Logistics contracts need the Total Cost of Ownership

Roger OakdenLogistics Management, Procurement, Supply Chains & Supply NetworksLeave a Comment

Transport within logistics

Hub transport locations

Investment decisions in Logistics are typically made by individual entities for their own policy or profitability reasons. The objective is usually to reduce the unit costs for the entity – not to reduce total Logistics operations costs across the affected Supply Chains.

An example has been the development of ‘Hub’ sea and airports and multi-modal centres. Providing a shuttle service between ‘hubs’, using large transport units (ships, aircraft, trains and trucks) reduces a transport operator’s unit costs. From the unloading point, the goods are distributed to the final destinations, using smaller (and maybe different) transport units. However, for maximum profitability, this requires that each transport unit is fully loaded, with minimum turnaround time at the loading and unloading ‘hub’ points.

While hub-and-spoke transport systems are good for a transport operator, the larger transport units require infrastructure construction at the ‘hubs’ and for the handling of trans-shipment goods from the receiving ‘hub’ to the destination. The EU has estimated these costs to be about two percent of GDP, including the specialised infrastructure and equipment to handle larger transport units and the full cost of using public infrastructure, traffic congestion and transport vehicle pollution.

Hubs with ‘stranded assets’

Changes of Nodes and Links within supply chains can be influenced by customer preferences changing, or future geopolitical actions. These changes could leave the investments as ‘stranded assets’. Then, the financial decision becomes either the users continue to pay for the superseded investment, or the capital costs are written off and investors or taxpayers absorb the costs. But not the transport entities that required the initial investment in facilities for the lower cost transport service to operate.

An example of assets that may not be used over their operating life are at some ‘hub’ airports. Here, money was invested to accommodate the Airbus A380, in the expectation of increased passengers and freight. However, passengers and freight customers have shown a preference for airlines that fly ‘point to point’, rather than forcing a change of aircraft at a ‘hub’. For airlines that have changed to a ‘point to point’ service, their A380 aircraft now fly between major airports over long distances. However, at airports that no longer service the aircraft, the infrastructure investment remains.

Container shipping

It has also been the strategy of container shipping companies to reduce their unit operating costs through the use of ever larger ships. Although it has been estimated that container ships could increase in size to 30,000teu, factors concerning the long-term viability of larger ships should be considered:

  • Markets
    • customers prefer container arrival capacity to align closer with demand
    • trade patterns are becoming more regional
    • shippers prefer to send smaller shipments via ‘point to point’ services that include smaller ports
    • reduced demand in emerging markets
    • changed consumption behaviour (eCommerce)
  • Sailing routes
    • physical constraints e.g. Suez Canal 20m draught
    • growth of the land bridge between China and Europe
    • change of routes to less developed ports with lower capacity
    • trans-shipment volumes peak as pan-Panamax ships are re-routed to lower capacity routes
  • Port infrastructure
    • not providing for deeper draught ships, reducing the number of available berths
    • arm-length limits on container gantry cranes
    • container exchange time per call increases whenever the size of container ships increases. Estimates are that for a 20,000teu vessel on the Asia to Europe route, with four direct port calls, the container exchange required at each port is at the limit of port capabilities for efficient hinterland connections
    • limited capacity in container yards to handle direct onward local delivery, or for transhipment that needs to be moved, either to stack or waiting for a feeder vessel
    • limited Logistics capacity outside ports for container unstuffing and the road, barge and rail networks to move containers to their destination
  • Cost structure
    • returns reduce with increasing ship size beyond 18,000teu with a decreasing likelihood of a full ship per sailing
  • Technology in manufacture
    • local production e.g. additive 3D manufacture
  • Sustainability
    • regulations e.g. fuel types allowed
    • port restrictions to handling ‘ultra large container ships’ (ULCS)
    • increase in circular economy activities

Transport for commodities

In the bulk commodity trades, the same thinking exists about ship size and unit costs. An example occurred some years ago, with the export of iron ore from Australia to Germany.

The approach was that sales could be made into Europe at a competitive price as the iron ore can be mined at a low unit cost, combined with low unit shipping costs. The proposition was to use large bulk carriers to transport the iron ore from West Australia to Rotterdam, then by train to Bremen.

The competitor proposed that iron ore mined in Kiruna, Sweden be pumped through a slurry line to Narvik port in Norway, then shipped direct to Bremen in a fleet of three small bulk carriers. This option was expensive; however, it was awarded the contract due to savings in inventory. The iron ore delivered from Australia would arrive on an irregular basis in large loads, therefore high inventory must be kept at the steelworks. In comparison, the expensive iron ore from Sweden would arrive on a daily basis in shipments that could be handled by the steelworks, therefore minimal inventory was held. This case illustrates that Logisticians must calculate the total cost of ownership (TCO), not just the transport cost.

The TCO approach is now being undertaken at an iron ore mine in West Australia. A media report states that the long-held approach to transport of iron ore within a mine is that bigger is better. To this end, trucks have been getting ever bigger and now carry loads of at least 400 tonnes. The argument is that big trucks mean fewer trips along the mine roads and large loads provide higher efficiencies. However, there is a cost across the mine site to using such trucks.

At one mine, 40 tonne driverless trucks are being used to evaluate the two extremes. The result is that using small trucks has reduced the company’s total costs. They allow the ore to be more selectively mined, taking out about 10 percent less waste. The smaller trucks also allow mining to proceed steeper and deeper and around indigenous heritage sites, thereby reducing the size of the mine’s footprint. Environmental results will also be improved, due to the ease of changing the truck’s diesel engine to electric.

For professionals in supply chains, these examples illustrate that when evaluating the logistics in a supply chain, always calculate the total cost of ownership – do not accept that lower freight rates are automatically the best option.

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About the Author

Roger Oakden

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With my background as a practitioner, consultant and educator, I am uniquely qualified to provide practical learning in supply chains and logistics. I have co-authored a book on these subjects, published by McGraw-Hill. As the program Manager at RMIT University in Melbourne, Australia, I developed and presented the largest supply chain post-graduate program in the Asia Pacific region, with centres in Melbourne, Singapore and Hong Kong. Read More...

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