The Power of Cost Modeling
Benefits and shortcomings of an underestimated tool
In a recent article, we explored the elements of contracted rates and the diverse factors influencing them. Since many components are difficult to determine precisely, it's crucial to focus on those that can be measured accurately to obtain actionable insights. Among all the influence factors, the carrier's cost is the most significant rate element and arguably the easiest to identify. In this article, we'll demonstrate methods for simulating these costs and discuss both the advantages and drawbacks of continuous cost monitoring models.
The art of cost tracking
As already stated, there are multiple elements that directly or indirectly influence the contracted price level. To review these factors, please refer to the following link:
Unfortunately, there is no single source that tracks all cost factors comprehensively. Therefore, they need to be tracked individually, demanding a cohesive strategy to ensure consistency and accuracy. While it is straightforward to follow the development of diesel prices and toll fees, other cost elements like driver wages, investment, and administration costs require thorough research and assessment.
Once you have gathered all the necessary cost elements, you will quickly find that these values do not provide definite insights by themselves. These figures need to be combined to become meaningful. This can only be achieved by a dedicated model that is designed to reflect the network and individual transport requirements.
At Transporeon, we developed a cost model that accomplishes this through a structured approach. Naturally, all begins with a thorough research on cost elements, tracked quarterly, ensuring the data´s timeliness and relevance. This includes leveraging multiple sources and cross-referencing data to mitigate potential biases. The numerous countries in Europe add an additional layer of complexity as values need to be researched on country level and availability of information is not uniform. So even for a plain domestic transport, required cost information might come from various countries due to the freedom of movement in European transportation.
Building the cost model
Four major steps are required: Determine the known basics, identify the correct cost parameters, estimate what is unknown and transfer the derived values to an actual transport.
Determine known basics: for a transport from A to B, calculate the required time and distance, and determine the necessary time for loading and unloading.
Identify correct cost parameters: determine relevant cost values linked to the specific transport, such as diesel prices, toll fees, country-specific wages, and minimum wage levels of the concerned countries.
Estimate unknowns: make informed assumptions about factors like connection load probability, traffic situations or average velocity, empty return trips, shifts required, and equipment depreciation. These assumptions are refined through regular updates and validation against real-world data.
Transfer values to an actual transport: derive the necessary time-dependent (€/h, €/year) and distance-dependent (€/km) cost factors (fix & variable) and apply them on transport level in combination with specific parameters, such as connection load probability or empty return trips.
This approach allows you to identify and break down the total costs associated with a specific transport into individual elements. However, like all models, it requires assumptions that may not perfectly reflect reality. As a result, calculated costs can differ from observed market prices due to factors such as supply and demand dynamics or carriers' tactical behavior. Despite these limitations, a cost model provides valuable estimates at the transport level and offers actionable insights when aggregated (e.g. at country-to-country level).
Outcome & fields of application
The outcome of such calculation is shown in the graph below. It shows the cost shares of a domestic German transport at a distance of 302 km. The model reveals shifts of cost factor influence over the last two years, such as the impact of decreased diesel prices and increased toll fees.
Source: Transporeon Cost Insights
For shippers, this information clarifies the cost structure within their network. It provides a clear breakdown of how each cost factor impacts the overall price, empowering informed decisions during negotiations and budgeting. For example, shippers can easily understand the fuel share in rates and the proportion of driver and toll costs. This knowledge proves invaluable when faced with cost increase requests, such as those due to toll increases in Germany or the Mobility Package. Moreover, it enables shippers to set more accurate fuel floaters, as they have a precise understanding of the fuel share in their network.
Armed with this information, shippers can more accurately assess future cost changes, such as announced toll fee increases or projected wage hikes, based on precise cost shares rather than relying on rough estimates. This approach also enables swift set-up of forecast values for upcoming budgeting cycles.
Carriers also benefit from cost models in various ways. While they typically have a good grasp of their own cost basis, a model can help them compare against market standards. Additionally, carriers sometimes act as shippers when subcontracting, and in these cases, additional market information becomes crucial. This is particularly relevant in a market with many non-asset or limited-asset based players.
Both shippers and carriers can leverage cost models as an automated adjustment tool for components like toll and wages. This approach is especially beneficial for long-term contracts or when using specialized equipment, ensuring fair and up-to-date pricing throughout the contract duration.
The bottom line: Cost models as a compass, not a GPS
A cost model is like a trusty compass in the wild world of freight pricing. It points you in the right direction, but it won't tell you exactly where to step. However, it's important to remember that it's just one piece of the puzzle. The model provides an estimate, not an exact market price, as it can't account for all variables that influence a carrier's pricing decisions.
Think about it this way: carriers might offer lower rates if they have advantageous return routes or if their equipment costs (e.g. due to fully depreciated equipment) are lower than average. These factors aren't typically captured in a standard cost model.
Despite these limitations, don't let that scare you off! A cost model is still a fantastic tool to have in your freight toolkit. It helps identify key cost drivers, enhances transparency, and gives you solid ground to stand on during negotiations. While it's not a silver bullet for understanding all price fluctuations, it's an essential tool that, when used wisely, can seriously level up your freight pricing game.
Thomas Hang
Lead Domain Expert