18 Oct WARNING: Managing Your Supply Chain Using Averages May Be Hazardous to Your Company’s Health
Last month I authored a post on the FedEx 2017 rate increase, FEDEX 2017 GENERAL RATE INCREASE (GRI) IS NO “ME TOO” INCREASE, wherein I cited that the increases in freight rates were only part of the story. Increases in surcharges and the change in FedEx’s dimensional divisor were sure to raise shipping cost more than the announced 3.9%-4.9% average increases. I included a hypothetical example of how the billable weight of a dimmed shipment could be as much as 19% greater. This is just one example of how managing or budgeting for your supply chain using averages can be extremely hazardous to your company’s health.
While these averages and hypotheticals set our minds wondering, we know that with mathematical gymnastics the numbers can usually tell whatever story we want to spin, oftentimes resulting in misled conclusions (see: The Flaw of Averages). For the purposes of accurately understanding the potential impact of pricing changes, averages are of little help. So, rather than use averages, it is critical to simulate or model the change in order to obtain an accurate impact assessment.
Taking an actual example 2016 shipment of one of Grand Canal Solution’s customers, the impact of the 2017 FedEx rate can be clearly understood. The shipment was shipped FedEx Ground to a residential address in zone 7. The package was 16” long, 14” wide and 4” high. The actual weight of the package was 3 lbs. but its billable weight was 6 lbs. (using the 166 dim divisor) because of dimensional weight. The total charge paid $17.98. This total charge was a product of the weight charge for 6 lbs. to zone 7 with a 21% discount, plus fuel surcharge and a residential surcharge of $3.25.
Using the average GRI increase of 4.9% for FedEx Ground a quick calculation would indicate that this same shipment next January would cost $18.86. However, if the actual shipment parameters were modeled, a quite different result emerges.
First, the dimensional divisor has been reduced to 139. The results in the billable weight being 7 lbs. instead of 6 lbs. Second, the base charge to zone 7 has increased not 4.9% but 5.6%. But since the billable weight is now 7 lbs., actual weight charge increases 8.3%. Third residential surcharge increases to $3.45 from $3.25 or 6.1%. Of course, the 21% discount to the freight rate still applies. So the total cost of this shipment under the Jan 2017 rates is $19.37 or an increase of 7.7% from 2016 or .51 more than the average rate increase calculation. A summary of the differences can be seen below in figure 1 that shows 3 lb Shipment measuring 16″ x 14″ x 4″ originating in Hayward, CA destined for a residence in Mabelvale, AR. The 2016 Dim divisor is 166. The 2017 Dim divisor is 139.
[table id=1 /]
In the last 6 months, this customer shipped over 40,000 shipments with a wide variety of weights, destinations, and applicable delivery surcharges. With 14.5% of shipments incurring dimensional weight and 85% incurring residential surcharges, it can quickly be seen that budgeting the impact using averages is sure to result in a gross error.
In the past, calculating the actual increase was a daunting task for finance and supply chain managers. Unfortunately, that led to cost surprises that only avail themselves after budgets have been set and many other business plans put in motion. No one, especially CFOs, like these types of surprises.
Nowadays there is really no excuse for using averages in an attempt to understand future supply chain costs. Supply chain analytics can predict future shipping volume of products and accurately model these GRI changes in minutes. You need accurate information to run your business. Don’t fall prey to the Flaw of Averages.