A Pioneering Approach to Reducing Fuel Cost and Carbon Emissions from Transportation.
The purpose of this article is to present a unique approach to reducing fuel cost and emissions from transportation. The approach involves analyzing the potential for savings in fuel cost, engages shippers and transporters to bring greater transparency, and optimizes the choice of vehicle and route. The suggested approach has resulted in a saving of 7.5 million gallons of diesel in transportation and reduced 76,910 metric tons of C[O.sub.2] emissions for Whirlpool between 2007 and 2016 in the United States. This approach leads to the saving in fuel cost and a reduction in carbon emissions. The proposed methodology offers a mutually benefiting solution to supply chain management professionals in reducing their carbon footprint from transport activities while saving in transport cost.
Transportation, operations strategy, fuel cost, distortions in fuel prices, emissions, sustainability
The globalization of supply chains has increased the significance of logistics (Bouchard 2015). The share of transport costs in logistics activities is the highest. According to Swenseth and Godfrey (2002) about 50 percent of the total logistics cost is in transport, and fuel costs are one of the single largest costs (35%) in transportation (Gurtu, Jaber, and Searcy 2015). This article highlights the importance of managing fuel costs effectively and presents a case study of a pioneering approach to minimizing distortions in fuel prices and, thereby, reducing fuel costs as well as emissions from transportation in a manufacturing organization. This reduction in the fuel cost is achieved through greater transparency and collaboration between transporters (logistics organizations) and manufacturing organizations or, to use more general terms, between a "shipper" and its "carriers." The reduction in emissions is achieved through the use of alternate routes, alternate fuel, more efficient vehicles, the location of fuel filling stations on a route, and the use of intermodal carriers. The benefits of implementing this unique approach to a manufacturing organization are shared to demonstrate the efficacy of this approach. The organization, in this case, Whirlpool Corporation, which manufactures a wide array of household appliances in the United States, was engaged.
The potential to reduce transportation and logistics costs is well documented:
Transportation and logistics related costs as a percentage of sales range from nine percent to 14 percent depending on industry sector for companies who do not adopt a "Best in Class" management approach. These percentage ranges include all logistics related expenses such as warehousing, dedicated personnel, and transportation expenses. Transportation cost accounts for most of this expense for most of the manufacturing, trading and logistics organizations. By adopting a "Best in Class" logistics management approach, logistics related costs as a percentage of sales drops in the range of four percent to seven percent depending on industry sector. (Snowdale 2009)
As noted above, fuel costs constitute one of the single largest components of transportation costs, and the prices of gasoline and diesel are affected by fluctuation in crude oil prices. Consumers in many countries feel that an increase in the price of crude oil results in an increase in the retail fuel price at the fuel station quickly, but a reduction in the price of crude oil takes a long time to reflect a corresponding reduction in the retail fuel prices at the fuel station. A study was done to validate this behavior in retail fuel prices in Germany. The authors found evidence in support of this belief between 2003 and 2007. They also found a change in the behavior of retail fuel prices based on their analysis of the data between 2009 and 2013, that is, increases and decreases in retail fuel prices are now aligned with the corresponding changes in the price of crude oil (Asane-Otoo and Schneider 2015). However, consumers in many nations still feel that an increase in the price of crude oil results in an increase of fuel price at the fuel station quickly but a reduction in the price of crude oil takes a long time to reflect in lowering of retail fuel prices at the fuel station (Steafel 2016).
Consumers have been expecting greater transparency in fuel prices for a long time. Rossi and Chintagunta (2016) studied the effects of transparency in fuel prices in Italy and found a reduction in gasoline price by about 20 percent of fuel stations' margins when prices are displayed on large electronic displays. Despite the reduction in fuel prices, the authors found little change in the dispersion of the fuel prices. Further, they found that a very small number (less than 10%) of consumers used this information effectively.
On the other hand, the fuel price in the commercial transport industry is managed differently. Winebrake et al. (2015) studied the elasticity in fuel prices between 1970 and 2012 in the transport industry in the United States. They evaluated trucking operations in terms of vehicle miles traveled and fuel consumption for combination trucks. They found a complete shift in the behavior of fuel prices between this period. The fuel prices in the trucking industry transitioned from being very elastic in the 1970s to a relatively inelastic environment by 2012.
The need to pay attention to fuel cost has also been expressed by many authors (Andriolo et al. 2014; Gurtu, Jaber, and Searcy 2015; Oglethorpe and Heron 2010). Moving raw materials from suppliers to manufacturing locations and finished products from manufacturing locations to different markets is an important part of supply chains. This requires spending millions of dollars in fuel cost in transport activities each year. Therefore, it becomes important to measure the fuel cost accurately and have a strategy for managing fuel costs efficiently and reducing transport emissions effectively. Paying attention to the cost of fuel for transportation is important for reasons other than the short-term cost of transportation. Reserves of fossil fuel are finite. That makes the supply of fossil fuel finite. The conversion cycle time from organic matter to fuel is too long, which makes it practically a nonrenewable resource. The quest for finding a commercially viable and scalable substitute for fossil fuel continues. However, there are no substitutes for fossil fuel in the transport sector that are commercially viable and scalable. As a result of continuously increasing demand for fossil fuel, its prices have been increasing at a rate many times higher than the overall rate of inflation for more than half a century (Gurtu, Jaber, and Searcy 2015). In the absence of a commercially viable alternative to fossil fuel for transport applications, fuel prices may experience a steeper rise in the future.
The use of alternative fuel or electric/hybrid vehicles has been suggested to overcome the challenge of depleting fossil-fuel reserves. Fossil fuel is a very efficient source of energy in transportation and a lot of investment has been made over time in setting up the distribution network along highways and inner roads. Developing a network for the distribution of an alternate fuel or recharging stations is expensive and challenging (de Vries and Duijzer 2017; In and Bell 2015). The author developed a stochastic model to determine the locations of refueling/recharging station, tested the robustness of the model for the Florida state highway network, and obtained very encouraging results.
The high cost of transportation is leading to some strategic changes in global supply chain management. The three such identified strategic changes are (1) "from offshoring to nearshoring sourcing strategies to reduce the number of miles traveled"; (2) "from product and package designs for marketability and production toward designs that also incorporate 'shipability' considerations"; and (3) "from lean inventory strategies to lean inventory-transport hybrid strategies" (Russell et al. 2014). Due to the increasing cost of fuel in transportation, a likely change from offshoring to nearshoring and development of regional markets have been discussed as well (Bonney and Jaber 2011; Gurtu, Jaber, and Searcy 2015).
The focus on fuel in transportation is also increasing due to the dependence on fossil fuel in transportation and the associated carbon emissions, which are a prominent contributor to global warming. Furthermore, many authors and industry players have raised the concern about emissions from transport (Aljazzar, Gurtu, and Jaber 2018; Cadarso et al. 2010; Gurtu, Jaber, and Searcy 2015; Gurtu, Searcy, and Jaber 2017; Hawkins and Dente 2010; Pan, Ballot, and Fontane 2013). Therefore, this article does not elaborate on this further. In order to optimize the transport cost and carbon emissions, this article highlights the importance of fuel prices, and distortions in fuel prices in the United States. It further suggests a new approach to managing fuel prices in transport cost, and improving collaboration between manufacturers and transporters for greater transparency. The remainder of the article is organized as follows. The next section provides some information on the innovative approach to reducing fuel cost and emissions and the process steps for implementing this strategy. The next section presents the implementation of the strategy in a manufacturing organization, Whirlpool, and the benefits accrued from this approach. The last section presents conclusions, managerial implications, and recommendations for further research.
Principles and Implementation Procedure
Fuel costs change constantly, which makes finding the actual cost of fuel very difficult. For shippers, the reimbursement of fuel costs is a complex and expensive process. A shipper organization receives transportation services from carriers in the movement of input materials or finished goods. The standard means of reimbursement of the actual fuel cost is through a fuel surcharge (FSC) based on the US Department of Energy's (DOE) Diesel Price Index (referred to as DOE Index from here on). Published each Monday, the DOE Index represents the government's calculation of the average retail fuel prices in the country each week. The DOE Index prices are used overwhelmingly by shippers to reimburse their carriers for the fuel that the carriers purchase in transportation. The new method replaces this traditional FSC and enables a more accurate and transparent accounting for fuel costs between shippers and carriers. The new methodology determines the actual fuel cost paid by the transporter on every movement, each day throughout the journey.
The methodology connects with the shippers. The fuel costs paid by carriers through this technique at the identified locations are lower than the DOE Index price. This way the fuel costs for the shipper are reduced. This requires working with shippers to identify the correct fuel efficiency that corresponds to their freight profile, considering weight, density, and other factors that drive fuel-consumption rates. This benchmarking is constantly updated as truck technology improves, to ensure that shippers are reimbursing their carriers based upon current equipment performance.
Beyond these inputs for the accurate reimbursement of the fuel cost, opportunities to convert truckload freight to more efficient means of transport such as intermodal are identified. The importance of the location of hubs for an intermodal operation has already been discussed in the literature (Roso, Brnjac, and Abramovic 2015). With historical data of fuel consumption and fuel costs, the savings opportunity from shifting freight from the road to the rails is also identified. Rail fuel efficiencies sit routinely above 16 miles per gallon (MPG), while truck fuel efficiencies, in practice, sit around seven MPG at best. This difference creates a consumption advantage. Further, shippers can also realize the substantial fuel-tax benefit enjoyed by the railroads for each of the gallons they consume on the rails. As a result, an organization converts freight from truckload to inter-modal at higher rates than the industry.
In addition to freight mode conversions, visibility to real fuel cost facilitates the conversion of fuel, from, for example, diesel to compressed natural gas (CNG). These measures drive down the cost, consumption, and carbon emissions associated with moving raw material and finished goods. The ultimate outcome is improving the competitiveness of an organization while reducing the energy consumption and carbon footprint for moving the same freight across the country and beyond.
The fundamental guiding principle is that transport is a service and fuel cost is an input for providing this service. The fuel cost itself is not a service, though it is almost always bundled into the service cost of transportation. Separation of fuel cost from transportation cost and reimbursement of the actual cost of fuel eliminates various distortions in the fuel pricing. There are three distinct distortions in the fuel prices, which affect the transport cost. These are (a) the timing of fuel price applications, (b) the differences in wholesale and retail prices, and (c) the geography.
As noted above, the national retail diesel-fuel price index used by most shippers in the United States is published each Monday by the Department of Energy, on the webpage of the Energy Information Administration. However, retail fuel prices at fuel stations change on a daily basis based on fuel market conditions. Thus the traditional FSC, updated weekly, does not account for the daily price movements that freight transporters must pay, creating distorted reimbursement.
It is important to mention a little about the history of fuel surcharge in transportation. The concept of fuel surcharge started in the early 1980s because fuel prices started rising sharply due to OPEC market manipulations, and political disturbances in the Middle East. The rise in fuel prices was due to the shortage in the supply of crude oil. The fuel surcharge was introduced to compensate truck (and railway) organizations for increasing fuel prices without renegotiating the contract every couple of months or annually. The traditional fuel surcharge has been calculated as
FSC = PPG - BaseRate/MPG
where PPG (price per gallon) is the weekly DOE Index of the US national average fuel price in the US dollar per gallon, base rate is a cost of fuel that is embedded in the freight rate at the time of signing the contract between a manufacturer and a transport organization, and MPG is the fuel efficiency of the equipment being used to haul freight, as agreed upon by the shipper and the carrier. It may be surprising to note that many manufacturers and transport/logistics organizations still use the base rates from the 1980s, which were about one dollar per gallon then. The idea at the time was that an incremental fuel surcharge would only come into effect if fuel prices went above normal rates. Even though diesel prices have not approached 1980 levels in years, these standard base rates have remained in many contracts for decades.
The next distortion takes place due to the differences in wholesale and the retail prices. The variation in buying prices takes place on a daily basis whereas the DOE Index is a weekly price. It causes an anomaly in paying the fuel surcharge accurately. In other words, the fuel surcharge formula is static for a week, but the actual fuel prices change on a daily basis. This fluctuation on the daily basis is sometimes beneficial to transporters and sometimes it hurts them. This presented an opportunity to develop a more transparent and dynamic pricing system in transportation, which will be discussed in detail in the next section. The average difference of about $0.30 per gallon across the country, but it varies significantly by geography and time. In some extreme cases, such as in January 2015, when wholesale fuel prices fell much faster than retail, this difference was as high as $0.90 per gallon. Also, the DOE Index is based on retail fuel prices, whereas well-managed trucking companies procure fuel at a wholesale cost. This wholesale cost is represented by the "rack" cost or the cost at which fuel stations purchase fuel from a wholesale terminal or rack. The difference between the wholesale price and the DOE Index varies widely by geography, and it fluctuates substantially over time. The wholesale and DOE Index prices are two fundamentally different price points. Shippers pay distorted prices when they do not reimburse on the basis of a wholesale price for each freight movement.
The last distortion comes due to the geography, hat is, the location of the fuel station. There is substantial variation in fuel price between states and sometimes even within a state. However, the DOE Index provides just a single price for the entire United States. The most significant driver of the variance in price due to geography is taxation. The tax rates on fuel by states vary substantially. The range between the lowest-tax state and the highest-tax state is above 50 cents per gallon on any given day. Adding complexity to this tax component, trucking companies must declare the miles covered in each state on their route between an origin and a destination monthly by law. They pay the differences in taxes to the state department of transportation for each state for the fuel filled outside the state but traveled in a state on a monthly basis, through the International Fuel Tax Agreement, or IFTA system (IFTA 2018). That is, fuel taxes are paid based upon miles driven by the truck, and not based upon where the fuel was purchased, and the DOE Index makes no provision for this accounting. It simply provides one all-in index price for the entire country. However, after taking care of taxes, the commodity prices of fuel are still different across states, and the program accounts for these changes in real time whereas the DOE Index has no provision for such accounting. The next section combines the above three opportunities and presents a working methodology to save the cost of fuel in transportation for manufacturers.
This section should provide readers with a high-level summary of steps on engaging an organization and coming up with a strategy for managing fuel cost and reducing emissions. The steps for engaging an organization are as follows:
A sample route for an organization is selected and current costs and emissions are calculated as a baseline. The saving in fuel cost and the reducing emissions for moving the same freight between those two points from implementing the proposed methodology is calculated. Moving the same freight may or may not be on the same route. A new route does not necessarily mean a change in route. It sometimes means filling different volume of fuel at different fuel filling stations on an existing route. Trials are conducted and the benefits from the trial runs are reviewed. The methodology is rolled out in a phased manner. Annualized savings in the fuel cost and emissions are monitored and reviewed.
The fuel prices are dynamic in nature and change constantly. These routes are continuously monitored and altered when needed. This requires receiving a continuous flow of data from various fueling stations and an algorithm to update the most effective route, the location of the fuel filling station and how much fuel should be filled. It suggests how much fuel to be filled to reach the next fuel filling station to avoid carrying the excess load of fuel. Therefore, a route chosen today may not be the most cost-effective route tomorrow. The next section discusses a case study of implementing this approach.
One of the organizations that has implemented this methodology successfully is Whirlpool. One of the biggest consumer appliances manufacturer in the world, Whirlpool group includes other brands such as Kitchenaid, Maytag, Indesit, Hotpoint, Consul, Brastemp, Amana, Jenn-Air brands, Bauknecht, Acros, Diqua, Everydrop, Gladiator, Affresh, and Yummly in addition to Whirlpool. This global organization employed about 93,000 employees at 70 locations across the world in 2016 and had an annual revenue of about $21 billion (Whirlpool 2017).
Whirlpool adopted this methodology in April 2007. One of the main objectives of the program is to make the cost of fuel transparent to the manufacturer (shipper) and the transporters (carriers), to use more efficient consumption rates for fuel, thereby reducing the fuel/transport costs, and to use optimal intermodal means of transporting finished goods to reduce the carbon footprint of Whirlpool's transportation activities. As stated earlier, fuel cost is one of the single largest cost components in transportation (25-35%) and reducing it by even a fraction for a global organization has a significant impact on the total cost of their operations.
Whirlpool has about 200 carriers of various sizes. Their modes of transportation include trucks, railways, ships, and intermodal. One of the challenges for small and regional transporters is to get better fuel prices. Using vehicles with the latest technology, which provide better fuel economy in addition to comfort and safety, is equally important in reducing the cost of transportation and carbon footprint.
The analysis included finding the most economical route with the least emissions based on the volumes and its, sizes of their products, efficiencies of carriers, and route. Further, a roadmap for implementing it in phases is required. A phased approach is required to convince the management and get buy-in from the parties affected.
The first identified family of products was home laundry appliance (dryer, washer, and pedestal). The next step was collaborating with transporters on an identified route and explaining the changes that they (transporters) will no longer have uncertainties in their profit margins. Here it is important to reiterate that the profit of a trucker or a transport organization from each route fluctuates between each trip due to various distortions in fuel prices discussed above. This approach provides transparency and stability to the profit margin of a trucker or a transport organization. Through this approach for the 10-year period, Whirlpool saved 7.5 million gallons of diesel in transportation and reduced 76,910 metric tons of C[O.sub.2] emissions. According to Jim Thompson, senior manager, Transportation, Whirlpool became an industry leader in managing the fuel consumption and carbon footprint (Breakthrough Fuel-Whirlpool Partnership 2018). Whirlpool has been recognized by the US Environmental Protection Agency for its environmentally friendly shipping practices. According to internal benchmarking data Whirlpool is 70 percent better than other shippers that are managing fuel cost conventionally. Further to the success of this approach, Whirlpool is continuing to expand this approach.
This article presented a new approach to reducing the cost of transportation and reducing carbon emissions from transport. Further, the paper shared a case study of a large home appliances manufacturer that employed this approach and accrued a saving of 7.5 million gallons of diesel as fuel in transportation and reduced 76,910 metric tons of C[O.sub.2] emissions in a 10-year period starting in 2007. At an average price of US $3.00 per gallon, this translates into a saving of $2.25 million per year in transport cost for Whirlpool besides an annual reduction of 7.691 metric tons of carbon emissions. The article also highlighted the type of distortions that take place in calculating fuel cost and the harm of bundling it with transport or logistics cost. The contribution of this article is sharing this approach in detail for wider acceptance and implementation.
Reducing the cost of operations is extremely important to remain competitive in the market. Similarly, reducing carbon emissions is equally, if not more, important for reducing the harmful effects of carbon emissions on humans and climate change. Almost every nation agrees on the harmful effects of carbon emissions on environment and living species and is committed to reducing the carbon emissions. Organizational leaderships and other stakeholders are also committing resources to reduce carbon emissions from their operations. There is an increasing pressure from consumer groups and nongovernmental organizations (NGOs) on organizational leadership to reduce the environmental impacts of their operations.
Every manufacturing and trading business requires both inbound and outbound transportation. As a rule of thumb, the bigger the organization, the bigger the transport budget gets. However, a smaller company producing specialized freight, which in turn requires specialized carriers, may have a disproportionately high transportation budget. Therefore, it provides an opportunity for small and medium-sized organizations as well. Every small or medium-sized organization may not have in-house resources to take care of such specialized skills. However, they can engage with professional consulting organizations to get such services with a payback period in mind or on the basis of sharing the savings.
This methodology provides a transparent price and the earnings of a transporter do not fluctuate due to the fluctuations in fuel pricing. Therefore, this methodology does not cause any reduction in the overall earnings of the transporters. Since the fuel price has been removed from the equation, the earnings for transporters become transparent, steady, and predictable. In the past, the earning used to fluctuate, sometimes favoring transporter and sometimes favoring shipper. Now, transporters feel happy due to the transparency, simplicity, and reliability of the earnings from an assignment. In the cases where the actual prices increase substantially than the weekly DOE prices, transporters have no motivation or incentive to take a load knowing they will lose money. That uncertainty has been removed and they can focus on providing quality services.
This approach provides an opportunity to accelerate efforts for reducing carbon emissions from transportation in all industrial sectors and not just manufacturing and retail. The revenues from the global transportation industry were $1.6 trillion in 2015. The highest share of this industry was in the Asia-Pacific region accounting for 39 percent of total revenues followed by the Americas at 32.9 percent, and Europe at 23.6 percent. The contributions of developed nations and emerging nations in this sector were 71.5 percent and 23.8 percent of the revenues, respectively. Thus, only a small part of this sector can be assigned to underdeveloped economies (Downie 2016).
The combined size of the logistics and transportation industry in the United States was $1.48 trillion in 2015. This is 8 percent of the annual national GDP of the United States. The figures in the previous paragraph were only for global transport and the US figures are for logistics and transport. In addition to transportation, logistics services include warehousing, materials handling, order fulfillment, and inventory management, among other things. The share of air freight was $82 billion. Railways transport delivers an average of 5 million tons of goods every day. Ships move most of the international trade materials, which include 76 percent of US exports by tonnage. Truck transport revenues were the record of $719.3 billion in 2015 and $676.2 billion in 2016. Trucks transported about 10.4 billion tons of cargo in 2016 (US Department of Commerce 2017).
The above numbers present an opportunity for professionals engaged in transport and logistics globally to work toward optimizing the cost of fuel, routes, and modes of transportation to save fuel, fuel cost, and reduce carbon emissions.
This study has the potential for expansion for other modes of transportation including intermodal transportation. This approach can also be extended for the domestic transportation in other nations. Another possible extension of this approach could be to apply it in international trade. Developing such an application for consumers could be another potential application.
University of Wisconsin-Green Bay
Thanks to Craig Dickman, former chairman and CEO of Breakthrough[R] Fuel and his team, and James Thompson, North America Logistics-Senior Manager, Whirlpool Corporation, for their help in completing this study.
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|Title Annotation:||Industry Note|
|Date:||Sep 22, 2019|
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