WalMart's Inbound Freight Move Could be a Game Changer

There is a difference between strategy and tactics and many confuse tactics with strategies.  Strategy is the art and science of overall planning and conduct of a large-scale operation. Strategy involves defining goals, or even better, defining results and the purpose of the results.  A tactic is an expedient for achieving a strategic goal; nothing more than a maneuver. Far too many people get confused and deploy tactics under the guise of strategy.

Reading in the general business and trade press about Wal-Mart's “new” “strategic” initiative to expand their control over their inbound domestic freight humors me for two reasons: First, the conversion of freight terms from prepaid to collect isn’t a “new” concept.  Second, it can't be called a strategy; it is really just a tactic.

A large aggregator of freight from a wide range of locations should always be endeavoring to “control” its inbound supply line. Sun Tzu teaches that “The line between disorder and order lies in logistics”.

Big-box retailers, and WalMart is the biggest of the big box retailers, like to have order.  Disorder adds costs, and WalMart is on a strategic mission – from the deepest of the corporate DNA – to eliminate costs.  There are several tactics that a retailer can use to “control” inbound logistics.  Some tactics involve changing the freight terms, others don’t change the terms but negotiate the process.  One option is not intrinsically better than the other – they are just different.  The choice of the tactic should be determined by what best supports the strategic goals of the organizations served by the supply chain.

Tactics Support Strategies

But why would I insist that this is a tactic and not a strategy? Simply put scale is one answer. But another is this is an enabling tactic that supports even grander strategies than simple “control, so control becomes nothing but a mere tactic.

I learned some time ago, perhaps from reading Peter Drucker, that every tactic deployed should support as many strategic goals as possible.  A tactic that supports only one strategic outcome is not a very effective tactic. A tactic that supports 5 strategic goals is a fabulous tactic.

In the case of WalMart's recent decision and initiative to convert a majority of its inbound freight volume from prepaid to collect freight terms, the lines between strategy and tactics become a little blurred in so many people’s minds.  So let us work on under blurring the lines.

Basic Cost Reduction Strategy

Sam Walton’s core epiphany when he operated his original 5 and 10 stores was: as long as the wholesalers controlled the distribution the wholesalers would control the profit Walton made.  Caught between the competitive pricing of the rest of the retail stores who were buying from effectively the same wholesalers, Walton’s stores would always have to fight for customer’s attention.  He needed a pre-emption strategy.

Now Sam didn't like the idea of limited profits in a “fair” competition – he wanted to win.  When dreaming his new kind of store he developed ways to be able to buy the merchandise direct from the manufacturer and provide his own distribution network. That distribution network is the competitive edge that WalMart possesses. Other retailers did the same thing, but Sam Walton set out to make sure that his distribution network was the most efficient it could ever be. He instilled throughout the supply chain organization the drive to minimize costs at every point, in every link of the supply chain. In fact it's been joked that WalMart is nothing more than a fabulous supply chain that happens to have some retail outlets.

It's really not a joke.  It is a reality.

Since transportation can be as much as one-half to two-thirds of the total cost of distributing product it only makes sense to drive is in as many efficiencies into your transportation network as you possibly can. WalMart's approach using private fleets to deliver to their stores is a tactic that helped the company achieve two different strategies. The 1st strategy is to limit the margin that would have to be paid to a third-party providing that service. The 2nd strategy is controlling the fleet Wal-Mart can control the quality and timing of the service to move the freight from the distribution centers to the stores. That 2nd strategy is an important goal in reducing labor costs and maximizing the utilization of assets and resources. Under Drucker's instructions the tactic of operating a private fleet in meeting those two strategies is pretty good.

Take it one step further; using that same fleet to backhaul freight from suppliers back into the distribution centers helps offset the cost of running the empty miles from the retail stores back to the distribution centers. Some would call it a “no-brainer”, but so many companies have failed to optimize as well as they could. In fact I know of companies that internally waged war on the idea of using the fleet for backhaul.  So now we have a third strategy that the tactic of operating your own fleet supports; being able to pick up the freight from your suppliers.

The Basic Logic of Freight Terms

The following discussion may be remedial for part of our audience, so please allow me to apologize up front for the following  simplified treatise  on freight terms. I carry the scars of many a skirmish from my time in the logistics trenches where people who should have understood the nuances of freight terms did not.  So for the benefit of those who may not know about the freight terms I will quickly explain.

There a 3 sets of freight terms used typically here in the United States.

FOB origin - Collect: Loosely translated as the title of ownership of the freight transfers at the seller stock and the buyer arranges and pays the freight cost. (In modern INCOTERMS this is EXW – Ex-Works).

FOB destination -- prepaid and add (PPD&ADD): where title of ownership transfers at the buyer's stock, the seller arranges and pays the freight and charges the buyer for the freight on the invoice. (There really is not an INCOTERM for this very popular term).

FOB destination – prepaid (PPD): where the title of ownership transfers at the buyer stock, the seller arranges and pays for the freight and the freight cost is a rolled into the price of the merchandise. (INCOTERM DDP).

Converting freight terms under the first two examples is easy; just change the purchase terms.  In fact, with a PPD&ADD program, IF the buyers has a transportation management team they should evaluate the sellers freight charges against their own costs and decide if making a switch will save money.

But with the 3rd there is a rub: you have to negotiate with your supplier and get an allowance for that freight cost.  In many cases vendors shipping under prepaid pricing are providing that transportation service to a large number of customers, small customers, that do not have their own transportation departments. As the retail environment has changed and more and more large chain stores have grown to where they have created their own distribution networks there's been a growing pressure on vendors to change their terms.

When vendors are pressured to give an allowance on PPD terms they will often argue that the removal of that buyers freight volume will drive their transportation costs up, a cost that will have to pass along to the rest of the customers.  “It’s not fair to our other customers,” is an argument that I would hear when I was running a logistics organization and we converted terms.  My response at the negotiation table would be “where is it written that life is fair?”  I referred to this argument as the "socialized freight" argument and that "socialized freight" is almost as bad as "socialized medicine".  I would drive on stating “that as a capitalist I don’t understand why my company should have to support the profit line of our competition.”

I would challenge the vendor with the claim that the removal of my freight volume would change the “marked up with margin” rates that the vendor would pay. I suspect that Wal-Mart is facing the same resistance as my past teams did as WalMart Vice President of Corporate Transportation Kelly Abney said he was running in recent articles.

In the long run the buyer really dictates the terms so you could say "resistance is futile" on the part of the vendor.  In some cases (far more than you would imagine) the challenges come from within the retailers own organization with friction between the logistics and merchandising teams. In many retailers the merchandise managers don't understand the cost of transportation and sadly enough believe what the vendor's representation tells them over that of their own company’s logistics team.  I doubt that that is an issue at WalMart since the merchandise category managers are compensated on the net margin dollars that their product lines produce.

The strategic goal of all of this tactical effort to convert freight terms is traditionally thought as a “buying strength” argument where the large retail company with their superior transportation buying power is able to move the freight at a lower cost than the vendor.  The same argument is sometimes used by the vendor that is much larger than the retailer against terms conversion.  I have seen more than once that “size” does not equal “pleasure” where large companies costs were higher than the smaller customer.

If the goal of the effort to covert terms is focused on creating additional net profit dollars for the buyers company, the tactic is considering just a singular strategic goal being accomplished; not a high-efficiency tactic following the Drucker rule.

More Freight = Lower Rates is not Always True

As I mentioned above, bigger is not necessary better – more does not automatically mean less.

With more of the inbound freight volume under their control WalMart could be in a position to command better rates from their carriers, but I really doubt that is the strategy they have in mind with the initiative.  Wal-Mart is already a huge shipper. The sheer number of shipments that come in and out of the WalmMart distribution centers is staggering. Approximately 315,000 inbound loads are delivered to Wal-Mart distribution centers every month More than 3.7 MILLION ANNUAL inbound deliveries. Of those inbound deliveries approximately 115,000 per month are shipped freight terms Collect, about 37%.  The new goal is to convert the other 200,000 inbound loads per month.

Stop and think about the number of inbound loads Wal-Mart already controls. 115,000 loads of month is 1.4 million loads a year. Any shipper controlling that kind of volume already has effectively levered a large buying power pricing position with rates. Would more than doubling the freight volume create more significant rate reductions just because of size? I think the idea that by muscling up even more volume to hammer rates may be a little presumptuous.  There must be other strategies being addressed with this effort.

Other Strategic Goals?

There must be additional net profit dollars to be gained with WalMart converting the rest of its inbound over to collect freight terms.  Wal-Mart invested in multiple supply chain management software platforms, including Transportation Management Systems (TMS), EDI, Dock & Yard Management (YMS) and with help for MIT is busy knitting these platforms into a enterprise system.  Converting terms  requires a substantial long-term analysis and negotiation effort.  Managing the movement of over 450,000 truckloads a month requires a substantial trained and experienced staff.  This will not happen overnight and there is not an easy task in any of these efforts.

You could make the argument that with proper systems and processes that Wal-Mart will build a large enough critical mass to drive higher levels of efficiency into the freight management task. But just because something is bigger does not necessarily drive more efficiency into the operation. We industrial engineers understand this very well under the law of diminishing returns. At some point the additional effort needed to manage all of that freight movement effectively may require more input per-unit been managing only half of the total freight movement.  The return on the freight “margin” and the rate negotiation strength is not enough to offset all of these investments – so there has to be more returns.

Source: http://www.scdigest.com/