June 29 2009 10:20 AM

    Over the past several years, UPS and FedEx have fundamentally changed the way they offer discounts to their customers. Instead of giving discounts by service, regardless of the level of spend, they now peg some, or all, of the discounts to tiers that are based upon the rolling average of a customer’s weekly gross spend. 

    There can be several different tiers, each representing a range into which that rolling average can fall. Each tier has a different incentive tied to it. The carriers tie the rolling average to revenue tiers in order to manage a number of dynamic situations. If a customer’s revenue is growing, and the rolling average is growing, there is often one or more higher tiers of incentives built into the agreement that will yield greater incentives in return for the greater revenue. This rewards the customer without having to renegotiate the agreement. On the flip side, if a customer’s revenue falls due to economic conditions or a shift in the business, a lower rolling average can yield a lower incentive if the rolling average falls into a lower tier. The tier system, therefore, allows for some fluctuation in business without a renegotiation of the agreement and is somewhat self-correcting.

    Rolling averages are typically set on a 13- or 52-week basis and, if used correctly, can insulate a shipper from dips in business due to seasonality. Additionally, many agreements are structured so that there is a target tier in which revenue is anticipated to fall. If revenue climbs, incentives climb. However, if the rolling average falls below the target tier, the incentives drop, which will negatively, and often significantly, impact your net effective discounts. However, the economy is in unchartered territory and a situation analogous to the mortgage rate reset is coming to a head. Many shippers have seen sales plunge by 30% in the past several months. This, in turn, has caused a dramatic reduction in shipping volume and in gross weekly revenue from these shippers. Many of these companies have a 52-week rolling average, whereby the oldest week drops off each week and a new week gets added in and the new total is divided by 52 weeks. In this manner, the rolling average can hide a precipitous drop in business, often for some time. The catch is that when the gross weekly revenue finally does impact the rolling average, the results can be dramatic and difficult to recover from, as demonstrated in the following example:

    ABC Company gives all of their business to Carrier X, which averages approximately $84K in gross weekly revenue. Company growth has been flat and the company has been achieving the incentives in their target tier of $80K-$90K in gross weekly revenue. However, ABC Company, as shown in the summary below, was hit hard by the economic downturn, and only had $68K in gross weekly revenue for nearly 19 weeks, from October 2008- February 2009. ABC Company was unaware of the impact and fell off of their target tier after 19 weeks of falling gross weekly revenue. If ABC Company does not take immediate action, it may take ABC Company 34 weeks at $84K in gross weekly revenue to get back to their existing target tier. If or example, ABC Company lost 12% of their incentives when they fell off their target tier, and stayed at the lower tier for 53 weeks, the increased cost to the company would be $534,240.. This is an economic hit twice over – first with dropping sales, then with higher costs.

    While companies are still giving most or all of their business to one shipper, which is the intent of the tier structure, some companies are in imminent danger of losing a substantial portion of their discounts. This is an unintended consequence of the economic environment and one that shippers should very carefully analyze in order to avoid a potentially dramatic economic hardship. If a shipper finds themselves in the danger zone, it is critical they meet with their carrier and try to negotiate a solution that will mitigate the impact. 

    Melissa Priest is a Transportation Consultant for AFMS. She can be reached at melissa.priest@afms.com

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