Analysis: Deficit rating is a ‘habit’ US LTL carriers should break

Analysis: Deficit rating is a ‘habit’ US LTL carriers should break

A truck travels in South Dakota, United States.

For those who think that it’s somehow counterintuitive to have a pricing model designed to create a loss or to reduce operating margins, rest assured, it is. Photo credit: Shutterstock.com.

Note: This is Part 2 of a 5-part series. Part 3 will be published later this week.

Part 2

The less-than-truckload (LTL) industry has long practiced what can best be described as “deficit rating.” For those who think that it’s somehow counterintuitive to have a pricing model designed to create a loss or to reduce operating margins, rest assured, it is.

Like many other bad habits acquired over the decades, the LTL industry routinely prices its services to give away money. In this case, carriers charge the same amount per hundredweight to recognize economies of scale that result from an increase in weight.

The problem is caused by the weight bands used to recognize such economies.

Pricing in the LTL and parcel industries has been primarily determined by two factors: shipment weight and the distance between origin and destination. Since parcel carriers handle weights ranging from 1 to 150 pounds, parcel rates change with each pound. However, the LTL industry handles shipment weights with a much wider range, from 100 pounds to 10,000 pounds.

So, during the 1970s, LTL carriers developed pricing bands that range from 100 to 500 pounds, 501 to 1,000 pounds, 1,001 pounds to 2,000 pounds, 2,001 to 5,000 pounds, and 5,001 to 10,000 pounds. As a result, LTL carriers have the same rate per hundredweight for all shipments ranging from 100 to 500 pounds and similarly for all shipments ranging from 2,001 to 5,000 pounds.

Billing by weight

To make matters worse, to avoid charging more for a lighter shipment than a heavier shipment, LTL carriers rate the shipment at its actual weight at the higher hundredweight rate, then compare it with what the charge would be at a higher weight with a lower hundredweight rate, and then bill for the lower amount.

Here are details of this pricing insanity for two real-life shipments. The first shipment of Class 100 weighing 950 pounds was moved from ZIP code 29073 to ZIP 75201. The actual charges were computed at $2,933 but billed at $2,460, a reduction of $473, or 19 percent. The second shipment of Class 60 weighing 4,500 pounds was moved from ZIPs 30301 to 23211. The actual charges were computed at $3,801 but billed at $3,276, a reduction of $525, or 16 percent.

Let’s get this right: the carriers take on extra work (including reweighing the shipments) to collect lower charges by adjusting the weight to a higher number so they can apply a lower rate per hundredweight to charge less than if it was just billed at its actual weight of 4,500 pounds.

Common sense would indicate that if a shipper has a lower rate for a 5,000-pound shipment, then it should be told to put extra product in the shipment to increase the weight. That doesn’t happen, however.

The parcel carriers also have lower rates for heavier parcels but do not apply such deficit rating to billing. For some shippers, parcel contract rates on a five-pound package are higher than on a six-pound package. However, SJ Consulting Group’s ShipMatrix database on hundreds of millions of parcels shows that parcel carriers do not charge a five-pound parcel at the lower six-pound parcel rate.

Lower margins in the LTL industry can be attributed to the antiquated LTL pricing model. LTL carriers use rate tables that date back to 1988, before many pricing analysts were even born. In addition, with several hundred rate tariffs and a very aggressive discount structure — exceeding 90 percent in some cases — the mattress retail business, with its even 80 percent off list price offers, has more pricing discipline. While carriers and shippers are familiar with such aspects of LTL pricing, few are aware of the problems created by deficit pricing.

Antiquated pricing 

This deficit rating practice actually dates to the regulated era of 1970s. It made sense then since the LTL carriers had to depend on basic calculators to determine charges as computers were not available. However, over these 40-plus years, although the LTL industry has invested hundreds of millions of dollars in powerful computers to handle more weight bands, it still relies on an antiquated pricing model developed for the calculator age.

LTL carriers should replace their weight bands with smaller increments. This could start with 100-pound bands and over time be reduced to 50 or even 10 pounds. With extensive computing power used by the LTL industry in many other functions of the business, changing the weight bands should be a high priority.

A positive result of eliminating deficit rating will be fewer invoice adjustments by audit and payment firms. While that will not be welcome news for those firms, it will be a blessing for the carriers and their shippers.

For decades, LTL carriers have complained about their inability to improve operating margins, claiming their sector is more fragmented than parcel. However, they fail to notice that a far more fragmented truckload industry has a healthier pricing model and operates at higher operating margins.

With capacity tight in all US trucking segments, LTL carriers should get rid of deficit rating to increase operating margins sorely needed to match the profitability of parcel and truckload carriers, and to reinvest in drivers, equipment, and technology.

Satish Jindel is president of SJ Consulting Group, a consulting firm focused on transportation sector with offices in Pittsburgh, Pennsylvania, and Jaipur, India.

Note: This is Part 2 of a 5-part series. Part 3 will be published later this week.

Part 1: Analysis — US trucking should follow airline lead with demand-based pricing

Comments

This article presents a very good description of the problem that exists with deficit weight rating. However, the author fails to offer a solution. How would the industry go about changing this practice of deficit weight rating? Does SMC3 have a rate base that does not use deficit weight rating?

Deficit rating does not cause the carrier extra work, they are not reweighing the shipments.....the rating program, whether it be Czar Lite or the carriers own rating system, automatically calculates the charges both ways and selects the lowest cost alternative. As to "Common Sense" try selling the shipper on the concept that a 4,500 lb shipment will cost you more to ship than a 5,000 lb shipment. And the shipper cannot simply "increase the weight to 5,000" as the author suggests...if your customer ordered 4,500 lbs, that's what they get. In one sense the shipper has increased the weight to 5,000 by adding 500 virtual lbs. And freight bill auditors could care less, they do not find errors in non-application of deficit weights, as noted, the rating programs select the lowest alternative without any human intervention.