In 1986, Robert Sullivan left a senior management position at an LTL carrier to develop a proprietary costing and cost management software, the Effective Management System (EMS). Recently, Sullivan used EMS to analyze the operations of a less-than-truckload client, one terminal at a time.
To make it through the current recession and to survive in the future, companies have to pay much closer attention to the profitability of customers, he concluded.
Sullivan recommends that carriers focus on contribution dollars (revenue minus variable cost) per customer. In years past, fleets could increase their overall contribution dollars through revenue growth and efficiencies. This time they will have to surgically remove unprofitable customers and the variable costs that go with them.
“I went in with the predetermined notion that all we would need to do is improve operating efficiencies, and all would be well,” he says. “I got the surprise of my entire career.” His analysis showed that even at 100 percent efficiency, the company still would be unprofitable, and positive cash flow “iffy.”
Some carriers continue to calculate their variable cost as a flat hourly or mileage-based rate using data from a profit-and-loss statement. To identify unprofitable customers, however, it is critical for carriers to know their costs and to cost shipments properly. For instance, variable costs differ by customer due to factors such as deadhead miles, appointment times, toll costs, freight density and layovers.
Removing unprofitable business in a down economy can be a risky proposition, however. Even unprofitable shipments can provide some contribution to overhead and fixed costs. If you remove customers, things may get worse unless you can remove them and improve your contribution margins.
Sullivan says he began his analysis by using the EMS system to divide the customers into three groups by their contribution ratio (CRAT), the ratio of revenue to variable cost. The first group consisted of customers with a CRAT of 1 to 100. This group was not only unprofitable; it was subtracting contribution dollars away from the other two groups. The second group consisted of unprofitable customers that provided some contribution to overhead. The third group consisted of customers with a CRAT above the carrier’s break even point of 135.
In Sullivan’s analysis, combining groups one and two resulted in negative revenue and negative contribution dollars per shipment.
“We think we are getting contribution dollars from the mid-level group, but the reality is that the sub-100 group negates any contribution you are getting from the middle group,” Sullivan says. The third group is the only group providing contribution, and for many carriers, this third group generally represents 60 to 65 percent of total revenue, he says.
After identifying unprofitable customers, the next step is to eliminate the variable cost that goes with them. This is complicated because removing a customer affects the operations and costs of multiple terminals.
The EMS system uses engineered standards for the time each shipment should take to pickup and deliver. Standards consider distance, shipment size, weight and many other factors. In sum, analyzing customers based on work standards, as opposed to your actual costs, is a better way analyze the amount of work each customer represents and to know how much work – and cost – to remove, he says.
Based on his industry experience, Sullivan believes carriers no longer will be able to operate solely under the “grow revenue, control cost” scenario now or even after the current recession ends. “I believe we have to grow revenue and manage operating efficiencies at a higher level than ever before, but at the same time be able to surgically manage the customer base on an ongoing basis.”