Risk Sharing in Contracts: The Use of Fuel Surcharge Programs Author: Madhavi Kanteti and Jordan Levine Advisor: Dr. Chris Caplice MIT SCM Research Fest May 24-25, 2011

Discussion Points: We will be discussing fuel surcharges in the truckload (TL) industry. Agenda Introduction to the truckload industry Research scope and methods The benefits and limitations of an industry standard FSC Main Points The aggregate or “all-in” rate is the critical metric within the transportation industry. Standardization of FSCs can benefit the industry. Standardization can only be achieved with collaboration. May 24-25, 2011 MIT SCM ResearchFest

The US Trucking Industry $688 billion1: The U.S. Transportation Industry in 2009 (~5% of GDP) 87%2 of all goods delivered in the U.S. 84%2 of the nation’s freight bill 1: Wilson, R. (2010, June 9). 21st Annual State of Logistics report. Presented by CSCMP and PENSKE, Slide 2. 2: Trego, T. (2008, December). An Analysis of the Operational Costs of Trucking. The American Transportation Research Institute, (pp. 12-25). May 24-25, 2011 MIT SCM ResearchFest

Invoice Between a Shipper and Carrier Load Number Unique Identifier 9874632 Pick Up Date No later than date June 2nd, 2010 Pick City/State/Zip Origin of Lane Dallas, TX Drop City/State/Zip Destination of Lane Baton Rouge, LA Temp Dry-Van / “Reefer” Dry-Van Mode Truckload (TL) / Less-than- TL Truckload(LTL) Mileage Distance 427 Miles Line Haul Rate Fixed Component. Decided $800 via a Bid Process (1-2 Years) or on the Spot Market Fuel Surcharge Variable Component. $190 Decided via the Bid Process. May 24-25, 2011 MIT SCM ResearchFest

Research Scope Fuel Surcharge (FSC) Schedule established as a risk sharing contract between carrier and a shipper Addendum to the line-haul rate. How effective is the current FSC structure? Can the FSC structure be modified by either party with a profit motive? Most commonly employed FSC method in the TL trucking industry: May 24-25, 2011 MIT SCM ResearchFest

FSC Equation Efficiency is a proxy for truck efficiency. It can be thought of as a “Scale” or the Slope of FSC. FSC is paid by the shipper when the fuel price crosses the trigger point, also called the peg. American Trucking Association (2011). American Trucking Trends 2011. (pp. 63). May 24-25, 2011 MIT SCM ResearchFest

NULL HYPOTHESIS Modifications to an FSC Structure are Revenue Neutral. Line Haul Rate $800 $850 $900 Fuel Surcharge $190 $140 $90 Aggregate or “All-In” Rate $990 $990 $990 May 24-25, 2011 MIT SCM ResearchFest

Methodology Carrier Interviews Mathematical Analysis (Simplify and Quantify) Shipper Interviews Carrier Survey 800+ Targeted Invitations 122 Responses 85 Complete Responses Carrier Interviews May 24-25, 2011 MIT SCM ResearchFest

Null Hypothesis: Not Rejected Line-Haul Rates and FSCs Compensating Conclusions Modification of an FSC for profit margin increase is not recommended. Modification of an FSC to an industry standard has significant advantages. May 24-25, 2011 MIT SCM ResearchFest

Trigger Point = $0.00 Support: 52% of 89 Carriers. Opposition: The positive impact made by the change does not out-weigh the one-time administrative cost of changing the system. It will significantly influence their business in a negative way. (Owner-Operator carriers with limited drivers and capital equipment) May 24-25, 2011 MIT SCM ResearchFest

Escalator Impact Carriers are indifferent to a “Generous” FSC and an “average” FSC. Carriers try to avoid a “Below Average” FSC. May 24-25, 2011 MIT SCM ResearchFest

Industry Standard Escalator A “Generous” escalator does not lead to higher service. Also, causes some carriers to reduce their line-haul which leaves them exposed to a drop in fuel price. A “Below Average” escalator can lead to service failure. Difficult to set a point standard. As such, a range might be more appropriate. Further Research: Shippers with private fleets tend to have more generous/accurate FSC programs. May 24-25, 2011 MIT SCM ResearchFest

Benefits of a Standard Avoidance of the Winner’s Curse. Winner’s Curse: The winning bid exceeds the value of the auctioned asset. Decoupling of Transportation Costs and Fuel Costs. Note: Collaboration amongst the shipping community is required. May 24-25, 2011 MIT SCM ResearchFest

Summary The aggregate or “all in rate” is the critical metric. Risk sharing contracts should be simplified to the greatest extent possible. Collaboration with trading partners/competitors to establish standards can increase efficiency. Results could be applicable to the airline and LTL industries. May 24-25, 2011 MIT SCM ResearchFest