Delft University of Technology
Faculty Mechanical, Maritime and Materials Engineering Transport Technology / Logistic Engineering
Y.A. de Boer New cost allocation for container management
Masters thesis, Report 99.3.LT.5234, Transport Technology, Logistic Engineering.
Context
To make profit is an elementary mission for companies in general. A way to pursue maximum profit, is to minimise costs, whilst keeping revenues maximum. Although essential, in the container shipping industry minimising costs is complicated. In addition, for a large company like P&O Nedlloyd in an industry with low profit margins, operational cost awareness is fundamental.
An influential part of total costs of P&O Nedlloyd is incurred by the fact that container supply and demand do not match on most locations in the world (container imbalance). Container imbalances incur the repositioning of empty containers, which causes costs, without the matching revenues.
However, by accepting cargo from a location in the world with a container surplus to a deficit location (or vice-versa), costs for container imbalances can be prevented to a large extent. In order to achieve cost savings by preventing imbalances the International Container Management (ICM) department of P&O Nedlloyd requires a cost allocation that stimulates the commercial trade divisions ('trades') to make smart logistical moves. The process of financial stimulation and disincentive is based on aggregated business forecasts of 'trades' and is called the 'incentive mechanism'. This mechanism has great impact on the cargo acceptance decisions of the trade divisions, for they are all individually responsible for their own profit.
Assignment
In reference to the above, the purpose of this report is:
To come up with a new allocation method for the imbalance, provision and empty storage costs to the trades, including a new incentive mechanism. For this purpose the relevant logistic cost-drivers should be identified and considered.
All in accordance to the constraints:
Charge 100% of the costs made by ICM to the trades;
Stimulate the commercial organisation to minimise the global logistic costs by giving the right incentives; Be fair, easy to understand and consider all reasonable logistic cost-drivers;
Make charging to third parties possible. Current problems
According to a survey of the current way of charging costs to the trades, a number of problems became visible: Marginal profit interests of the company and a single trade are not always in line as for the solving of imbalances;
Trades are not held accountable for their own long-term or short-term business forecast, on basis of which operational and tactical decisions are taken;
The control process of incentives and the according reactions, lacks feedback;
Unrealistic financial credits and penalties as incentives, complicate charging to third parties;
Aggregated information causes inaccurate and erroneous charges for the aggregation level of the costdriver does not match that of the cost allocation;
Various cost-items are not allocated in accordance to their costdriver.
Relations costdrivers and cost-items Because of the importance of the ability to allocate all costs, in accordance to their true costdrivers, a (stochastic) analysis is made, which appoints the following relations between costdrivers and cost-items:
Multi-trade imbalance Imbalance costs
Fluctuating container supply and demand pattern Safety stock costs
Dominant leg Cycle stock costs
Forecast error Various costs
It appears that if tracking information is made available on a more detailed level, all cost-items can be classed into three cost-clusters, being: Imbalance related costs;
Stock related costs; Forecast error costs.
The third cost-cluster; 'Forecast error costs' can be distinguished in theory. Practically however, the extent of these costs is hard to determine exactly. Therefore the size of this costcluster needs to be appointed arbitrarily.
Allocation methods
Once the size of the three cost-clusters is determined, an allocation has to be appointed that covers all three cost-clusters. In this respect the allocation is also split up into three separate types of charges for which a number of alternative options are elaborated:
Imbalance charge
Allocate, proportional to the extent a trade did not solve its imbalance quota; Allocate, according to real-time updated market prices for imbalances; Allocate financial incentives as promised;
Allocate proportional to trades' volume;
Allocate, according to trades' imbalance performance, indexed to that of the best performing trade; Allocate, according to a certain distribution key, represented by a shared interest matrix;
Forecast error charge
A net charging result of zero, the exact forecast error costs, or another amount; A charge for forecast errors, according to a linear, a quadratic, or a discrete function. Stock charge; differentiated into cycle stock and safety stock.
Evaluation of methods
Hereafter all options are matched to the following criteria:
1. Accountability for trades' own long term and short term forecast; 2. Incentives have to steer towards low total logistical costs; 3. Make a fair allocation of costs among trades;
4. Charging has to be applicable, irrespective the number of chargeable zones; 5. Charging has to be simple;
6. Charging mechanism has to be cheatproof. Findings
The only allocating method for imbalance costs that meets all requirements and constraints as far as theoretically possible, appears to be one where the aggregated imbalance is real-time updated and trades are charged in accordance to the aggregated imbalance situation at the time of cargo acceptance. Nonetheless one may expect this option not to be implemented within P&O Nedlloyd on short term.
Therefore a less far-reaching, easy-to-implement option can be appointed, which brings improvements in respect to the control-skills of the incentive mechanism and the extent to which the method is applicable for charging third parties. This mechanism indexes the imbalances of all trades in a particular zone to the imbalance of the trade that helped most improving the aggregated imbalance situation. The trade which helped best, receives no charge and the other trades receive a charge, proportional to the extent to which they performed worse than the best performer.
The current charge for storage costs can be included in the new stock charge and needs to be differentiated into a charge for cycle stock and a charge for safety stock (according to trades' measure of fluctuating container demand and supply).
A charge for forecast errors needs to be introduced in order to make trades accountable for their own forecasts and hence their charges more representative for actual performance. A forecast error charge may also make incentive mechanisms more cheatproof. Depending on which of both above reasons the charge is introduced for, P&O Nedlloyd needs to implement a charge where the relation between forecast error and charge is respectively a linear or a nonlinear function.
Reports on Logistic Engineering (in Dutch)
