Closing the freight gap

by Scott Benfield

Distributors have plenty of ways to leak profit. At a cursory glance, these leaks are small and won’t sink the ship. When reviewed in their entirety, they can make the difference between a satisfactory return and an unsatisfactory return.

Common profit leaks are where the firm has poor accounting and cost controls regarding special services. One of the more common and egregious profit leaks concerns non-proprietary freight. Our definition of non-proprietary freight is any inbound freight charge not part of a stock order or inter-branch transfer and any outbound shipment not part of the normal route system done on company trucks.

Inbound and outbound freight can be rather complex, with the customer having numerous options of receiving the product including parcel post, air freight, rail, emergency delivery, same-day delivery and dedicated truck. The difference between non-proprietary freight paid for and billed to the customer can be substantial. In recent pricing audits, we found gaps of six and seven figures, which if closed, could make substantial differences to their firms’ profit picture(s). The purpose of this article is to enlighten distributors on how to estimate their freight gap and what to do about it.

Measuring freight loss
If you don’t have specific measurements and tight controls on non-proprietary freight expenses, you are probably losing substantial money on them. To estimate these expenses, take the following steps.

• Review all payments to freight vendors including parcel post emergency shipments, air freight, priority mail and dedicated trucks. It doesn’t matter whether the expense was inbound or outbound. Just measure the expense.

• If you are a multiple-branch operation, be sure to include expenses to the numerous messenger companies and regional LTL carriers.

• Also include the freight on special-order items that are not part of a stock shipment and have a separate freight charge.

If you are having trouble tracking charges, such as UPS special shipments, request a breakdown of the charges from your vendor. And, if you find it difficult to track inbound freight for non-stock shipments, take a sample of 50 or so invoices and capture the freight charge as a percent of the cost of goods. Use the percentage freight factor and apply it to all non-stock cost of goods for one year. Add all figures together and consider this the total non-proprietary freight expense.

The next step is to find out all freight charges billed to customers in one year. This is typically a special query from your IT system or it may be captured separately in your accounting ledger. Also, note that the freight billed may not match up between inbound transactions to outbound delivered invoices. Some customers may be billed a freight charge on a proprietary fleet shipment. In most circumstances, freight billed to customers is for non-proprietary shipments, as stock orders on the company fleet are normally not charged freight on a separate line-item basis.

Finally, deduct the difference between the non-proprietary freight payments and the freight billed to customers. The net difference is your freight gap. For most distributors, the size of the gap is sobering. We typically find that 40 percent to 60 percent of non-proprietary freight is billed.

Plus, each dollar of the gap is one less dollar that would go to your bottom line if correctly billed to the customer. Once the nausea subsides, read the remainder of this article on how to close the gap.

Freight policy, decision-making and responsibility
Freight charges are part of pricing called cost recovery, which includes legitimate costs incurred by the customer that are not billed because of inadequate accounting or lax pricing rules.

Pricing, in turn, is part of the marketing function, and salespeople should be limited in the discretion they have to override freight charges.

Granted, there are instances where your company will absorb freight and not bill the customer. Special-delivery promises or stock-outs for critical applications are common examples where freight is not passed to the customer. In most instances, however, the gap exists because of a poorly established freight policy and control system.

Management, including sales, marketing and operations managers, should set your freight policy. We recommend the following steps to stanch freight leaks.

1) Typically, there are customers who will not pay freight because of a negotiated agreement or a no-freight policy. When this occurs, you have several options. If the freight is easily estimated for an outbound shipment, simply add the estimated charge to the product price. And, if the charge is a known inbound charge, add it to the product price. It is best to design automatic charges into the freight system for specialized shipments. However, many common ERP systems have rather weak freight modules and may require substantial programming to help close the freight gap.

Also, many pricing modules have an option for the customer not to be invoiced extra freight charges. Once a year, check which customers designated as “No Freight Charges.” Review their transaction history, sales and margin dollars. We recently did this for a customer with more than 400 customers in the “No Freight Charge” designation and more than 30 percent were small accounts.

2) For small customers that cost more to serve than they generate in margin dollars, the best procedure is to bill all non-proprietary charges. This can be a simple dictate from top management and is easily measured at the order-entry level. Also, for small customers, it often makes financial sense to deliver them using parcel post instead of company vehicles. Why? Most distributors have a delivery cost of $20 to $40 per shipment, which is two to three times more expensive than a comparable cost of parcel post. In short, save the company fleet for customers who give large enough orders to afford the “free” delivery.

3) For non-stock specials, it is often difficult to know the freight charge, as the vendor will ship it prepaid. This causes problems when the distributor quotes the price of the item to the customer before receiving the final bill. It is difficult to research past invoices and bill them separately to the customer. For non-stock items, we have been successful in estimating a freight charge as a percent of the line item’s cost of goods. For instance, if the cost of goods sold (COGS) is $0 to $50, then the estimated charge is four percent of COGS. If the cost of goods is $51 to $100, the freight charge is 3 percent of COGS. A careful sampling of non-stock freight charges should be sufficient to give managers a reasonable scale to estimate freight charges on special items.

4) Emergency shipments, including two-hour messenger or “hot shot” deliveries, same-day deliveries and overnight deliveries are exceptions to the standard “next-day 24-hour” service promise. For these instances, we advocate automating the freight charge or developing a corporate policy and measurement/compliance system to bill special delivery charges. Also, be sure to include any special inbound charges including air freight, special parcel post, and pick up and delivery from a local vendor.

5) Outside salespeople often have discretion over freight and do not bill it because of fear of customer complaint. Our experience with outside salespeople controlling freight is that most will not bill it overtly, or claim it is in the margin of the product. Our research finds that 90 percent of freight charges are not in product margins as claimed by outside salespeople.

To check the claim, simply compare margins on sales where freight was billed separately vs. sales where freight was included in the margin. Be sure to have common customer types and transaction sizes when performing the analysis. Also, consider deducting unbilled non-proprietary freight from sales commissions. Typically, this simple rule causes quick and measurable changes in closing the freight gap.

6) If you amortize freight over the cost of goods, link the cost file to the list price file. For instance, if the product cost was $100 and freight was $2, then landed cost is $102. Simply link the landed cost to a list multiple, for instance three, to give a list price of $306. And, if you have a lot of cost-plus pricing, simply add a freight percentage to the cost field and restrict salespeople from using other cost fields to price.

These are the more common methods available to close the freight gap. We stress that automating the pricing system to recognize and automatically bill non-proprietary freight charges is preferable to manual inspection systems. However, most software systems have a long way to go in their freight and cost-recovery modules. Until then, implementing the above suggestions can narrow the freight loss and expand the razor-thin margins common to merchant distributors.

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