WHAT FREIGHT TERMS? AND WHY?
by Mike Starling
An often overlooked part of a company’s transportation spend management program (if they pay attention to it at all) is the matter of selecting the right freight terms to apply in specific shipping situations. Neglecting freight terms can not only drive up freight expense but put a kink in your operations from unintended or unforeseen consequences.
So, what are the basic freight terms you see in domestic distribution?
PREPAID: Inbound, this means the Vendor pays the freight and selects the carrier. Outbound, this means you pay the freight and select the carrier.
COLLECT: Inbound, this means you pay the freight and select the carrier. Outbound, this means the Customer pays the freight and selects the carrier.
PREPAY & ADD: Inbound, this means the Vendor pays the freight, selects the carrier, and adds the freight charge to the invoice to you—so you pay the freight. Outbound this means you pay the freight, select the carrier, and add the freight expense to the invoice to the Customer. In both these instances, some companies bump up the actual freight expense charged on the invoice to generate extra revenue.
So what are the reasons for selecting and using a particular freight term? In a word, “CONTROL.” Control of the freight expense. Control of the mode and carrier selection process. Control over the dispatch and receipt process and timing. Control over where title to the merchandise changes hands. Control over the risk management related to the shipment. Control over what transportation tactics are employed. Control over contract terms and conditions negotiated with the carrier. Control over your own destiny!
The key is to choose and apply the freight term that makes sense for the company to achieve its prime directive—MAKE MORE MONEY, NOW and TOMORROW. That’s the sole reason all companies exist.
You need to think beyond the individual shipment. You need to think beyond the transportation tactic employed. You need to understand the impact of the freight term selected beyond the transportation department or the warehouse shipping dock. Lets take a look at how the Vendor or the Customer can intentionally or unintentionally impose added “expense” on your operations by simply using a “freight term.”
INBOUND: Your purchasing department gets a great deal on a volume buy. They agree to “delivered” purchasing terms, which translates in "transportation speak" to inbound “PREPAID” shipment. They select the carrier. They pay the freight—and maybe add a little mark-up and bake it into the price of the product. You have no way of knowing anyway, since you didn’t ask them to break out the freight and assessorial expense.
So how does inbound “prepaid” put you and your company at risk?
1. They choose the carrier and you have no say or control over the expense.
They might be the worst carrier in the world, one you would not touch with a ten-foot pole. But they selected “Joe Schmuck's Luckless Freight Lines” because they were the cheapest alternative. They build freight into the product price based on the market rate, but they are not paying that. They are pocketing the difference.
Joe Schmuck lines is noted for not calling to schedule a dock appointment, so they show up and demand to be unloaded right now. Your docks are tied up and you tell them to just get in line. No problem, they love charging hourly tractor detention to add to the invoice for the delivery. The vendor is going to CHARGE you whatever they get charged by the carrier.
Now let’s think beyond the shipment:
2. This can have a negative impact on your operations and operating expenses.
Your upstream visibility of inbound shipments sucks! At best it is 24 hours’ advance notice of an inbound for you to plan and schedule not only receipt but warehouse labor to handle put-away as well.
The short-notice or no-notice shipment strains your warehouse receiving staff, who were not ready for this added workload. It ties up dock space that was being reserved for scheduled inbound shipments. Receiving and put-away takes more time than expected, and you incur warehouse staff overtime to clear the decks. Get the idea?
And how about outbound “Collect"? What risk does this pose for you?
Again, “they” choose the carrier.
The customer has the opportunity to negotiate a freight expense allowance into the price of the product you are selling them. If they can find a cheaper way to get the product from you to them, they make money. Expect obnoxious, demanding drivers to grace your shipping dock, willing to disrupt your loading dock operations to get you to accommodate their schedule.
But the most egregious use of outbound collect is the customer using your loading dock as an extension of their warehouse. Since they dictate the time/date when the carrier pick-up gets scheduled, their motivation is to move the shipment when it is convenient for THEM. Bottom line, they tie up dock space needed for your PREPAID outbound shipments, disrupt your operations, slowing picking and staging of orders in the warehouse, and add to the under-utilization of scheduled labor and equipment. But worst of all, your customer is in fact delaying your ability to invoice for shipments that don’t get out the door, which impacts your operational cash flow. Expect this to happen at month-end when you are trying to hit your sales numbers!
BOTTOM LINE: Choose the freight terms that make sense for supporting the company’s goals and objectives. This means that those from the top down understand the economic impact of freight terms, not just as a component of controlling expenses, but the broader strategic impact of the freight terms on operations, inventory, opportunity costs, and cash flow.
Do this by ensuring the alignment of corporate goals and objectives with the departmental tactics employed, and providing visibility of results against goals both operationally and financially, vertically and horizontally, to all levels of management for continuity of effort to achieve the prime directive.
So, who is responsible for the selection and specification of freight terms in your company?
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