Inbound freight: Often a missed opportunity

Editor’s Note: This article originally appeared in the March/April 2002 issue of Supply Chain Management Review. The authors have written an updated version looking at what has changed with inbound transportation since then. That article appears in the November 2024 issue of Supply Chain Management Review. You can view it here.

While supply chain management has evolved into perhaps the hottest corporate initiative for competitive positioning, focus on individual functions has been uneven at best. Perhaps the most easily overlooked function has been inbound freight. Unfortunately, by allowing this mundane responsibility to slip beneath the corporate radar screen, companies are missing an opportunity to reduce costs and increase control of the supply chain. Quite simply, inbound freight is the glue that links an enterprise to its suppliers. Optimum supply chain management, therefore, demands that inbound freight be managed as aggressively as any other part of the chain.

Inbound freight suffers from mismanagement for a variety of reasons. Many companies do not isolate their inbound freight expense, preferring instead merely to add it to product cost. Once an item disappears from the financial reports as a separate entry, the chance of its receiving significant management attention is almost nil. Also, because suppliers are usually knowledgeable about moving their own products and because many operate sizable private fleets, many purchasing managers are tempted to abdicate the inbound responsibility to their supplier’s experience and control. Some purchasing organizations see this as one less function for the buyer to handle. Unfortunately the old adage about leaving money on the table when one takes the easy way out is all too applicable to inbound freight. Our joint working experience in more than 10 large companies has shown that active management of inbound freight generates a savings of 5 to 8 percent.

If most logistics practitioners readily acknowledge the financial benefits of managing inbound freight, why do so many companies overlook it? The answer gets at the crux of supply chain integration problems. In situations where purchasing and inbound transportation are not aligned functionally with outbound logistics, typically not enough attention is paid to inbound freight. Furthermore, because outbound freight creates revenue and contributes to customer satisfaction, companies are more likely to focus their attention on that end of the business cycle. In outbound situations, transportation typically accounts for more than 40 percent of distribution cost, whereas inbound freight expense will make up perhaps 10 percent of material cost. Looking at these numbers, it is easy to understand the disparity in focus.

Finally, many companies don’t realize that the management of outbound and inbound freight differs significantly. Outbound freight affects customers, while inbound affects internal operations. Therefore, outbound freight requires an operational bent because success is determined by the ability to schedule and time deliveries. Inbound freight, however, is more of a planning and control process. For this reason, the skills, tools, and processes used to manage outbound freight are not automatically transferable to managing inbound freight.

Although there are many facets to good management of inbound freight, through experience we have learned that there are six key areas of concern: freight terms, rate negotiations, effective communication of routing instructions, routing compliance, controlling premium freight, and private fleet utilization.  By paying attention to these concerns, managers will gain better control of their inbound freight and see a marked increase in cost savings.

Freight Terms

Freight terms are an area of continuing confusion for many buyers. (A glossary of terms can be found in the sidebar on page 51.) More than once we have heard the naïve observation that if the supplier prepays the freight, it is also responsible for loss or damage claims. This belief completely ignores the freight terms associated with the purchase. All buyers must learn that who pays for the transportation is an entirely separate issue from when title to the product passes from seller to buyer. The terms “FOB (free on board) origin” and “FOB destination” specify when the title passes from seller to buyer. Accordingly, determination of both where title passes and who pays for the transportation (whether it is prepaid by the seller or collected from the buyer) should be part of the purchase negotiation. From a buyer’s perspective, the most advantageous arrangement is for the buyer to control the freight cost decision, while the seller holds title to the product until it reaches the buyer’s dock. This arrangement is covered under the term “freight collect FOB destination.” When consulting with buyers, we train them to use this as a starting point in negotiations. Sellers, however, prefer to control freight expense for delivery but have the title pass on shipment. The term “freight prepaid FOB origin” covers this circumstance, and all sellers should use this as their starting point.

Because many buyers aren’t well versed in FOB terminology, they often do not scrutinize it carefully enough during price negotiations. This makes it relatively easy for an unscrupulous seller to push responsibility for loss and damage to the buyer by making a simple change to freight terms. How many buyers would notice if terms of sale changed from freight prepaid FOB destination to freight prepaid FOB origin? Most people would focus on the freight prepaid aspect and miss the more important title passage designation. The title passage designation is important because the freight itself is far more valuable than the cost to transport it. Because ownership of the freight determines liability, great attention should be paid to the FOB terms because they indicate who will take the loss for damages that occur during transport.

If the product buyer isn’t fully familiar with this aspect of transportation, he or she should seek assistance from an experienced member of his or her logistics organization. Some of the more enlightened companies we have worked with demand that a transportation representative either be involved in the buying negotiations or approve the freight terms before the deal is sealed.

Even when purchasing seeks the expertise of the logistics department, problems may occur. Consider a circumstance where a procurement group has interacted flawlessly with its transportation department and has analyzed a number of freight term options proposed by the vendor. The decision has been made to go with either “prepay and add to invoice” (seller pays carrier and adds the freight charges onto the invoice) or “prepay and allow” (buyer pays the carrier but transportation cost will be deducted from the total cost of goods). End of story—maybe.

Without good interfaces and controls between accounts payable and freight payment systems, an organization risks paying for freight twice on the same purchase transaction. In these cases, the vendor may send an invoice that includes freight, and the carrier may also present a collect freight bill for payment. This lapse—where the vendor invoice is correct but the shipping document is not—has many potential causes. Believe it or not, manually prepared shipping documents are alive and well even in the Information Age. Major less-than-truckload (LTL) carriers have told us that up to 30 percent of shipments are still being tendered to them on a manually prepared shipping document. Any time a human being is involved in the carrier billing process there is a chance for error. Problems occur when correct order information doesn’t make it to the shipping department. Or sometimes, in the rush of trying to get the billing done and shipments out the dock door, the carrier’s billing clerk may incorrectly key in “collect” instead of “prepaid.” Although prepaid freight is billed on the vendor’s invoice, this clerical error results in a collect freight bill from the carrier, and the buyer is double-billed.

The probability that problems with freight terms will arise increases if the vendor is a reseller who ships directly from its subcontractor to its customer. A prime example is when an engineering/construction firm designs an item that is part of the buyer’s project and then outsources the production of it. In this case, your vendor may not even see the product, but the shipping will end up on your freight bill. It is difficult to ensure that the freight terms you negotiated with the vendor are communicated to its subcontractors.

Another potential problem can occur when a procurement group has negotiated a complex cost-based outline agreement with the vendor that contains provisions such as “freight collect if order is less than $5,000,” “freight prepaid if order is $5,000 or more,” “freight collect if order is less than 10,000 pounds,” or “freight prepaid if order is 10,000 pounds or more.” Though the terms may seem great conceptually, the buyer had better be certain that the vendor’s order entry/shipping system can translate the varying freight terms of the purchase contract into an accurate shipping document.

All of this points to the need for either systems control or management intervention to prevent overpayment of inbound freight charges. Most organizations require that their outbound freight bills go through payment authorization, pre-auditing, and post-auditing processes. Why not give the same level of attention to inbound freight bills to ensure that you are not making duplicate (vendor and carrier) payments?

Carrier rate negotiation basics

In addition to negotiating an agreement regarding freight terms with the supplier, companies need to pay attention to the other party involved in this process: the carrier. The first step in the inbound routing process is to have inbound rates negotiated with small package, LTL, truckload, airfreight, and expedited carriers. Although much has changed procedurally since the Motor Carrier Act of 1980 unleashed more price competition between carriers, the basic concepts in rate negotiation have remained the same. Meeting a carrier’s volume need and reducing its costs continue to be crucial elements in the process.

The ideal candidates for handling inbound freight are the companies that already move your outbound shipments. But don’t rule out soliciting carriers who don’t want to handle, or have been less than price competitive with, your outbound freight. The geography of your outbound freight may not be attractive to them, but your inbound might be. Take advantage of a carrier’s need to balance his volume, fill empty back-haul lanes, or develop a new market. It will often lead to a better rate for you. The question you should ask your carrier representatives every time you meet with them is “Where do you need traffic from and to?” Ask this question often, because just as your customers and sources of supply change constantly, so do a carrier’s. Nor should you restrict this inquiry to commercial carriers; make sure to ask the same question to private fleet operators as well.

Although it potentially complicates the inbound routing process, don’t be afraid to pursue a multicarrier program based on geography or specific lane of movement to gain a cost and service advantage. Again, a basic question to ask is, “Where do you need traffic from and to?” Involve procurement, receiving, and manufacturing in the process. Input from major suppliers is also helpful in identification of potential carriers.

A crucial part of rate negotiations with carriers is establishing where all of the products and supplies you ship and receive fit into the National Motor Freight Classification (NMFC). Each product (or commodity) is assigned an NMFC class (from 50 to 500), which helps to determine its freight rate. Companies can simplify this rating and analysis process by using freight-all-kinds (FAK) classifications. Basically, an FAK classification reduces the number of NMFC ratings that a carrier will apply to the items that you are receiving or shipping. To prepare for this part of the discussion, you need, at a minimum, a description of the items that you receive, including direct materials, packaging, and maintenance, repair, and operations (MRO) supplies and equipment. If you can tie volume to each description, it will enhance your bargaining position.

All of the carrier negotiations need to be aligned with the FOB terms that have been negotiated with the supplier. Additionally, make the negotiated rates apply as generally as possible to your organization and its wholly owned subsidiaries. This will require ensuring both that the carrier is applying the rate to all pieces of your company and that all of the pieces of your company are taking advantage of these negotiated rates. These rates and charges should apply to pre-paid and collect shipments originating from your facilities and collect shipments destined to your facilities, as well as to shipments in which you are named as the third-party payer of the freight charges.

If there are wide disparities in the items that you receive or ship, you may not be able to negotiate a single FAK class exception. For example “aluminum ingots” fall into class 55, whereas “ladders aluminum, with safety cages or hoops attached” are class 400, and therefore they probably could not be grouped together as FAK. Based on the volume information that you’ve put together, you may instead have to consider a multilevel FAK program that encompasses ranges. The following would be an example: class 50 may be applied to shipments of products that actually range from classes 50 through 70; class 77.5 for shipments with actual classes of 77.5 through 100; and class 110 for shipments with actual classes of 110 and higher.

As part of the negotiation, prepare a scope of work to give carriers a clear understanding of your expectations, requirements, and operations. This documentation will include all of the labor details involved in the transportation. These details may include whether the carrier will be involved in loading or unloading, what the handling fees will be, whether there are special temperature considerations, and whether the carrier should drop the trailer at your dock.

If you have enough volume, a carrier can drop at your receiving dock a trailer loaded with inbound LTL shipments consolidated from multiple vendors or a full truckload from a single vendor. This gives you the option of unloading the trailer at your operational convenience, and it also frees up the carrier’s employee and tractor from the unloading process. In exchange, approach the carrier about a pricing concession, either lower rates or an unloading allowance. Be sure to clearly define the carrier’s liability for short or damaged product delivered under a drop trailer program. The combination of liability scenarios that need to be addressed contractually with carriers would include shipments loaded and counted by carrier personnel, shipments loaded by the shipper under “shipper load and count,” and shipments unloaded and counted by receiving personnel without a carrier representative present.

All of the carrier negotiations need to be aligned with the FOB terms that have been negotiated with the supplier. Additionally, make the negotiated rates apply as generally as possible to your organization and its wholly owned subsidiaries. This will require ensuring both that the carrier is applying the rate to all pieces of your company and that all of the pieces of your company are taking advantage of these negotiated rates. These rates and charges should apply to pre-paid and collect shipments originating from your facilities and collect shipments destined to your facilities, as well as to shipments in which you are named as the third-party payer of the freight charges.

Routing compliance: “Best way” is not necessarily the better way

Once an enterprise has negotiated freight terms with the vendor and freight rates with the carrier, the hard part comes next: routing the shipment from the supplier to your receiving dock. Key components to maintaining inbound control are effective communication of routings and follow-up for vendor compliance.

You route purchases for the following reasons: to minimize net landed cost of purchases, to help control lead times, and to maximize internal operating efficiencies. Unfortunately, the most common purchase order routing in use is “best way.” This carrier routing gives a vendor freedom to decide the method and provider of transportation or logistics service for your purchase. Essentially, a buyer puts its faith and trust in the supplier/partner to do the “right thing” on its behalf in terms of cost and service. Unfortunately, this usually results in the “best way” and the “right thing” for the vendor rather than for the buyer. In many cases, it is tantamount to giving out a blank signed check.  Companies need to communicate their negotiated rates to all transportation, procurement, accounting, and freight bill auditing/payment departments. They also should encourage their employees to seek the expertise of their logistics department when routing any purchases. Otherwise, the company will lose the gains made in negotiation.

A classic example of how shipping something “best way” can work to a buyer’s disadvantage occurred when an R&D department head from a company near Springfield, Mass., ordered a specialized piece of equipment from Taiwan. Without involving anyone from logistics, he asked the supplier to air freight the equipment the best way. Four weeks later, when the equipment still had not arrived, he finally sought the assistance of his logistics department. The logistics department traced the shipment to the Worcester, Mass., airport, 40 miles from the final destination, where it had sat for more than three weeks. The supplier had routed the equipment to this small airport because it was the closest one to the buyer. Unfortunately, in trying to best serve its customer, the supplier unknowingly had selected an airport that was not staffed by U.S. Customs. Thus the specialized equipment sat waiting for final customs clearance until the buyer called looking for it. All of this was straightened out in a matter of hours, but it couldn’t negate the expense of paying for air freight when ocean could have provided the same level of service for less money. This proved to be a costly lesson in logistics for the R&D manager. 

The most important lesson to take away from this example is always talk to your logistics department and encourage those who work for you to do so as well. The more information you can give the logistics department, the better. If you tell them what your ultimate goal is “instead of” need it here by tomorrow at 10 a.m. “they will be better equipped to find the best overall solution.”

The routing challenge: vendor compliance

Clearly communicating the proper carrier routing for a product is not just an internal challenge but an external one as well. There are various methods of communicating inbound carrier routings to suppliers. The most basic is to issue a hard copy set of blanket shipping instructions to your suppliers. The supplier then knows your options, and you depend on it to make the correct shipping choice. The options outlined should include when (based on weight or service required) to use small package, LTL, truckload, rail, air, expedited, or your private fleet, and which carrier to use for each of those modes. To facilitate compliance, the instructions should include phone numbers for pickups. This is particularly critical if you are using a private fleet operation because private fleets are harder for suppliers to track down than commercial carriers. Often, private fleets are not listed in the local phone books, and sometimes a company will not put its own name on its private fleet. Assuming that you have a current database of vendors, their addresses, and contacts, a hardcopy blanket set of routing instructions has the advantage of being relatively easy to issue and change. The downsides are that they are only issued once, pieces of paper get misplaced, and you are dependent on the skill level of your vendor’s shipping department to spend your money wisely.

Another option is to include blanket shipping instructions on every hard copy or electronic purchase order, and let the vendor make the routing decision. Repetition and ease of change are the advantages of this method. Potential problems may arise, however, depending on the format of your purchase order and how much space is available on it. Additionally, you still must rely on the skill of your vendor’s shipping department to select the best and most economical route for your shipment. However, if your enterprise resource planning (ERP) system is robust enough, you could let it make the routing decision and instruct the vendor on each purchase order or release. You need to be aware, however, that order releases may or may not equal shipments. Multiple releases made on the same day to the same destination should be shipped on a consolidated shipping document for freight and receiving efficiency.

If you’re paying the freight bill, most vendors are more than willing to comply with your routing instructions. “Willing” is the operative word because, in spite of the best intentions, problems do occur. This is why it is necessary to have an ongoing method of compliance auditing in place.

Given the problems with these methods of communicating shipping instructions, companies may prefer to establish an “inbound routing center” for vendors to contact on a transactional basis. The center could be operated either internally or through a third-party logistics provider, and it could either be manned or on the Web. If the company decides to have a Web-based routing center, it can either host the site internally or use service providers that specialize in hosting Internet “route guides.” The benefit of a Web-based guide is the potential for current information, which would take advantage of changing transportation market conditions. Your route guide Web site could also have hot links to carrier Web sites, which would aid in compliance. The company, however, must somehow ensure that all suppliers know that the Web site exists and that they use it.

Controlling premium freight costs

As you communicate your routing instructions both internally and externally, you should also make clear what process should be followed when exceptions occur. For example, say you’ve given your vendor adequate lead time on your order. The vendor has agreed to a firm delivery date that meets the requirements of your business. But then it falls behind in its schedule, and, with collect freight terms, ships via a premium (more costly) mode to make the required delivery date. What system does your organization have in place to control this occurrence? Is the vendor responsible for the excess freight charges incurred? Within your own organization, who has the authority and accountability to decide when to deviate from routing standards?

These are decisions that should be made before a product is shipped from the supplier. You need to clearly define what discretion, if any, your vendor has in changing routings or modes of shipment and the consequences for unauthorized deviations. These agreements need to be made up front. Otherwise, if you wait until after the shipment has been sent via premium freight, you will have to rely on your leverage within the supply chain as you try to negotiate who should cover the cost. Control of premium costs (air and expedited) should rest with the department that is accountable for inbound freight costs and not with accounting or finance. These costs should be handled by people who have the pertinent transportation information, including, at a minimum, an understanding of carrier service capabilities and comparative costs.

If you’re paying the freight bill, most vendors are more than willing to comply with your routing instructions. “Willing” is the operative word because, in spite of the best intentions, problems do occur. This is why it is necessary to have an ongoing method of compliance auditing in place. Receiving documents and freight bill payment records are an ideal data source. Something as simple as running a carrier report would identify vendor non-compliance. If “ABCXYZ” truck line is not one of your authorized carriers and it appears on your freight payment records, you need to take some form of corrective action with the vendor who used it on your behalf but not at your request.

Not just external partners but also internal employees need to understand the consequences of not complying with negotiated agreements. Although seemingly an extreme case, the following actually occurred and is not atypical. A project engineer contacted a supplier directly on the delivery of a casting required for a project and instructed the vendor to “get it here as soon as possible, we’ll pay the freight charges.” The casting, which weighed 200 pounds, was given “exclusive use” to an expedited trucking company and driven 1,400 miles at a cost of$2,279. Ironically, the casting itself only cost $1,200. If the project engineer or vendor had contacted the purchaser’s transportation department, he or she would have learned that the company had contract air rates. Under these rates, the casting would have been delivered the next day at a cost of $229. Managers need to stress the potential cost of not contacting the transportation department before agreeing to any shipment.

Private fleet: The solution or a complication?

The presence of a private fleet further complicates rate and routing questions—particularly if both buying and selling companies operate their own trucks. On the buying side is the dual consideration of equipment availability and cost of operation. When considering whether to use a private fleet, the first issue is quite visible and easy to understand: Is there a company truck available when the freight needs to be maintenance, shared phone lines, computer services, and so forth? Our experience has been that, when a company claims its private fleet costs are substantially below for-hire carriers’ rates, it is usually because all of the costs are not included. Even if a company has a good handle on private fleet costs, the question of what to charge is a prickly issue. For example, if the truck is already coming back from a customer delivery run, what does a backhaul pickup really cost? Some companies mistakenly assign no charge to inbound freight hauled on their own fleet and consequently record an inaccurate product cost in their records. The most equitable internal solution we have seen is for the private fleet to match the lowest freight cost that the purchasing department can negotiate on the open market.

When a supplier is using its own private fleet, its prime concern is to get full utilization of the equipment. In these circumstances, purchasing managers often have explained to us that the buyer’s logistics department cannot control the freight because the seller wants to use its own fleet for delivery. The best solution is to have the supplier’s private fleet quote a delivery cost and to measure that cost against the negotiated market price. If the supplier’s fleet can meet the required delivery date at a lower price than the buyer can negotiate, it is a good business decision to let them make the haul. If they can’t, the buyer must take this into consideration as it evaluates whether or not to use that particular supplier.

Most importantly, companies should not make the mistake of using the rationale that because the business has invested in a private fleet, it is a sunk cost and the equipment might as well be used. The corollary to this bad logic is that because the fleet already exists, why try to track operating costs? In all circumstances of private fleet existence, even if the main purpose is service, costs should be tracked as accurately as possible, and each run should be charged even if it is for memo purposes. Better long-term trucking decisions will result from this approach.

Evaluation of acquisition costs

As these six discussion points have shown, overlooking inbound freight can mean overlooking significant opportunities for cost savings. For this reason, companies need to consider inbound freight costs as a key component of the total cost of acquisition for any major blanket order or purchase. The calculation for the total cost of acquisition will also include procurement, manufacturing, transportation, warehousing, and financial data and requirements. We recommend the following formula, shown in Exhibit 1, for evaluation. This equation can be a useful tool when performing a total cost comparison between different freight terms (freight collect vs. freight prepaid) and between different channels of acquisition (direct vs. distributor). 

 

When evaluating a vendor’s proposal, buyers need to use this equation to conduct a total cost comparison of freight terms. The first step involves obtaining vendor quotations for materials bought on “freight prepaid” and “freight collect” bases. To do an accurate comparison, an analysis must convert order shipment quantities to weight, determine freight descriptions for the commodities, and identify the origins and destinations. This information will be the basis for the transportation expert (either in-house or external) to develop a cost for collect transportation. This transportation cost information should then be combined with the “freight collect” pricing that you’ve obtained from your vendor and compared to his “freight prepaid” quotation.

If you elect freight terms of “prepaid and added to invoice” (as opposed to “prepaid and allowed”), it is not unreasonable to request from your vendor substantiation of charges added. This documentation of charges can come in the form of copies of freight bills, carrier contracts, or tariffs. Information gathered from these sources can then be used to help calculate the total cost of acquisition. 

If you buy through a distributor, you need to use the total cost of acquisition equation to evaluate the option of buying direct from the original equipment manufacturer (OEM). Likewise, if you have multiple locations using the same product, you can use the equation to evaluate the option of increasing your order size to obtain bracket pricing.  The starting point for this comparison is obtaining a direct delivery “small” order price quotation from either the manufacturer or the distributor. Conduct the prepaid vs. collect freight evaluation that is described above. This will establish the benchmark price for making a decision.

For the next part of the evaluation, you will need to aggregate demand from all your facilities to set a “bulk” order level. Obtain a quotation from the OEM, based on the bulk order size. Once again conduct the prepaid vs. collect freight analysis, and compute a net landed cost for shipping the material to your redistribution location or central stocking point. To this you need to add capital costs and the operating costs for internally processing and delivering the correct order size quantities to your different locations.  The costs that need to be accounted for and unitized in your evaluation may include the following: corporate inventory carrying charge; cost of labor for in/out handling at your redistribution facility; space (real estate taxes, building depreciation, rent, utilities, maintenance); risk of obsolescence, pilferage, and damage; transportation from the redistribution location to the end user; packaging materials; insurance; and inventory taxes.

If your redistribution facility or dedicated delivery vehicles have empty or unused capacity, you may consider not assigning a cost for these services in your calculation. In developing these costs, it is essential to get input and guidance from transportation, operations, and accounting.

The total unitized cost of internal redistribution should be compared against the “small” shipment OEM or distributor pricing, and the appropriate decision made. If the decision is made to redistribute internally based on lowest total cost of acquisition, inventory level and turn metrics will need to be adjusted.

As companies investigate their different inbound freight options, they will find that the total cost of acquisition equation provides an excellent tool for comparison by placing the decision within a larger context.

The risk of mismanagement

Companies that fail to manage their inbound freight are taking a number of risks—not only the risk of letting dollars slip through their fingers but also the risk of missing out on a superior supplier that lacks freight expertise. They are missing an opportunity to reduce costs immediately while increasing control of product flows. Reaping the full benefit from inbound freight management, however, requires the company to view it within the context of the total integrated supply chain. As the link to your supplier, inbound freight is an important component in the end-to-end vision of managing material flow from source to consumption. Those companies that simply lump inbound freight into the purchasing management bucket fail to realize the efficiencies and cost sav-ings that can be gained by involving not just purchasing but logistics, receiving, manufacturing, and external suppliers. These companies risk losing out to supply chain leaders that have already discovered the operational and financial leverage of doing the job right.

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