Pricing and costs
“It’s not the load that breaks you down - it’s the way you carry it.” -Lou Holtz, former college football coach
Everybody is struggling to come to grips with rising commodity costs and their impact on pricing. Truckers know this especially well as diesel fuel prices spikes earlier this summer pushes the cost per gallon well over $5 in many parts of the U.S. Add that to rising sticker prices for new Class 8 tractors - in some cases well over $10,000 more - due to higher steel costs and emission reduction mandates and it‘s no wonder many fleets (small and large) are throwing in the towel.
It‘s not any easier in other sectors of the transportation. The Associated General Contractors of America (AGC) reported that states are struggling with rising prices for construction materials required to build and maintain the roadways truckers use. Asphalt costs have more than doubled since the beginning of 2008, with increases of as much as 40% announced in many regions since July 1. On-highway diesel fuel costs, as we all know, jumped 68% in the past 12 months, with reinforcing steel (rebar) roughly doubled in price since the beginning of 2008. Then there‘s the price of construction plastics, such as polyvinyl chloride (PVC) pipe and plastic fencing and moisture barriers, which have risen 10% to 25% percent since early 2008.
The problem could get worse in 2009 when the U.S. Department of Transportation (DOT) may be forced to cut highway funds to states by a minimum of 34% because revenue into the federal Highway Trust Fund is falling - in no small part because people are driving less, thus reducing the flow of fuel taxes into the fund.
(Frankly, the hand wringing over this is stupid, because government at BOTH the federal and state level in this country wanted people to drive less to reduce oil consumption and tailpipe emissions. Now that it‘s actually happening - Americans drove 12 billion FEWER miles in June this year compared to 2007 - everyone is whining about the reduction in fuel tax revenue. Get real.)
For truckers, though, the question is how to cover cost increases while still making a profit. Obviously, rates need to rise - but by how much? That‘s the tricky part, and for a little insight into how to manage price increases from a broader business perspective, I thought I‘d let Professor Jerry Osteryoung from the college of business at Florida State University share his thoughts on the subject. For more trucking-specific ways to manage rates - especially from the small fleet perspective - you should really touch base with Contributing Editor Tim Brady, a past master at this. OK, back to Professor Osteryoung - the floor is yours, sir:
“In this economy, most businesses are caught between rapidly increasing prices of commodities and raising prices for their goods and services.
For one firm that we are assisting, the cost of steel increases almost every month. It has already gone up by 10% for them in the first six months of the year. Competition has also increased, so the firm feels that it cannot raise prices despite the fact that it is being squeezed by both steel and fuel price increases. Clearly, the owner is very concerned about maintaining their positive profits.
So many firms in today‘s economy are experiencing a similar squeeze. Forced to raise their prices in response, firms are now worried about losing sales and profits. However, there is so much a business owner can do to mitigate the damage caused by price increases.
If you are competing with other firms, it is important to remember that they have to buy the same products you do and are experiencing the same price increases. If many firms in an industry begin raising prices, consumers will be able to understand and tolerate the increases that you implement.
Most consumers understand that in order to stay in business, a firm needs to make a profit and cover its costs. Most will tolerate a 5% increase in price, especially if you clearly explain why you are doing this. Most understand as they are seeing costs increase all over, particularly in food and fuel. Increasing price because of the higher costs of fuel and other commodities is clearly understandable.
For example, we are working with one service industry firm that increased its prices mid-year by six percent. Following their price increase, they saw no decrease in sales. In fact, some customers wondered why they waited so long to raise prices.
Firms should also consider unbundling as many products or services as they can. Doing so will allow you to mask the price increase. For example, one service company previously included transportation in its pricing. They removed it from the bundle and began billing transportation costs separately. While some customers were unhappy, the majority understood what the firm was doing - especially following the nice letter that was sent out to announce the price increase.
What is important to remember here is that receiving complaints from a limited number of customers does not necessarily mean that the price increase wasn‘t tolerated. Rather, certain customers are just always going to complain about price increases. Paying too much attention to the vocal minority could be very dangerous to the financial health of a business.
Clearly every business needs to be profitable over the long run. Raising prices to cover cost increases is simply good business and economics. If you are, however, in an environment that prohibits you from increasing your prices, you may need to think about the products or services that you are providing. It may be that you are in a much too competitive environment, in which case you will need to find better ways to differentiate your products and services from others in the market. You may also find that certain products or services are no longer viable for your business.
With costs rising all over, each and every business must make sure that they are covering all of their costs in order to stay in business.”
As usual, you can reach Professor Osteryoung by e-mail at jerry.osteryoung@gmail.com or by phone at 850-644-3372.
September 4th, 2008 at 9:17 pm
Sean, thanks for the accolade; now let‘s see if I can live up to it.
Professor Jerry Osteryoung made some very valid points which every motor carrier should heed.
1. If you are competing with other firms, it is important to remember that they have to buy the same products you do and are experiencing the same price increases. If many firms in an industry begin raising prices, consumers will be able to understand and tolerate the increases that you implement.
This is the one fact most trucking companies forget when looking at the need to raise their hauling rates. If it‘s costing you more to do business, your competition is most likely experiencing the same cost increases. Another very important point is if the cost increases are consistent and continuing, as they have been for the past two years, and in some cases accelerating at unprecedented rates, the company which holds back increasing rates will be headed down a very deep financial black hole. (Case in point: just this last week Priority Transportation closed its doors citing rising fuel and toll costs, and Jevic, a couple of months ago citing the same increase in fuel costs for its demise.)
2. Most consumers understand that in order to stay in business, a firm needs to make a profit and cover its costs. Most will tolerate a 5% increase in price, especially if you clearly explain why you are doing this. They are seeing costs increase all over, particularly in food and fuel. Increasing price because of the higher costs of fuel and other commodities is clearly understandable.
In this scenario what Professor Osteryoung is saying to trucking firms is, don‘t wait until you have to do a large rate increase, do it incrementally as the need arises. As he stated, “Most consumers (and shippers are consumers of your services) will tolerate a 5% increase.” The smaller your increase to your shipping customers means they will only have to raise their prices a small amount. If a carrier waits too long and needs a much larger rate increase to cover the higher costs, this can put a burden on the shippers, making it more difficult for them to raise prices to their customers. This will cause a lot of customers to jump ship and look for hauling services elsewhere.
3. Firms should also consider unbundling as many products or services as they can. Doing so will allow you to mask the price increase. For example, one service company previously included transportation in its pricing. They removed it from the bundle and began billing transportation costs separately. While some customers were unhappy, the majority understood what the firm was doing - especially following the nice letter that was sent out to announce the price increase.
Motor carriers need to do the same. In my opinion it‘s very important this be done in regards to your most volatile expenses, i.e., fuel and tolls. I have come up with a concept called FCAP (Fuel Cost Adjustment Policy) to replace the antiquated fuel surcharge. The concept is based on this unbundling of services or products. In simpler language, think of it in the same terms as a mechanic, electrician, or plumber handles their unknown costs. They quote a labor fee plus parts and materials. In transportation, labor would be the amount for handling the load: the loading and unloading time plus the time in transit; the parts and material fee would be the FCAP and could include any fuel and tolls when necessary. By doing it in this manner, you can have your Fixed expenses and Constant Variable expenses (those variable expenses which occur consistently on every load) along with your Profit Margin as your base rate; then add your Volatile or Load Specific expenses (fuel and tolls, etc.) to come up with the total hauling rate. By unbundling your fuel and toll costs from the base rate you would never be left holding the uncompensated fuel bill on a load.
4. Clearly every business needs to be profitable over the long run. Raising prices to cover cost increases is simply good business and economics. If you are, however, in an environment that prohibits you from increasing your prices, you may need to think about the products or services that you are providing. It may be that you are in a much too competitive environment, in which case you will need to find better ways to differentiate your products and services from others in the market. You may also find that certain products or services are no longer viable for your business.
Professor Osteryoung, all I can say here is well said! Every carrier — no, every business — should follow his advice. I coach and write articles targeting small motor carriers (1 to 50 trucks) and I have said over and over again a small motor carrier needs to fill a niche. You cannot succeed by running all 48 states as a small trucking company. You can‘t (and shouldn‘t try) to compete with the large carriers. About 80% of all manufacturers in the US have 25 or fewer employees, according to the Department of Commerce, and according to OOIDA over 80% of today‘s freight is hauled by small motor carriers. But the successful ones are filling a niche the big carriers can‘t or don‘t want to deal with and run in a specific lane tailored to the size of their fleet.
Hope I‘ve earned Sean‘s accolades
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