WHAT DOES IT “REALLY” COST TO DELIVER A GALLON OF LUBRICANT?  

Compoundings Magazine, May 2001
By Thomas F. Glenn
Petroleum Trends International, Inc.
 
Although it may seem like an easy question, it is not.  Some actually know what it costs to deliver a gallon of lubricant, many think they do, and others have no clue. This article is written to shed light on the “real” costs associated with delivering lubricants and to underscore the importance of accounting for these costs.
 Accounting for the costs to deliver lubricant is most challenging for those independent lubricant manufacturers with company owned and operated package and bulk trucks. Lubricant manufactures in this category are challenged to get a true handle on deliver costs for several reasons. First, the cost of operating trucks is a combination of fixed and variable costs and many of these are “hidden.” Secondly, tracking all the fixed and variable costs can be a real challenge for those unfamiliar with accounting procedures and/or  some accounting packages in use by independent lubricant manufacturers.

Whether you have two or 200 trucks, the costs to deliver lubricant will comprise both fixed and variable costs. Fixed costs are those that remain constant regardless of the volume of lubricants sold. These costs typically include such costs as leases or loans to pay for the vehicles, insurance, registration, and safety inspections. Another cost typically included in fixed cost is direct labor. A base load of labor is required to own and operate a fleet of delivery vehicles.  An independent lubricant manufacturer will often find that a minimum of two warehouse people are required to load and unload vehicles and some may even include a mechanic in the direct labor expense mix. In addition, indirect labor is also required to buy/lease vehicles, register vehicles, handle insurance, and other administrative tasks.

Although by definition, fixed costs remain constant regardless of the volume sold, it is very import to consider that fixed cost per unit changes as the number of gallons sold changes. This is due to the fact that the fixed cost is allocated across the total volume of lubricants sold. Consequently, the fixed costs of delivering lubricants on a unit basis will rise and fall with sales volume.  Most independent lubricant manufacturers are aware of this and will typically accommodate the fluctuations by scaling transportation costs to volume tiers. These tiers, or discounts on delivery charges will often be seen in increments of roughly $0.02 a gallon for volume windows spanning a number of tiers.  Although tiered pricing is an excellent way to leverage economies of scale, the frequency and basis for updating can be a challenge. In addition to the influence of costs and expenses and competitive forces, price tiers should be based on historical sales data and adjusted frequently enough to reflect the fixed costs per unit volume based on the most current sales data or forecasts. If the relevance of volume discounts are not revisited frequently enough, an independent can be spin its wheels on cash every time its trucks hit the road because its per unit delivery costs have been inching up as sales volume was inching down. Conversely, the competition across the street could very well be making money with the same delivery price and similar sales volume because they know true transportation costs and leverage economies of scale by operating with fewer trucks and employing the services of common carriers to handle surges in business.

Another fixed cost challenge for independents lubricant manufactures in determining the costs to deliver a gallon of lubricant is that many of the cost are “hidden” or incorrectly allocated to “other” categories in the general ledger. Labor is an area where one can typically find a number of unallocated fixed transportation costs hiding. These sometimes hidden costs include driver training/education programs, drug testing, the clerical time required to keep track of driver records, union negotiations, supervision, recruiting, uniforms, lockers. Yes, even driver safety awards add to the cost of labor. Collectively, these fixed costs can quickly run up well over tens of thousands of dollars a year for an independent lubricant manufacturer. Taken together they may add another several cents a gallon to the deliver costs. 

Fixed costs can also hide under your trucks. Even if you own the property and paid it off years ago, the real estate where your trucks are parked has alternative value and an “opportunity cost.” Opportunity cost in this case, is what you sacrifice when choosing to use your real estate as a parking lot over the highest valued alternative. The highest valued alternative might be to sell off some depreciable assets (trucks) and rent the space to an independent trucker at $8.00 a square foot, or barter for delivery services in exchange for the use of space. The value of the property where your trucks are parked can increase considerable if your trucks like to park under a roof or behind a high fence with security cameras.

Fixed costs can also prove challenging to tie back to the cost of delivering a gallon of lubricant due to the term “fixed costs” itself. There is a certain comfort level one gets when they hear the term “fixed cost.” It implies that you know what the costs are, they don’t change, and one can plan around them. Although this is generally true, it is very easy to be blindsided. The best example of this is the sky rocking increases in generally liability insurance. Increases in generally liability insurance as high as 40% are reported by some ILMA members already this year. It’s unlikely many anticipated this level of increase, let alone adjust delivery prices to absorb part of it.

Variable costs represent the next challenge for independent lubricant manufacturers in determining what it costs to deliver a gallon of lubricant. Variable costs are expenses that rise and fall directly with the volume of lubricant sold. Most of the variable costs in delivering lubricants start when the trucks start. They include direct labor, fuel, oil, tires, tolls, tank cleaning, line flushing, truck washes, and other costs directly linked to delivering a gallon of lubricant.

Variable costs are typically the most threatening to the profitability of an independent lubricant manufacturer because they are extremely difficult to control, hard to anticipate, and they like to hide from accounting. The challenge of controlling variable costs and its impact on profitability can be readily appreciated when one looks at the run up in fuel prices over the last three years. The average price for diesel fuel in the US in May of 1999 was $1.07 a gallon. The price today is $1.47. If your delivering lubricant on the west coast, your cost for diesel fuel averaged $1.16 a gallon in May of 1999 and could top $1.65 a gallon in May of this year. This means that a manufacturer delivering 250 gal of lubricant to an account 20 miles away, (given the fuel economy of a typical bulk truck and round trip fuel consumption), is paying close to $0.01 a gal more for the fuel to service that account in 2001 than they were in 1999.   Are you adding a fuel surcharge to your delivery prices?  The common carrier bringing you basestock and additives is likely adding a fuel surcharge to your invoice. Fuel surcharges on inbound raw material together with the added cost of fuel on outbound transportation can add as much as several cents a gallon to the cost of finished lubricants.

In addition to the challenge of controlling variable costs, the variable cost area is one of the best placed to look for delivery costs hiding or masquerading as (repairs and maintenance or general and administrative costs, or  “others.” As shown in Figure 1, the “other” category for a typical fleet of trucks delivering lubricant can easily reach 8 % to 10% of the total outbound transportation costs. Repair and maintenance can add another 10% to 15% to the total. There can be wide swings in these costs, and consequently profitability, due to accounting practices, operational efficiencies, and luck. Variables costs to deliver a gallon of lubricant do include the mirror that got knocked off when a driver rounded a corner too fast whiletrying to make up two hours he spent drinking coffee with his “friend.” By the way, the cost of the driver’s idle time and probably even the coffee is also part of the cost to deliver a gallon of lubricant.  

Variable costs also included the tow truck fees incurred when the roof was “can opened” when the truck “looked like it would make it under the viaduct.” Although insurance will pay for the damage, and maybe even the tow truck fee, better take a look at the general liability insurance cost when the policy comes up for renewal.  And yes, repair and maintenance is a variable expense, but how many actually considered the expense of the two clutches burned out by the new driver who quit in frustration? Or the overtime you paid your other drivers to cover while another driver was hired and trained? This too is a direct labor cost that contributes to the cost to deliver a gallon a lubricant.

Through no fault of their own, even the best trained and most diligent drivers are also adding costs to delivery lubricants by increasing idle time, burning more fuel per mile, and increase per mile maintenance costs. This is occurring as a result of increased traffic on the roads. According to recent findings by the Texas Transportation Institute after studying traffic congestion in 68 urban areas, the average person spends 36 hours a year sitting in traffic. The average in Los Angeles is 56 hours. The report notes that nationwide this is up from 11 hours a year in 1982. The nation’s cost of waiting in traffic this year will approach $80 billion in time and burned fuel. The escalating cost of waiting is included in what it costs you to deliver a gallon of lubricant.

It would be easy to get to this point in the article and feel that you need to increase deliver charges, or that operating you own fleet is a nightmare and should be avoided, or worse yet, that the author has only told one side of the story and has made things more complicated than they need to be. This is not the intent. The intent of this article is to underscore the importance of keeping an eye on transportation costs and to consider the true costs of delivering a gallon of lubricant. Although many of the issues of variable and fixed transportation costs are well know to professional fleet managers, and independent lubricant manufacturers, they can easily be forgotten, not visited frequently enough, or completely overlooked during the heat of battle to grow ones business. 
 Clearly there are advantages to owning your own trucks to deliver packaged and bulk lubricants. First, the trucks and their operation are under your control. The units can look the way you want, be ready to roll at the drop of a dime, and proudly wear your company’s logo and project your brand identity and image.  In addition, you can train your drivers to present an image consistent with your company’s interests and have them potential assist in selling. In fact, some of the best lubricant sales representatives got their start as drivers. Drivers are on the front line talking with customers everyday. In fact, sometimes a driver will have a two-hour cup of coffee with a “friend” who also happens to be a good customer (although unlikely, that broken mirror and cup coffee may have been money well spent). A good driver can be the highly prized back door sales person and will often see a competitive product working its way into a shop before the sales rep does. Good drivers, together with clean, well maintained trucks that make deliveries on time, every time, can say more about your company than thousands of dollars on advertising. Operating company owned delivery trucks is a genuine competitive advantage for many independent lubricant manufacturers.
 
What does it “really” cost to deliver a gallon on lubricant? - One answer does not fit all 

There is no one answer to what it “really” costs to deliver a gallon of lubricant to a customer with company owned vehicles. The answer will be different for each independent lubricant manufacture in the marketplace and the answer is dynamic. Sometimes the cost will change quickly and be easy to recognize, as is the case with a 25% increase in fuel cost or a 40% increase in insurance rates. These obvious changes in cost come up quickly on the radar and are relatively easy to adjust to and explain to customers.  Other changes, however, are imperceptible slow and diffuse. They can collectively add a significant burden to cost and are typically very difficult to explain to customers when there is a price increase. These are the dangerous ones. They manifest themselves as “cost creep.” Cost creep is quite and frequently goes unnoticed for extended periods of time. Depending on how rigorous the cost accounting processes is, (e.g. weekly, monthly, quarterly recap reports) an independent lubricant manufacture may not see the impact of cost creep until the books are closed. Or worse yet, may not “discover” it until it has already been gnawing away at profits for many years.

And at the end of the day, one could conclude that although operating a fleet of package and bulk tank trucks made economic sense when the company was started, “cost creep” has made it a financial drain on the company in today’s economy. Once the true costs of delivering a gallon of lubricant have been determined, the value of owning and operating trucks can be objectively assessed and compared with other options. The other option being outsourcing.
 
Outsourcing

 As an alternative to operating a fleet of delivery vehicles, independents can outsource delivery of lubricants to common carriers and/or independent trucking companies.  From an accounting perspective, this enables one to roll up virtually all of the fixed and variable costs associated with delivering a gallon of lubricant into an expense.  The expense to deliver a gallon of lubricant is then directly tied to the number of gallons sold; most of the overhead goes away. 

Outsourcing provides the most direct path to determining what it costs to deliver a gallon of lubricant. Either the supplier or the customer will receive and invoice for delivery charges. The invoice will clearly state, for example that 400 gallons of bulk oil was deliver and the cost for the delivery can be calculated at $0.25 a gallon. And if the volume increases to 1,000 gal you will see a drop of $0.02 a gallon, as another example.

Sounds simple and it is. But it too has its share of issues. Common carriers and independent truckers make profit by delivering product. They work very hard to be efficient, and typically know their costs down to a fraction of a cent. These costs will be passed on to either you or you customer. They can include demurrage charges, fuel surcharges, pump charges, tank cleaning charges, and potentially others. They are rarely hidden and can require a very different mindset for both you and your customers.

 In addition, there is loss of control when outsourcing delivery and brand identity can be diluted. These and other issues associated with outsourcing delivery are examined in Part II of this article.

Copyright © Petroleum Trends International, Inc. 2002