Shrinking rarely makes for profits

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How much revenue does a trucking company need to generate enough profits to recover the cost of a dollar of wasted expenditures? Many people believe that since most trucking companies only net out a nickel for every dollar of revenue, a dollar wasted represents the profit from $20 of revenue – for a 20 to 1 ratio.

You hear figures like this tossed about at industry meetings, typically by consultants trying to promote a service. The most extreme I have heard is that a cargo loss claim of $50,000 represents $1 million in revenue. Taken to the extreme, this would mean that a small carrier with revenues under a $1 million of revenue might as well shut the doors if they experience a $50,000 or greater loss. They can’t possibly make any money.

The problem with this approach is that it confuses a carrier’s gross margin and net profit. Gross margin is the difference between revenue and variable operating costs such as driver wages, fuel, maintenance and tires. At most carriers, the gross margin is around 33 percent of revenue. Net profit is what a carrier has after all the dust settles. This includes fixed costs for tractor and trailer payments and overhead expenses such as office employees, as well as interest and taxes. In a good year for trucking, the average carrier might indeed net out 5 percent of revenue.

Using these figures, each dollar of revenue a carrier hauls generates about 33 cents of margin to cover a dollar of non-operating expenses. So a $50,000 cargo loss represents the profit contribution of $150,000 of revenue – about a three to one ratio.

Understanding the difference between gross margin and net profit is one of the keys to making money at trucking. I recently worked with a small carrier that also operated a small brokerage company. The owner was convinced that he was better off growing his brokerage operation, which generated 5 percent net of revenues, than his trucking operation, which was losing money. In fact, he had been shrinking his trucking operation and devoting time and energy to the brokerage business.

This owner didn’t realize that each dollar of revenue from the trucking operation was paying a much higher margin than the brokerage. He had fallen into the trap of thinking that losing a dollar of trucking revenue only cost him a nickel. Nor had he cut back on the cost of his office or trailer fleet. So with his fixed cost remaining largely the same, every dollar of lost trucking revenue added to his overall loss by 33 cents.

To return this carrier to profitability, the owner started to grow revenue without increasing fixed costs. He did this by adding owner-operators to the fleet without adding any dispatchers, clerks or trailers. By growing the fleet to a level where he could not expand any more without adding to fixed costs, the owner was able to generate an 8 percent net margin.

In trucking, it is very difficult to shrink your way to profitability. Revenues disappear instantly, but fixed costs continue until trailers are sold off or severance is paid out. Sure, there are a few carriers that have downsized their way to profitability, but they are few and far between. When a carrier starts to lose revenue significantly, that’s usually the beginning of the end.

Another lesson is that maximizing profitability means operating at a level where you are straining all your fixed resources, such as trailers and office staff. Extremely successful operators keep adding to their tractor count. They don’t acquire any more trailers or hire more office employees until they are convinced that every resource is fully utilized. They instinctively understand that when pushed, their organizations will respond by becoming increasingly efficient.

Finally, if you decide you shouldn’t grow this year, watch all your fixed costs closely. They have a way of increasing even if you are not growing. People often rationalize the need for additional staff or jump at a deal on additional trailers. Don’t do it. When you are standing still, any increase in fixed costs comes right off of the bottom line.