Opinion: Beware of the Last Bit of Business

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B>By Michael DuVall

I>Principal

harter Consulting

This year, trucking companies and logistics providers have emerged from their most difficult economic challenge in recent memory. The notable pickup in demand has carriers planning again for growth. Unfortunately, if history is any indication, the majority of these companies will fail in their attempts to grow and remain profitable.

A recent study of the financial performance of 24 publicly traded trucking companies shows some of the key factors driving growth that is also profitable. The study by my colleagues and me disproves a common misconception that revenue growth is the primary driver for growth in profits.

Instead, we found that the most successful companies were those that created the greatest shareholder value and were able to grow revenue in conjunction with improvements in operating ratio. In fact, companies that experienced above-average revenue growth — absent consistent OR improvement — actually destroyed shareholder value.

It seems counterintuitive that carriers experiencing substantial revenue increases could wipe out their reserves. It is generally believed that due to their large structure of fixed costs, truckers enjoy improved operating profits as a result of greater network density. This assumes, though, that the extra cost of adding one more job is constant. In reality, what economists call marginal cost appears to increase with incremental freight.

After an initial boost in productivity, a carrier’s network approaches a point of diminishing profitability as the last loads of freight are added to the system. Bottlenecks form, constraining overall network efficiency.

Consider the example of a terminal operating at capacity. With dock doors at a premium, drivers sit idle in the yard. Because trailers are not available, freight must be staged on the dock, requiring extra handling, increasing claims and generating delays. All these factors contribute to rising marginal cost.

Just as the marginal cost of operating increases with additional freight, the marginal revenue those jobs bring in may decrease. Trying to improve the top line, companies may get caught in the trap of buying market share. As carriers expand beyond those shippers that value their relationship with the carrier, they begin to compete on price. This manifests itself in steep discounts and the exemption of accessorial charges.

There are three approaches to addressing the implications of marginal cost and revenue. Cost increases can be tackled directly, through operational improvement. Revenue shortfalls can be fixed through a focus on revenue enhancement. Finally, finding a balance between these two factors requires a focus on yield management. These imperatives are not mutually exclusive. Attention must be given to all three to ensure profitable, sustainable growth.

To deliver operational improvement, carriers must align their business processes to deliver optimal value to their customers. Taking a “customer-centric” view of operations allows companies not only to better serve their customers, but to eliminate activities that do not provide value for the customer.

“Six Sigma” — a popular business tool developed by Motorola — is one example of a continuous improvement approach that focuses on customer requirements, process alignment and timely execution. To reduce the marginal costs of new business, teams can be engaged to address those areas affected by growth, such as freight claims, load average and labor productivity.

Profitable revenue growth requires understanding how value is defined from the customer’s perspective. A trucking company’s revenue quality is directly proportional to the value provided as perceived by the shipper-customer. This may require the carrier to hone in on its most important customers — those accounts offering volume and stability of freight shipments, a substantial revenue stream, above-average profitability and future growth potential.

Providing dedicated support to a key subset of core accounts allows the carrier to direct more efforts toward the critical few — rather than the less-crucial many.

Through a better understanding of these core account needs, better alignment of services to meet those needs and the development of team selling capabilities, carriers can derive more business and profit from these customers.

Yield management is the final, critical component to the growth equation in trucking. Yield management seeks to balance marginal cost and revenue for optimal profitability. This requires a thorough understanding of operating costs — by lane and by account. With this information, carriers are able to identify those accounts that are too costly to serve and determine whether to renegotiate rates or to drop the business altogether.

Similarly, a yield program incorporates capacity management, identifying lanes that need to be priced more competitively to improve density and other lanes to price more aggressively because capacity is stretched to its limits. This allows carriers to balance marginal costs against marginal revenue and ensure that scarce service capacity is allocated to the revenue of highest quality.

Trucking companies have a tremendous opportunity now to create value for their owners as the economy continues to recover. Those wishing to succeed must address the marginal cost/marginal revenue implications of growth. Achieving profitable growth requires an integrated, balanced program of operational improvement, revenue enhancement and yield management.

With offices in Chicago, Cincinnati and Houston, Charter provides management consulting services for companies in transportation and other industries. The author writes from Chicago.

This story appeared in the Dec. 6 edition of Transport Topics. Subscribe today.