Transport Operator (Professional Carrier)

Hot Topic 2

How smart operators succeed by working with all 3P's

 

Purpose  |   Performance  |   Profit

While road transport operators struggle against the odds to keep their heads above water in a fiercely competitive, deregulated industry, these 3Ps create a competitive advantage for smart thinkers.

Smart thinkers see all the moving parts, while the rest focus on just a few. They understand that competitive advantage comes from leveraging what others miss. Most operators would agree that the only reason for operating a vehicle is to get a return on capital invested in the vehicle. That return relies on managing both costs and revenue.

Many operators place a disproportionate focus on only one of those factors by using Operating Cost Estimates (OCE’s) as a guide to operating costs. Smart operators know that by managing both, revenue and cost, they double their ability to respond to competitive market forces.

Working with all 3Ps (PURPOSE, PERFORMANCE & PROFIT)

“Three P’s” (not to be confused with 3PLs) is a way of looking at your business, seeing all the working parts and leveraging each one to create a sustainable and successful business. Let’s take a closer look at the 3P’s in road transport and see how each can change the focus of decision making in your business:

  1. Purpose

Why you do it: To stay in business. You may have a passion for trucks, you may feel you are making a meaningful contribution the economy, or you may just do it to feed and clothe your kids, but whatever personal reason, ‘staying in business’ is the primary purpose of the business. No business - no reward.

How do you do it: You create the optimal balance between ‘risk and reward' that ensures a sustainable return on investors’ funds within the framework of legislative requirements.

When a business runs out of money, it runs out of business. Investors; whether that’s you, the bank, or just people (shareholders) who believe you will make them more money than anybody else by employing you, need to know that your focus in the company is to use their funds with a ‘Return Mind-set’. That mind-set means considering both transport rates and costs. Operators, with a rates and costs focus, calculate how much they need to charge for a particular vehicle (asset) ahead of time so that they know when to walk away, i.e when the revenue may be positive but the return is negative (after servicing the interest on the loans i.e. cost of capital).

Smart operators know that their purpose is to ensure there are always willing investors, who trust them with their money and create that trust by focusing on where it begins . Remember, if you lease a vehicle you may eventually own it, after servicing and redeeming the debt!

​    2. Performance

Why you do it: To hit the targets you set. If you don’t know where you going, how do you know if you are getting there?

How do you do it: You set your targets based on the required return-on-capital-employed to achieve your purpose i.e. maintaining investor confidence.

Ask any number of managers for a target and you’ll get different answers: A business development manager may guess a revenue target for the year based on market conditions; a service manager may add 6% to last year’s budget; an operations manager may estimate total distance based on secure contracts. Often these targets are in direct conflict with each other.

So who is right? Whoever can most accurately predict how to achieve the required ‘return’ target for each vehicle in the fleet, and then provide KPIs against which to evaluate progress toward those targets.

“Smart operators know that this means synthesizing and integrating many different data points, they know who has the best data and they understand how each piece of data impacts every other piece. They make accurate predictions and then manage towards them, correcting when necessary, re-evaluating when appropriate. “Checking the results of a decision against its expectations shows executives what their strengths are, where they need to improve, and where they lack knowledge or information.” Peter Drucker

  3. Profit 

Why you do it: To grow your business. There are many ways to measure profit but whichever way it is expressed – it’s a critical component in growing a business after servicing debt.

 

How do you do it: You fund growth from after-tax profit to avoid cash-rich competitors taking away market share.

 

Smart operators know that profits must also be measured in ‘real’ terms of capital growth - after inflation and this is extremely difficult in high-inflation economies, like SA. I believe it was American business guru, Peter Drucker, who also said: “There is no such thing as profit, it’s only deferred expenditure.”

Ways to achieve increased Profitability 

  • Increase Profitability or reduce Capital employed

  • Monitor Profit on Capital employed

  • Increase Price or reduce Cost

  • Monitor Profit on Sales   

  • Reduce Capital employed

  • Monitor Sales as a multiple of Capital employed

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Michael Cs Thoughts

I beg to differ from a professional point of view, that's not how it works: my motto is:

I-identify.

P-predict.

D-decide.

E-execute.

You can focus on your slogan, but as there is a human issue at hand, I have to lead and may not always be best, therefore I.P.D.E. is my motto, which I share.

Hugh's Thoughts

Michael, thanks for your valued response.

Your "Thoughts" are very valid when attending to managerial situations affecting the company's performance. In other words: attending to negative variances that might affect the predetermined trading [budget} performance of the business. However “Three P’s” is a way of looking at the business, seeing all the working parts and leveraging each one to create a sustainable and highly competitive business. It's about building a strategy to exceed shareholders' expectations. This is your core Value (‘Return Mind-set’) that investors are buying when they employ you - not just competency to sustain the status quo. 

 

Are trucks still a worthwhile investment?

Why the value of what you transport determines the return on your investment

Ernest Vs Question

We operate a small fleet of 10 m³  double-axle, end-tip trucks, delivering crushed stone within delivery distances up to 30 km. Mostly, we average around 5 loads a day. The work is pretty constant so our trucks average around 70 000 km a year. The daily on-road travel time is about 5 hours - leaving a total of +-5 hours for loading and offloading - call it an average of 2 hours per delivery. Round trip distances also vary, when it’s less than 60 km we mostly get in an extra load that makes up for when there are delays at the sites or when round trips are more than 60 km.

Payment is by load delivered within certain radii from the quarry so it is difficult to budget revenue for each vehicle. We take the good with the bad and try our best to balance the total workload over the fleet to equalise target revenues across the fleet each month.

You refer to a “Return Mind-set” that means considering both transport rates and transport costs. We can’t do anything about how much we charge as the customer (Quarry) works on set rates, all we can do is maximise deliveries and focus on reducing costs. This is where the challenge comes in. The rates won’t cover monthly repayments on new vehicles, which means we have no option but to operate good used trucks. It sounds simple but there is a snag as we have to maintain the fleet and this is getting incredibly expensive due to enormous increases in parts prices and very little or no discount as well as delays in getting slow-moving parts for the older vehicles.  I have tried keeping spare trucks but they are expensive to operate and soon become just another truck in the fleet.

Have you got any suggestions on how I can calculate if I am getting a reasonable return on each vehicle to justify keeping it on the road?

Hugh's Thoughts

Ernest, thanks for your response as this is indeed a very challenging problem faced by many small, privately-owned, road transport companies, not only here in SA, but also worldwide.

Before we begin, you referred to: “We operate a small fleet”. Are you a shareholder or employee (manager)? This is an extremely important first question in addressing your challenges:

  • If you are a shareholder then you should question the risk/reward issues

  • As a manager the issue becomes more difficult, as you are employed to exceed shareholders’ expectations, while looking after your job.

 

Let’s begin by assuming you are a shareholder with a "Purpose" (Why you do it). Have you ever thought – which I am sure you have – would I be better off by selling the business and investing in any one of the commercial banks’ long-term fixed deposit schemes? Right now you can get over 7,5% pre-tax return on your money, with very little risk, especially in comparison with your present business prospects.  Let’s talk the Risk factor (Macro-environment). I would say given our present situation, without going into too much detail, the civil engineering industry's prospects are bleak – both in infrastructure and new construction developments and will be so for some time to come. Either way, you need to look at achieving at least double-digit, pre-tax return on Capital employed. Remember in your situation, if you are having to finance the vehicles through a bank, it comes at Prime +- 2,0%.

If you are deploying someone else’s vehicle (Asset) by way of an “easy-terms” leasing/finance deal offered by some OEMs then, as you say, new trucks are exorbitant as you must redeem their Capital and service the interest charges.

Also, you have no option about including a Full Maintenance Contract (FMC), therefore new vehicles are out for your reach in this type of operation.

Crushed stone is a high mass-low value product which makes it extremely sensitive to transportation cost

In establishing competitive transport rates one must consider the type of operation as well as the value of the Unit (m³)  being transported. In your case this is the delivery cost/ of crushed stone. Although I am not familiar with the price per m³,  I would guess it to be in the order of R300.00/m³ at the plant, and this places severe limitations on the delivery costas crushed stone is considered a low-value product relative to its transportation cost

Other challenges include:

  • Short hauls with an empty return leg: low Asset Utilisation, making high fixed cost recovery/revenue Unit (m³)

  • Relatively low average speeds in congested urban traffic: high fixed and variable cost per revenue Unit (m³) also reduces Asset Turn, so important in servicing the investment in delivery vehicles

  • Delays in turnaround time - queuing for loading and off-loading: seriously affects Asset Utilisation

  • High load density/low value payload:  affects maintenance cost per revenue Unit (m³)

  •  On/off-road operation: severe on tyre and repair costs.


It becomes obvious that this operation is not conducive to achieving the single most critical measure in operating any capital-intensive business: I am referring to Asset Turn or, Sales as a multiple of Capital employed before Interest and Tax as well as Profit on Capital Employed. These are two Ratios that measure the business acumen of Smart Thinkers.

How to set the Rate

Say a vehicle has an average book value of R700 000.00 for the trading year. Now in any road transport operation, the Asset Turn should be in the order of 1,6. Put simply, this means turning sales revenue of (1,6 x R700 000.00 = R1 120 000.00).       Divide this number by your annul km (70 000) and you need to recover R16.00/km. Therefore you need to Bill  (R16.00 x 60km = R960.00/load).

To arrive at a rate/m³, divide R960.00/10m³ = R96.00/m³. NOTE: THIS IS YOUR REVENUE UNIT (not km).

Transportation is therefore 24,24% of the delivered price/

How to calculate the Cost

In order to justify the average investment in this vehicle, you need to bill a minimum of R1 120 000.00 per annum. Having calculated the net sales revenue for the year, you are ready to address the Cost per m³ before interest and Tax.

In order to survive and grow the business, you need to clear at least 20% Operating profit on sales revenue. Applying this thinking, means your total Operating Cost is (R1 120 000.00 x 80% = R896 000.00 per annum) or (R896 000.00/70 000 km) R12.80/km. In other words this funds your Fixed and Variable costs

Here is something to think about. Given the figures above, your breakeven point will be close to +- 8 months of trading, 7 500 m³ billed, 45 000 km and Sales R721 000.00.

Let’s see what happens if you have to cover say 80 000 km to bill sales revenue of R1 120 000.00.

Say you have to produce 80 000 km from an Operating cost budget of R896 000.00, which means you are left with having to reduce the Cost/km down to (R896 000.00/80 000 km) R11.20/km to service your investment in the vehicle.

 

It now becomes obvious why establishing rates from conventional Operating Cost Estimates (OCEs) can miss-lead those who set rates derived from a base of cost/km-plus-a-mark up.

Note: all the information used in this response (Hugh's Thoughts) must not be construed as factual. The numbers used are to expound the principals in calculating Rates and Costs. They bear no resemblance to any actual company or transport operation.

Wynant P's Thoughts - experienced road transport operator

Hugh, I go along with a lot of what you are saying but first, what has the value of the freight being hauled got to do with Sales as a multiple of Capital Employed and second, you are far too ambitious expecting to clear 20% profit in the stone haulage business – if you clear half of that you are very lucky.

Another point I don’t get is, why you are talking about two “profits” – after all profit is profit – there can only be one profit and this is how much you make at the end of the year? Also what is the difference between Profit on Sales and Profit on Capital Employed?

Hugh's Thoughts

These are very critical points you are addressing as they are the basis of any business success, especially in road freight transport. Essentially they are relative to competitive business strategy decisions, particularly in any deregulated trading situation.

Let’s look at the crushed stone industry, where the geographical situation relative to the market, could make-or-break the success or failure of competing suppliers. Ok, there are a number of other technical and supply considerations but given that both suppliers are equal in this regard, the closest one to the point of delivery is more likely to be awarded the contract due to the delivered-to-site price per m³.

Take Ernest’s case, where the load is worth R300.00/m³ ex-plant, and the delivery price within 30km from the crusher is R96.00/m³ or 24,24% of total delivered price of R396.00/m³. Now add another 10 km to lead-haul distance and the delivery cost goes up to R128.00/m³. Note the delivered price then moves up to R428.00/m³ or 29,90%. So it is easy to see how transportation cost can be a critical factor in any industry that trades low value goods.

In other words: What percentage of the delivered price of goods consists of transport?

If the value of the load (goods sold) was in the order of R3 000.00/m³, then the delivered price over 30 km from the crusher would be R3 096.00/m³, of which transportation is only 3,10%, instead of 24,24%. This is why low value loads are extremely sensitive to transportation cost.

Five ratios that is critical in assessing the financial performance of any business:

  1. Sales as a multiple of Capital employed

  2. Profit on Capital employed (%)

  3. Profit on Sales (%)

  4. PBIT/Capital employed (%)

  5. PBIT/Sales (%)

Sales as a multiple of Capital employed

In this case we are relating to capital employed in the vehicle under discussion   ̶   not the entire business   ̶   this is why I prefer not to use the term “Asset Turn”, which usually includes all the fixed assets and working capital in a company.

Going back to Ernest’s case, where he said the exorbitant price of new trucks put them out of reach for his operation (refer “How to set the Rate”) a figure of *R700 000.00 was used as the average Capital Invested in a “good used truck” instead of a new truck, at nearly twice this price, for the trading year.

Using a Sales as a multiple of Capital employed ratio (1,6), together with a Profit on Sales PBIT (20%), provides information about how the Profit on Capital employed can be used to understand how well the business uses its assets to generate sales.

 

Using information provided in the profit and loss account and balance sheet:

Sales as a multiple of Capital employed   = Sales ÷ Capital employed

                                                                      = R1 120 000.00 ÷ R700 000.00

                                                                      = 1,60 times

 

The above ratio shows that the company should generate R1.60 of Sales for each R1.00 of Capital employed in the truck.

The required Profit on Sales before Interest and Tax (PBIT)  = R1 120 000.00 × 20.00) /100  = R224 000.00

     This is where so many Road Transport Operators get confused about the meaning of "Profit".

Profit can take on many different meanings. You mentioned that “Profit-is-Profit”. However caution is needed in expressing it: are you referring to: earnings on shareholders’ equity before or after interest on secured loans (i.e. financing the business), which is tax deductible?

By using Profit before Interest and Tax (PBIT) it provides a far more meaningful assessment of how well the business is being managed, as managing directors seldom feature in how capital is raised by the shareholders!

So now that we are talking PBIT, we can explain the importance of how these ratios are used in analysing business performance.

By using Profit on Capital employed percentage as the key ratio, from which Profit on Sales and Sales as a multiple of Capital employed can be derived, we can accurately assess business profitability.  

 

Why Profit on Capital employed is justification for CAPEX expenditure.

Profit on Capital employed % = Profit on Sales % × Sales as a multiple of Capital employed %

  Let’s put the numbers to it:

        Profit on Capital %            

           224 000 × 100         

                700 000    

                   32%       

                              

          Profit on Sales %

             224 000 × 100

                1 120 000  

                    20%

     Sales as a multiple of Capital

              1 120 000 × 100 

                      700 000

                      1.60 times

 

Note:

Any change in the value of Profit on Sales % or

Sales as a multiple of Capital employed %

will consequently impact upon the

Profit on Capital Employed %.

 

Ways to achieve increased Profitability:

  1. Increase Profit on Capital employed

  2. Increase the Rate or reduce the Cost

  3. Increase Profit on Sales

  4. Reduce Capital employed*

  5. Increase Sales volume.

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Johannesburg, South Africa