Raw-material spend accounts for 50 to 70 percent of sales revenue for chemical companies. A growing number of these companies have already realized more accessible cost savings, so procurement leaders need to turn to undermanaged areas to find additional savings opportunities.
Inbound freight offers one such opportunity. We estimate that these costs account for 8 to 12 percent of total raw-material spend, but they are often overlooked. Buyers typically focus on renegotiating the price of the raw materials themselves and rarely discuss freight costs. This is largely a problem of cost transparency; delivery costs are often handled directly by suppliers and might not be disclosed separately.
In our experience, chemical companies that make the most of a new suite of tools and techniques—and that follow a structured approach—can typically save 5 to 10 percent of their baseline inbound-freight costs. The first step is to create a detailed view of this baseline, which involves gathering and combining a broad range of data sources. Second, they should use cleansheet analysis 1 to develop a specific sense of what their inbound-freight costs should be and compare this to their baseline. Finally, and starting with the areas that offer the biggest savings opportunities, they should develop a new negotiation approach that takes into account all potential cost-saving levers.
The inbound-freight opportunity
Predefined International Commercial Terms (Incoterms) are standardized terms that allocate costs, risks, and insurance responsibilities between buyer and seller. For raw materials bought under C- or D-Incoterms,2 responsibility for freight costs lies mostly with suppliers. These transactions typically account for around 70 percent of total raw-material spend (Exhibit 1), and suppliers will often not explicitly disclose these freight costs. Conversely, freight is handled—and paid for—mostly by the buying company when raw materials are bought under E- or F-Incoterms.3 Even in cases in which the buying company is responsible, however, freight is usually managed by a dedicated freight team, with little or no input from the buyers themselves.
In both cases—in which either suppliers or a separate team is responsible for freight—buyers typically focus on renegotiating the raw-material price and rarely look at inbound freight. Undermanaging these costs leaves a lot of value on the table; inbound freight typically makes up 8 to 12 percent of total raw-material spend, and a full renegotiation can lead to savings of 5 to 10 percent of this total (Exhibit 2).
Three steps to extract value from inbound freight
Three factors contribute to the undermanaging of inbound freight. First, costs are often not disclosed separately when they are handled by suppliers, leading to a lack of transparency. Second, when freight costs are handled internally, it may be unclear whether the buying team or a separate logistics team is responsible for cost negotiations. Finally, in most cases, the material buyer has no insight into target costs.
To extract value from their inbound freight, chemical companies should follow a structured approach:
- Create a baseline of current spend.
- Calculate what the spend level should be.
- Develop a new approach to negotiations, starting with priority cost-saving areas.
1. Create a baseline of current spend
Combining multiple data sources will help make current inbound-freight costs for each raw material more transparent.
Material-specific data requirements will depend on Incoterms. The difficulty of defining and locating the right data sources will depend on the transaction in question. For transactions in which the cost of inbound freight is managed by a dedicated freight team within the company, the situation is relatively straightforward: costs should already be visible somewhere within the company’s internal system.
For transactions in which the cost of inbound freight falls on suppliers, the first step should be to see whether freight costs are declared separately on invoices. Buyers typically do not look at invoices as part of their job, so there may be a wealth of unused data available. Often, however, freight costs are folded into the prices of raw materials, which makes the sourcing of data more complex. In this case, there are three ways to estimate the baseline cost. First, costs can be extrapolated based on data mining, which involves locating prices for the same materials from the same supplier but with different Incoterms. The difference in price can be assumed to be the cost of inbound freight. Second, costs can be estimated based on a comparison with similar transport routes for which the costs are known. Finally, costs can be requested from suppliers.
A multilayered approach to the data search can save time and resources. To get the most accurate estimates and to avoid wasting resources, companies should take a structured, multilayered approach to their data search. First, they should use spend-cube data to define their transport routes, which are referred to as “lanes.” Depending on internal data availability, companies may be able to automatically populate current cost estimates for some lanes. Text-recognition algorithms and robotic processing, which can pull and analyze data from a large volume of PDF invoices, may then be able to fill in some gaps.
Once readily available internal data sources have been exhausted, buyers can use their knowledge of price formulas to create some of the missing estimates. If there are many lanes, a Pareto analysis—which clusters SKUs by ordered quantities—can be used to define the largest lanes and prioritize the effort.4
If gaps remain, an external request to the suppliers should be the next step. If the number of suppliers is large, we recommend using online platforms where suppliers can log in and input the requested information. The system should automatically track responses, sending reminders where necessary. One company used this sort of consolidated supplier request for information (RFI) to fill holes in its cost estimates after it had pulled all available data from its SAP system. The RFI went out to more than 100 suppliers, and within three weeks, the company had a baseline for more than 60 percent of its freight spend.
If freight data for key lanes are still missing, the last resort is to use cleansheet analysis—which we cover in detail in the next section—as a conservative estimate of baseline costs.
In our experience, the process of gathering data tends to be more complex than companies initially expect. This complexity is due to the variety of both the sources needed and the methods of data storage. There is no way around this step, however; a detailed understanding of the status quo is vital to locate savings opportunities.
2. Calculate what the spend level should be
There are typically three ways to estimate the size of a cost-saving opportunity:
A. Internal benchmarking. A full baseline can, by itself, be used to evaluate outliers and find discrepancies within the existing data, which can lead to considerable savings. A multinational chemical company used this approach to compare the inbound-freight costs of two materials with identical lanes and comparable logistic requirements. It found that one material was more than 20 percent costlier than the other—and with the same supplier. The discrepancy was quickly rectified in favor of the chemical company.
A European specialty chemical player used internal benchmarking to identify that it paid one supplier almost the same cost for two routes of disparate complexity. It calculated that the true cost of the simpler lane—which was one of its lanes with the highest spend—was only around half that of the more complex one.
While a lane-by-lane comparison is useful for revealing quick wins and easy fixes, the newly created benchmarking dataset can also be employed on a larger scale to help define target costs and get a feeling for standard logistic prices. A global chemical player used its baseline data, which had more than 2,000 lanes, to create an internal benchmarking tool. This tool enabled buyers to select key parameters—such as region, distance, and transport type—and get an immediate overview of both average cost and the overall cost range.
A second company used its benchmarking database as the back end for a live dashboard, which was accessible by all buyers and updated with the most recent quotes in real time. Quotes could then be compared with appropriately filtered benchmarks.
B. Cleansheet analysis. Cleansheet models calculate what freight services should cost on a lane-by-lane basis, and they therefore offer a useful benchmark. The database behind these cleansheet models takes into account costs that are specific to individual materials, countries, and lanes, allowing for specific cost calculation. The resulting “should cost” estimates are broken down into their constituent parts, such as fuel, labor, and backhaul (Exhibit 3). This enables buyers to have detailed, informed conversations with material suppliers and freight companies and to identify and tackle discrepancies between their cleansheet analysis and their cost baseline.
One global chemical player was able to immediately reduce spend on its biggest lane by 10 percent simply by optimizing loading, which was a parameter it had not thought to investigate before conducting the cleansheet analysis.
There is a set of standard approaches that is used in both cleansheet analyses and cleansheet negotiations. Companies that are new to these techniques will need to ensure that they have the right capabilities in place to understand the cost drivers behind the analysis and to develop a clear, considered negotiation strategy.
C. Collaboration with outbound transportation team. Internal logistics teams can be enormously helpful in sizing—and realizing—cost-saving opportunities. They are a useful source of benchmark quotes for the largest lanes, which can be valuable both as complements to cleansheet analysis during supplier negotiations and as inputs into a discussion about what might be better handled in-house.
3. Develop a new approach to negotiations, starting with priority cost-saving areas
Once high-opportunity areas have been identified and prioritized, focus should shift to realizing these savings. In our experience, value capture is highest when there is a dedicated strategy for each material. These strategies should take into account all potential cost-saving levers, including optimizing transport, renegotiating, and bringing costs in-house.
Choosing the right lever in each scenario requires cross-functional collaboration. A dedicated team that comprises experts on both procurement and logistics representatives—and that has support from a responsible lead executive—will need to evaluate the various options. Making a fully informed decision about where freight costs should sit may require some or all of the following: developing an in-house quote, tendering selected materials under a variety of different Incoterms, and renegotiating specific targets with the incumbent.
In situations in which supplier renegotiations are judged to be the best way forward, the negotiation strategy should take into account that the aim is not to decrease the supplier’s profit—unless it has a “hidden” margin, which is not usually the case. In most instances, suppliers that are responsible for freight costs are simply passing on the costs of a subsupplier. The supplier is usually not aware of the large gaps between current and benchmark costs; they can use this information to renegotiate with their subsuppliers going forward, which may save them a considerable sum on other contracts.
The value at stake is significant, but companies can start small
A specialty chemical company used the three-step approach laid out in this article to realize a savings of more than 6 percent on the identified transportation baseline. A truck manufacturer was able to take this even further, achieving a logistics cost reduction of almost 74 percent through the optimization of inbound flows and the synchronization of orders from suppliers to optimize truckload.
Realizing the full cost-saving opportunity from inbound freight will require significant investment in key tools, processes, and capabilities. Companies can choose to start small, however, in order to generate momentum and illustrate the value that can be captured.
For example, a global specialty chemical player started with a dedicated transparency workshop, which brought buyers together with key experts on data-warehouse pulls and internal logistics. The team identified priority lanes for a pilot project and then created a simple matrix of Incoterms and level of transparency. This matrix was then used to define the required data sources and allocate responsibility for their collection. In parallel, the team started to define the target cost and negotiation strategies for the pilot cases.
A lack of transparency around inbound freight has meant that companies have generally overlooked these costs in their recent drive for procurement excellence. Because of new tools and techniques, it is now easier to track spend on inbound freight and to tackle discrepancies between baseline and benchmark costs. Companies that continue to ignore this cost bucket are leaving a lot of value on the table and risk being left behind by their competitors.