to recoup some of the high fuel costs. Most customers are accepting this charge as a cost of doing business.”

Nearly half of survey respondents are not adding a fuel surcharge to orders or deliveries. The rest vary anywhere from $1 to $10 per order.

Sales team’s role. Sales people should consider the size of an order before making a commitment to delivering it. At one company, this means making smaller customers wait until it’s economically feasible to deliver. The company may ask larger customers to increase their order size, and marginal customers may be asked to will-call an order.

“This approach has always met with mixed results but with fuel costs on everybody’s minds it has become easier to increase order size because both the sales person and the customer truly understand that costs have risen significantly,” the distributor says.

Other ideas for mitigating fuel cost hikes:

  • Roughly two-thirds of survey respondents are using UPS/FedEx/DHL or a local courier/delivery service more often. Some distributors have chosen to pass on those costs to the customer; others have not.
  • Integration of rising costs into the price of products. One distributor raised prices 1 percent across-the-board. Another did the same and said customers didn’t notice the change.
  • Consolidating delivery runs/smarter routing. Some distributors are considering buying truck routing software. One distributor is limiting special runs: “All (deliveries) must be on a standard route.”
  • Restricting delivery by order size/increasing minimum-order requirements.
  • Driving slower and using more fuel-efficient vehicles. Also, improving maintenance on company vehicles.
  • Many fuel companies offer rebates through their credit cards distributors can use these as a savings tool.

Manage Transportation Costs
“As transportation costs keep rising, companies will only be able to pass along to customers part of those costs,” says Dan Miklovic, managing vice president for manufacturing and industries advisory services at Gartner Consulting, an Information Technology group.

“Those companies that can manage to keep transportation costs low will have a price advantage over those companies that have higher costs. Either those companies must absorb the costs to match the more efficient company’s process, or have a higher price point.”

Miklovic believes that managing your transportation costs is just as critical as optimizing labor and material costs. He says targeting reduced shipping costs could have as high a payback as other supply chain management techniques.

Help from Technology
Transportation optimization technology analyzes and determines the most cost efficient ways to distribute products. The method balances less-than-truckload, truckload, rail, container, air and ocean freight to get the best solution based on source, destination and time constraints. Miklovic says you can also factor in planning which distribution center to fulfill orders from.

“For example, it might be more cost effective to source from a more distant DC if you can fill the truck from that single DC and pay full truck rates than having to do LTL from two DCs, if neither can fill the order alone,” he explains.

Though a full transportation optimization IT package might cost big bucks, and therefore may be limited to larger distributors, smaller distributors can still analyze their transportation networks to determine whether there are more cost-effective ways to deliver product and fulfill orders.

One solution:

The average cost of a gallon of diesel has hovered above $2.90 recently, up 33 percent from the year before. While the West Coast has endured the highest prices California is averaging $3.24 a gallon prices in the Rocky Mountains and the Midwest have risen the fastest, at 35 percent since last year.

Fuel costs are burning the bottom lines of all distributors. Fastenal, for example, has seen its fuel costs double over the past two years. The company, which runs its own fleet of delivery vehicles, reported fuel costs averaged $1.2 million per month in first quarter 2005 and steadily climbed until they hit $1.8 million a month in the first quarter 2006. But just two years ago, its fuel costs averaged $0.9 million a month. In its annual report, Fastenal attributed much of this increase to the rising price of fuel.

The impact of rising fuel costs on distributors varies.

One electrical distributor’s costs have gone up $3,000 a month; another said his costs are up 37 percent in the first quarter 2006 compared with the first quarter 2005.

One distributor said the impact of rising fuel costs is felt in cost per delivery which for him is up 10 percent year-over-year. But he says that perhaps a more important number to consider is delivery cost as percentage of profit dollars delivered: This is up about 5 percent for his company.

Still others have reported minimal cost increases, including an electronics distributor who said the company had absorbed just a 1 percent increase. Others say that the impact on their businesses has been hard to pin down because they must take many factors into consideration.

An electrical distributor reported his fuel-related costs are up 16 percent but sales have jumped 36 percent; he says increased profits have made up for the jump in fuel costs.

Nearly two-thirds of survey respondents report fuel costs have had some impact on their profitability. Half of respondents say they are absorbing the increased costs; some are reluctant to institute fuel surcharges before their competition takes that step.

As long as fuel prices stay up and they will in the near term distributors will have to deal with surcharges passed down by suppliers and logistics providers. Tripp Dunman, managing director for risk management firm FCStone’s fuel surcharge group, says shipping companies have seen a 20-40 percent escalation in the fuel portion of their freight bills in the past two to three years. What’s more, diesel prices have risen at least 16 percent since January.

“They have to recover the cost of fuel,” Dunman says. “It’s probably not something that is going away anytime soon.”

Holding the Line
Most distributors are tackling rising costs by controlling other costs or charging surcharges based on per order, per delivery or weight, says David Gordon, principal at Channel Marketing Group, Raleigh, NC.

Another strategy distributors are employing is differentiating prices based on pick-up vs. delivery, or as an incentive to achieve minimum-order sizes. Others are negotiating fuel prices with local gasoline stations, changing delivery schedules or reducing the number of deliveries.

Distributors in the recent MDM-Channel Marketing Group survey described strategies they have been using to mitigate rising costs.

Delivery charges. One distributor says: “We really haven’t applied surcharges because this implies it’s temporary. We’ve increased delivery charges one for out of town and one for city’ delivery.”

But some distributors are encountering resistance to this idea. Interestingly, one remarked: “While I’m certain that most or all of our customers would balk at a delivery charge from us, none seem to have a problem paying UPS, courier or LTL charges. This stems from the industry’s practice of bundling in free

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