Risk Management Strategies in Transportation Capacity Decisions: An Analytical Approach

Date01 December 2016
DOIhttp://doi.org/10.1111/jbl.12144
Published date01 December 2016
Risk Management Strategies in Transportation Capacity Decisions:
An Analytical Approach
Jiho Yoon
1
, Hakan Yildiz
2
, and Srinivas (Sri) Talluri
2
1
Kansas State University
2
Michigan State University
In recent years, access to freight transportation capacity has become a constant issue in the minds of logistics managers due to capacity short-
ages. In a buyerseller relationship, reliable, timely, and cost-effective access to transportation is critical to the success of such partnerships.
Given this, guaranteed capacity contracts with third-party logistics providers (3PLs) may be appealing to shippers to increase their access to
capacity and respond effectively to customer requirements. With this new opportunity, 3PLs must focus on approaches that can assist them in
analyzing their options as they promise guaranteed capacity to shippers when faced with uncertain demand and related risks in transportation.
In this paper, we analytically analyze three capacity-based risk mitigation strategies and the mixed use of these individual strategies using indus-
try-based data to provide insights on which strategy is preferable to the 3PL and under what conditions. We posit that the selection of a strategy
is contingent on several conditions faced by both the shipper and the carrier. Although our approach is analytical in nature, it has a high degree
of practical utility in that a 3PL can utilize our decision models to effectively analyze and visualize the trade-offs between the different strate-
gies by considering appropriate cost and demand data.
Keywords: buyersupplier relationships; transportation capacity; risk mitigation; analytical models
INTRODUCTION
Supply chain risk management (SCRM) is receiving increased
attention in recent years. Much of the literature in this area
focuses on manufacturers and retailers (Tang 2006; Ho et al.
2015; Snyder et al. 2016). However, several recent trends justify
the need for SCRM research focusing on transportation services
in a supply chain context due to the emphasis on maintaining
strong buyersupplier relationships. In the context of the current
paper, we specically focus on risk management strategies for
transportation capacity management, which may have a signi-
cant impact on buyersupplier relationships as transportation
capacity shortage can result in increased costs and reduced level
of on-time deliveries. Sourcing for transportation services in this
setting has important implications to the literature in the domain
of buyersupplier relationships, where the buyer is the shipper
and the seller is either a third-party/fourth-party logistics provider
(3PL/4PL) acting as an intermediary. In such a context, risk
management strategies for transportation capacity management
used by the 3PLs, as sellers, become critical in building sus-
tained relationships with their buyers. The risk management
strategies presented in this paper are applicable, for the most
part, to both shippers who are operating or considering operating
a private eet and 3PLs that provide transportation services to
shippers. This is especially critical for buyersupplier relation-
ships that operate in a just-in-time environment where shipments
have to be received in a timely manner and any unexpected
delays can cause severe disruptions in effectively meeting cus-
tomer demands.
Recent industry studies and data demonstrate that demand for
trucking is increasing more rapidly than the capacity increase.
Morgan Stanleys (MS) dry van truckload freight index indicates
a market that has recently experienced record capacity tightness
as seen in Figure 1.
1
According to the Transplaces CEO Blog on March 28, 2014,
this capacity tightness can be attributed to prolonged extreme
winter weather, shortage of intermodal capacity, stricter
Hours-of-Service regulations, and the economic recovery. From a
shippers perspective, the potential cost of not having access to
transportation capacity can be very high. For example, an auto
assembly plant maintains 2 to 4 hr worth of materials in general.
If the delivery of a certain material used in the assembly line
delays and does not arrive until the safety stock is depleted, the
assembly line will be shut down. According to Business Forward
Foundation 2014,
2
each hour of down time of an auto assembly
plant costs approximately $1.25 million.
Although the capacity shortage has taken a downturn, the
recent upswing may not completely fade as some of the afore-
mentioned reasons may continue placing pressure on trucking
capacity moving forward. This issue was predicted in September
2013 by Bob Costello, chief economist of the American Truck-
ing Associations, while he was speaking at TMW Systems
Transforum 2013 user conference, where he said we are headed
Corresponding author:
Srinivas (Sri) Talluri, Department of Supply Chain Management,
N370 Business Complex, Eli Broad College of Business, Michigan
State University, East Lansing, MI 48864, USA; E-mail: talluri@
msu.edu
1
Please note that materials that are referenced comprise
excerpts from research reports and should not be relied on as
investment advice. This material (Figure 1) is only as current as
the publication date of the underlying MS research. Additionally,
MS has provided their materials here as a courtesy. Therefore,
MS and the authors do not undertake to advise you of changes
in the opinions or information set forth in these materials.
2
http://www.businessfwd.org/SevereWeatherAndManafacturing
InAmerica.pdf
Journal of Business Logistics, 2016, 37(4): 364381 doi: 10.1111/jbl.12144
© Council of Supply Chain Management Professionals
for a capacity problem. The industry is not adding much capacity
today.
3
The 3PLs are one of major components of todays supply
chains. Companies in various industries have been outsourcing
their logistics activities to achieve more effective and efcient
supply chains. There is a tendency for more shippers to out-
source some portion of their transportation and logistics to 3PLs.
The 2010 Global 3PL & Logistics Outsourcing Strategy survey
by Eye-for-Transport presents the nding that 97% of shippers
intend to increase their use of 3PLs in the future. As a result, the
3PL market becomes one of continuously growing industry seg-
ments. Over the last 20 years, outsourcing to 3PLs has grown
about three times faster than the gross domestic product, and in
2012, 3PLsgross revenue in United States was $141.8 billion
(Armstrong & Associates, Inc., 2013
4
).
Among the logistics activities outsourced, the majority are the
transportation activities (Power et al. 2007). About 73% of total
3PLsgross revenue ($103 billion out of $141.8 billion) in the
United States is contributed by transportation activities (Arm-
strong & Associates, Inc., 2013). Thus, in todays volatile supply
chain environment, one of the major challenges 3PLs face is risk
management due to demand uncertainty. In majority of the man-
ufacturing and service industries, there is inherent demand uncer-
tainty, which creates the same level of uncertainty in the demand
for transportation services. Moreover, because of the increased
capacity shortage in transportation industry, transportation costs
can be very high and the availability of capacity options may be
a major problem for shippers. Given this, shippers are constantly
looking for ways to mitigate the risk of high transportation costs
in the face of demand variability and capacity shortage.
Traditionally, there are three types of relationships between
transportation carriers and shippers. The rst type is dedicated,
where a shipper charters trucks from a carrier for long-term and
becomes the only user of these trucks. The second type is
contractarrangement, where shipper and carrier agree on a
price list for the services but there is no capacity guarantee. The
third type is the spotmarket, where capacity availability and
rates are determined by the supplydemand dynamics in the
transportation marketplace at any point in time. A fourth type
that has been discussed in a few studies is the use of transporta-
tion options (Tibben-Lembke and Rogers 2006; Tsai et al.
2009), similar to the real options in stock and commodity mar-
kets, where a shipper would buy a transportation option from a
carrier, which would give the shipper the right but not the obli-
gation to send a shipment in a particular freight lane at a speci-
ed future time for a specied future cost. This new type of
contracting guarantees capacity in exchange for higher rates and/
or upfront reservation payment for the transportation option.
In our recent discussions with two shippers, one manufacturer
and one service provider, we learned that both rms have had
an interest in engaging in a transportation option contract with
their preferred carriers. The manufacturer rm is currently pilot-
ing such a contract arrangement with a truckload carrier, where
the carrier guarantees capacity for a number of trucks in
exchange for rates higher than regular contracts. Similarly, SGA
Production Services, which provides seating and staging solu-
tions for entertainment events, have explored considering such
an agreement with their preferred carrier to have access to guar-
anteed capacity due to carriers high quality service. As a ship-
per in services industry, the transportation service quality and
access to capacity in a timely manner is essential to their busi-
ness. Recently, their preferred carrier has subcontracted their
shipments to other carriers more often than usual, which can be
interpreted as a shortage of capacity in the premium transporta-
tion services SGA uses. These examples demonstrate that there
are shippers, both in manufacturing and services, which are in
search for new ways of contracting in the face of the trans-
portation capacity crunch, which creates higher and more vola-
tile rates in the marketplace. In that context, we study the
transportation capacity and risk management strategies from a
3PLs perspective, when such a carrier is contracting with a
shipper with guaranteed capacity. We build an analytical frame-
work and related decision models to understand the effective-
ness of 3PLstransportation capacity management strategies
(TCMS) in the face of demand uncertainty while providing
guaranteed capacity.
This study is mostly tailored toward small to medium size
3PLs providing truckload services due to several reasons. First,
for small carriers, even the addition of a single, sufciently large
customer may require the carrier to make capacity management
decisions. This makes the problem not a rare but a recurring
issue for such carriers. Second, capacity management decisions
can have a bigger impact on the nancial health of a small car-
rier compared to a large carrier. Third, capacity decisions of
truckload carriers in contrast to less-than-truckload carriers, such
as buying new equipment or outsourcing, can be made in near-
isolation without much impact on the use of existing equipment.
Fourth, less-than-truckload carriers, given their business model,
serve multiple customers with small loads on the same trucks
through a series of consolidation and deconsolidation activities
performed at multiple terminals and the use of multiple trucks.
Thus, addition of a new customer usually has a less drastic
effect. In case of a major impact, the capacity decisions are much
Figure 1: Morgan Stanleys dry van truckload freight index
3
http://www.truckinginfo.com/channel/eet-management/news/
story/2013/09/ata-economist-industry-faces-capacity-crunch.aspx?
prestitial=1
4
http://www.3plogistics.com/3PLmarketGlobal.htm
Risk Management in Transportation Capacity 365

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