With world events posing an unsettling outlook for the supply of fuel, it's time to take another look at fuel surcharges. Let's begin by defining a surcharge as a fee that's instituted by a carrier to cover an unanticipated cost associated with moving freight.
One of the primary issues that must be addressed is the length of time a surcharge will be in place. It seems reasonable to me that the time frame should be correlated with the length of the service contract. In other words, the shorter the contract, the shorter the amount of time the surcharge should be imposed. Carriers can usually protect themselves financially over the short term. But the longer they have to absorb the additional cost, the more difficult it becomes. This is where they need more flexibility in their contracts with shippers.
The amount of the surcharge and how long it remains in effect depends on which of the carrier's costs is involved. When fuel prices are being hammered, surcharges have to be adjusted more frequently than those put in place because of rising insurance costs, for example.
The length of the contract between the motor carrier and the shipper is a major factor in determining how surcharges are handled. A multi-year contract might have several insurance surcharge-adjustment factors built in, while a 90-day contract might have none at all. For a fuel surcharge, however, the same 90-day contract might have more than one adjustment period built in.
It's important to understand why surcharges are so important in a competitive environment. First, let's recognize that competition is supposed to drive costs down to their lowest sustainable level. While this works in a spot market, it does not hold fully in a longer term market, such as multi-year contracts for trucking services. In addition, in order for the contracting parties to establish the base price for optimal and normal operating conditions, even short-term adjustments are needed.
This holds true for companies making decisions about product distribution that are dependent on transportation services. An example would be a company growing apples in the State of Washington that's trying to establish a price for its product in Florida. It must compete with other apple producers from Washington, as well as those from Michigan and New York. Since apples are shipped year-round, careful planning is necessary to ensure sustainable profit margins in distant markets.
Christmas trees are another example. This is a short-term market, where all of the shipping takes place over a four-week period. The contracts for delivery quantities and prices, however, are usually signed months in advance.
The transportation costs for both apples and Christmas trees are relatively high compared to the price of the goods in the marketplace. Consequently, both the shipper and the trucking company have very little margin for error if they don't want their profit margins to disappear. Both would benefit from knowing the base price, as well as the adjustment that might be required if unanticipated transportation costs appear.
In order for a surcharge system to work effectively, shippers and carriers need to agree on the basic price of the service, as well as the adjustment procedures that will go into effect if certain transportation costs go up precipitously.
In any case, the costs for the service will still be negotiable by both parties — the core cost, the factors susceptible to a surcharge, and the adjustment procedure itself. Nothing is taken away from the arm's-length negotiation process.
Next month we'll discuss an efficient system.