Supply Chain Expertise and Technology Blog by TMC, a division of C.H. Robinson

Leveling the Surcharge Playing Field

fuel surcharge program

Is it possible to create a fuel surcharge program that is consistently fair to shippers and carriers?

As we have seen over recent months, the cost of motor vehicle fuel is a national preoccupation. Perhaps this is one reason why rising prices at the pump, and mechanisms such as fuel surcharges that are designed to spread the pain between shippers and service providers equably, attract so much attention.

Another possible reason is that freight practitioners come under pressure to control fuel costs when prices are climbing. Corporate procurement departments are not always familiar with the intricacies of freight transportation. When fuel prices are rising, procurement has been known to increase scrutiny of transportation managers’ decision making and pricing practices.

Even though these competing interests are unlikely to disappear, creating an unbiased surcharge formula that works for all parties in the transaction does seem like a good idea. Such a solution would remove – or at least mitigate – a potential source of conflict between shippers and transportation providers. 

One reason why this subject sparks lively debate is that some believe surcharges are not always used to fairly distribute the costs between shippers and providers.   The challenges of such programs are highlighted in research carried out recently at the Massachusetts Institute of Technology (MIT)[i] . The graduate students in the MIT Supply Chain Management (SCM) program at the MIT Center for Transportation & Logistics, point out that when a shipper modifies a fuel surcharge, “the carrier will counter with an adjustment to the line-haul bid. This means that ultimately line haul rates and FSC (fuel surcharge) schedules are compensating.” This “revenue neutrality” means that “it does not seem possible for a shipper or carrier to establish a new FSC or modify their existing FSC in order to significantly reduce costs (shipper) or increase revenue (carrier),” according to the researchers.

But even if a fair-minded fuel surcharge is desirable, is it possible? The answer is affirmative, providing more thought is given to how the formula is structured.

The number of miles that a truck covers does not necessarily correspond with the point-to-point distances between origins and destinations, for instance. Calculating mileage when driving a car is relatively straightforward: you simply record the odometer readings at the beginning and the end of a trip. In trucking industry parlance this is called hub miles (hub refers to a wheel hub or the actual miles traveled). However, carriers don’t get paid on the actual distance traveled but according to a set of theoretical miles derived from a mileage program.

Another complication is deadhead miles, which can significantly increase the distance covered to deliver a load and hence total fuel consumption. Short haul carriers tend to have higher deadhead mileage and probably worse fuel economy in terms of the number of loaded miles they travel. 

The three scenarios below illustrate how these factors affect the miles per gallon (MPG) figure that is the basis of fuel surcharge programs. The calculations show what the real MPG should be in order to fully compensate the carrier for the distance it covers. The hub miles refer to the actual distances traveled by the carrier, and the paid miles are point-to-point map distances as measured by guides such as PC Miler or Rand McNally.

We compiled the figures for illustrative purposes only. Scenario 1 might be a long haul carrier being paid on short miles. The statistics in Scenario 2 fit the profile of a regional short haul carrier with higher dead head. Scenario 3 depicts a long haul carrier being paid on practical miles. The difference in effective MPG between the highest and lowest scenarios is 17%; a significant number.

 

Scenerio1

 

Scenerio2

 

Scenerio3

The MIT researchers maintain that the escalator, the factor that represents the fuel efficiency of the carrier’s fleet in the fuel surcharge equation, is the “most contentious issue of the FSC discussion.” The above three scenarios illustrate why. The escalator defines whether a fuel surcharge is perceived as “at-market” or “below-market” or “generous” by carriers. Even a generous surcharge is not necessarily well received by carriers because “it forces them to drop their line-haul rates, in effect, placing the cost of transportation into the FSC.”

So what is an equitable solution? I’m not sure there is a single answer.  However, one way to minimize the variance in these scenarios is to set a fuel surcharge program base or trigger point as close as possible to your average fuel cost.  This minimizes the amount of variance between your fuel escalator and the carrier’s actual needs.  The approach is not without risk since a decline in fuel costs will require you to reduce the carrier’s rate, and as a manager you will have to explain why these costs have moved from the fuel surcharge expense bucket to the line haul bucket.

Do you agree, and what is your experience? We welcome your input.  

 


 

[i] “Risk Sharing in Contracts: The Use of Fuel Surcharge Programs,” Madhavi Kanteti and Jordan Levine, MIT Supply Chain Management thesis, Class of 2011.   To view the abstract and Executive Summary, visit http://ctl.mit.edu/library/risk_sharing_contracts_use_fuel_surcharge_programs.  To request a copy of the full thesis, please contact Dr. Bruce Arntzen, Executive Director, MIT Supply Chain Management Program at: barntzen@mit.edu

- Director of Consulting Services, C.H. Robinson
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Comments

Kevin

I would recommend Breakthrough Fuel, as a fair alternative to both the shipper and the customer, any feedback would be appreciated, since it is much more reasonable then the DOE average tied to an arbitrary scale, that does not work correctly on varying mileage shipments.

8.31.11

Reply

Bob Wilson

I would favor the complete removal of any and all fuel surcharges and much rather see rates that are true representations of what the actual cost is, as a shipping manager, I believe we should all have a basic understanding of the calculation steps necessary to determine what the rate should be. Considering all factors, such as lease cost, variable mileage, for the equipment, man power, social benefits, maintenance, and fuel cost, and then allowing for a reasonable ROI of between 25 to 35% for the carrier is a fair number. I've seen FSC programs where the FSC charge covers 160% of the cost of fuel for any given trip, and Line haul rates that would pay for 2 trucks on the same load.

8.31.11

Reply

dave smith

Stop cutting the pie in so many ways ! Fuel surcharges are another sales devise an revanue stream, That simple ! To place a cost increase in another line item like fuel surcharge is making all of our jobs harder. We UNDERSTAND when fuel is up, we all have T.V's. we see the price of fuel go up. The big thing about surcharges that bugs me is when fuel drops they never go down ? I have had surcharges stay the same for the last 5 years but fuel has been up and down. Less suger coating.... More bottom line numbers ? I dont need to know what your paying more for fuel. Dave Smith

8.31.11

Reply

Brian

Hi Kevin,

I am not sure if I completely on-board with your analysis yet. One issue I cannot seem to quantify is that carriers buy fuel at a discount but FSC programs based on EIA use retail prices

Are there fuel programs out there that take into account the price that carriers pay for fuel (10-15% discount from retail) since the EIA prices that many benchmark to are based on retail prices?

For instance in a zero-peg FSC environment with a 6 MPG assumption and $1.20 fuel for a 10 mile move, the cost of fuel is .20/mile*10miles or $2 according to the fuel surcharge.

However, in the case above holding a 6 MPG assumption, the carrier would actually pay only $1.70 for fuel based on a 15% discount from retail.

Put another way, if a carrier were to spend $2 on fuel (after discount or ~$2.35 retail) they would actually have enough fuel to move 11.75 miles vs the 10 miles in the example above.

While I realize this does not increase their MPG, it does affect the amount of miles they can move for a given fuel cost

Any input would be appreciated!

Brian

9.1.11

Reply

Albert

Actual fuel cost should be a completely seperate line item for truckload and dedicated contract carriage. Shippers and carriers should work together to determine how fuel consumption can be reduced, with incentives for the carriers if they can accomplish this.
I have seen many cases where the fuel "surcharge" covered +200% of the actual fuel consumption. Also brokers often make a margin on the fuel, thus adding profit and no value there.
I also get mad when drivers/carriers just spend all that money on fuel, wasitng it going 80+ MPH on the express way (probabyl average speed around the metro Atlanta area!) when they could cut fuel consumption and cost considerably if they would slow down to for example 55 MPH. Most regular fuel surcharge arrangements support such "bad behavior" with no incentive for making it better.

9.1.11

Reply

Kevin McCarthy

@Kevin - Thanks for your comments. Breakthrough Fuel is being used by many shippers. In my opinion, when using Breakthrough Fuel instead of the DOE, you are simply changing the base. Research seems to indicate that changing the base only results in moving costs from a fuel surcharge to line haul or back in the other direction depending on if the base goes up or down (see the MIT research noted in the post. However, we hope to learn more on this subject by sponsoring more research with MIT. We’ll be asking MIT students this year to look at actual data to see if changing the base, using a different index like Breakthrough Fuel, or changing the escalator changes the total cost of a load (line haul plus fuel surcharge). We will certainly share those results in the future.

@Brian – Thank you for your comments. You bring up valid points. Everyone buys fuel at a different price and there are certainly programs out there that use other indexes than the DOE. However, in my opinion changing the index is like changing your base or peg rate. If you use a base that is lower, a transportation provider may charge you less in line haul. If you use a base that is higher, you may be charged more in line haul. The escalator appears to be the key ingredient since it is the one thing that must mimic the overall efficiency of a carrier for a fuel surcharge to be fair. Hopefully, you’ve had a chance to read the MIT research on this subject (see link in post). There is quite a bit of interest in this subject and we hope to do more research with MIT this year (as noted in my response to @Kevin). We plan to build on the current research by looking at actual data and proving if certain pegs or escalators have an effect on the overall price (line haul plus fuel surcharge) shippers pay.

Thanks to everyone for their comments and opinions. Clearly this is a topic many people are interested in!

9.2.11

Reply

David Ward

A government mandated and regulated fuel surcharge is probably the last thing we need. That would be completely against the basis of a free-market economy. This is not a complicated issue at all. The carriers/brokers can decide on their own what is a fair price and what is not a fair price when it comes to how much they charge for a given shipment without the government (or any other organization) intervening. It really is just that simple.

9.2.11

Reply

George Yarusavage

Kevin, I think the MPG equations are reversed, and the results are as well. The difference between Scenario 1 and Scenario 2 is the nearly doubling of deadhead miles. This should have the effect of DEcreasing the carrier's effective MPG, thereby increasing the amount of fuel allocated to the shipper's move, and increasing the Fuel Surcharge needed to compensate. The same relationship exists in the Hub vs. Paid Miles ratios. Higher Hub Miles increase fuel use and should decrease effective MPG against Paid Miles, justifying the carrier's need for a higher Fuel Surcharge.

9.12.11

Reply

Kevin.McCarthy

@George - Thanks for the comment and sorry for the confusion. When we discuss effective MPGs, we are referring to what a carrier would have to achieve to be made whole by the fuel surcharge. So, the more deadhead, the higher the actual MPG --- or, what we refer to as ‘effective MPG’. If you have further questions or comments, feel free to reach out to me at kevin.mccarthy@chrobinson.com.

9.13.11

Reply

Wayne Milligan

This is certainly a contentious issue. Has been for some years now, and will, I suspect, continue for some years yet. I have multiple carriers using multiple indices to arrive at a fuel surcharge. Some seem to make sense, while others are illogical. There will never be an industry agreement as to FS and to calculating MPG. Each carrier will continue to issue base rates and establish fuel surcharges that they deem necessary based on their company model, market conditions, relationship with individual customers, and other factors. I have no problem with almost any approach that carriers wish to use. The bottom line (the ultimate cost of a shipment taking in base rates and any other surcharge) is THE thing that matters. I make my decisions based solely upon that final cost (assuming, of course, that you are using 'tried and true' carriers, freight brokers).

9.26.11

Reply

Janice Brannan

I think alot of the carriers would be more happier, if they were getting the whole surcharge for fuel, like this was intented in the first place. A lot of the carriers out here in the rat race are not large carriers, so therefore, they do not all get discounts on the fuel they pay for. So when the brokers have low rates to begin with and then take a portion of the fuel surcharge, that really digs into your profit margin. Most of your owner-operators are barely getting buy because of this very reason. Until the brokers stop taking most of the surcharge that the shippers give, to be passed on to the carriers, the situation is not going to get any better. It is not about a fair way to caculate the surcharge, it is about giving the surcharge to the carrier where it should be going in the first place.

Janice Brannan

1.17.12

Reply

Kevin.McCarthy

Thank you for your comment. We appreciate the feedback.

1.19.12

Reply

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