The less-than-truckload (LTL) industry has long practiced what can best be described as "deficit pricing." Some might think it's counter-intuitive (and effective) to have a pricing model designed to create a loss or to reduce operating margins. Rest assured, it isn't.
Like other bad habits it's acquired through the years, the LTL industry routinely gives away money by the way it prices its services. In the case of deficit spending, carriers charge the same amount per hundredweight in order 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. The LTL industry developed its pricing bands with a much wider range because it handles shipment weights that range from 100 pounds to 10,000 pounds. The bands extend from 100 to 500 pounds, 501 to 1,000 pounds, 1,001 pounds to 2,000 pounds, 2,001 to 5,000 pounds, and, finally, 5,001 to 10,000 pounds. As a result, the 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. In the parcel industry, by contrast, rates will change with each pound but the weight tops out at 150 pounds.
To make matters worse, to avoid charging more for a lighter shipment than they do for the heavier shipment, LTL carriers rate the shipment at its actual weight at the higher hundredweight rate, then compare it to what the charge would be at a higher weight with a lower hundredweight rate. Then they bill the shipper for the lower amount.
An LTL carrier was kind enough to share the details of this pricing insanity. One shipment of a Class 100 commodity 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. In another case, a Class 60 item 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 re-weighing 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.
Some people involved with developing LTL tariffs will claim there is a law requiring carriers to use deficit pricing. In that case, why are the parcel carriers not in compliance? ShipMatrix, which has visibility to parcel rates for thousands of shippers, shows that many shippers have contract rates which result in a lower charge for a heavier parcel. For example, the rate for a 6-pound package is lower than on a 5-pound package. If parcel carriers were following such a "law," they would raise the weight of the 5-pound parcel to 6 pounds, and then bill the shipper at the lower rate.
It is clear that LTL uses an antiquated and broken pricing model. Carriers rely on rate tables that date back to 1988, before some pricing analysts in the LTL industry were even born. In addition, with several hundred rate tariffs and a very aggressive discount structure that exceeds 90 percent in some case, LTL pricing makes the mattress business, with its 80 percent discounts off list price, look attractive by comparison.
Carriers and shippers are familiar with the idiosyncrasies of LTL pricing. However, few are aware of the specific problems created by deficit pricing.
The practice actually pre-dates deregulation, reverting to a period when LTL carriers used calculators to determine charges and consumers used rotary dial telephones. However, while the rest of the world has made quantum leaps in technology consumption, the LTL industry is stuck in the 1970s.
The carriers should start by replacing the weight bands that are used at smaller increments; for example, they could make the changes at 100-pound bands, or even 50 and 10-pound bands and then reduced to 50 or even 10 pounds. With the industry making extensive use of computing power, changing the weight bands as suggested herein should be a high priority.
Another positive effect of eliminating the deficit rating mechanism 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 tried to improve their profitability with annual or bi-annual rate increases. Yet, during all these years, they have failed to revise the rate table that results in deficit pricing. It is ironic that a far more fragmented truckload industry has a healthier pricing model than its LTL counterparts where the top 25 carriers control about 90 percent of the market.
With tight capacity prevailing in LTL, the timing is right to get rid of deficit pricing. It will yield an instant increase in operating margins sorely needed to catch up with the rates of return generated by parcel and truckload carriers, and to reinvest in its drivers, equipment and technology.
(Satish Jindel is President of SJ Consulting Group, Inc., a consulting firm focused on the transportation sector with offices in Pittsburgh, PA and Jaipur, India).