Evaluating Total Distribution Cost

Sept. 19, 2006
Total distribution cost (TDC) analysis requires some assumptions. These include current observed rates and transit times for standard air freight, full

Total distribution cost (TDC) analysis requires some assumptions. These include current observed rates and transit times for standard air freight, full containerload (FCL), and less-thancontainerload (LCL) service.

To estimate transit time, MergeGlobal analyzed the origin-port-to-consignee transportation process to calculate days of transit time and estimate where savings could be made in processing at the origin and destination ports. The example compares several transport options for a shipper moving 2,500-kilogram consignments from Hong Kong to Chicago.

Standard LCL service is the least expensive but slowest option with the lowest on-time delivery rate. An alternative is to purchase a dedicated twenty-foot container, which would be more expensive than LCL, but FCL service would shave approximately six days from transit time and be more reliable because it avoids consolidation/deconsolidation processes.

A day-definite LCL service would also be more expensive than standard LCL but would offer the faster transit times and higher ontime delivery than either of the other ocean services. Standard air freight is the most expensive but the fastest and most reliable way to move the goods in the sample lane from Hong Kong to Chicago.

To simplify the comparison, assume the shipper can choose only one of the four transport options. Another assumption is that every factor but transportation is identical across all four scenarios: same annual sales volume and daily demand variability, same product value, same shipment frequency, size (kilos per shipment) and density (kilos per cubic meter) and the same inventory carrying costs. The assumptions are necessarily arbitrary in order to be specific, but are consistent with levels observed in trade data, shipper surveys and academic research.

Finally, without established pricing for the newly announced day-definite LCL service, we assumed the all-in cost of moving a shipment from the origin port of Hong Kong to the consignee in Chicago was 50% higher via day-definite LCL than via standard LCL.

Under these assumptions, the analysis shows:

  • Standard LCL would minimize transport-related costs (at only $1.2 million per year), but would incur by far the highest inventory-related expenses ($2.2 million per year) due to long and highly variable transit times.
  • Using full containerload (FCL) rather than LCL reduces inventory-related costs (from $2.2 million to $1.7 million per year) but to do so would spend more than the inventory-related savings on transport-related costs (from $1.2 million to $2.0 million per year) due to the wasted space in 20-ft. containers occupied by only 2,500 metric tons of freight.
  • Switching to air freight to minimize inventory-related costs would incur the highest transport-related expenses, leading to the highest overall total distribution costs ($6.5 million per year).
  • Day-definite LCL could minimize total distribution costs (sum of transport and inventory related costs). Compared to LCL, the shipper would spend about $600,000 more on transportation to use day-definite LCL service ($1.8 million vs. $1.2 million per year) but would capture approximately $825,000 in inventory related cost savings ($1.3 million vs. $2.2 million per year).

Shippers need to perform their own analysis with live data to reach an accurate conclusion, but even this simplified analysis demonstrates how many different factors affect each firm's total distribution cost calculation. Two of the most important are product unit value (value per kilogram) and inventory carrying cost (percentage of inventory value). Logically, products with relatively high unit values or relatively high inventory carrying costs would be most likely to justify the higher cost of premium ocean service.

Routing Transit Time (days) Door-to-Door Cost per 40 Foot Container
Via west coast 16-24 $5,350-5,500
East coast via Panama Canal 21-30 $4,350-4,450
East coast via Suez Canal 35 NA

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