How To Maximize Profitability

From Oliver Gritz and Renato Chiavi

“Freight forwarding is the art to turn thin air into great profits.” This quote stems from the Asia-Pacific CFO of Kuehne & Nagel who I had the pleasure to meet in 1995 for lunch in Hong Kong. When he said it, I wasn’t quite sure what he meant. That was until I met Renato Chiavi for the first time at a budget meeting in Hong Kong a few months later.

Renato who became my main professional mentor is the embodiment of freight forwarding. He joined Danzas in 1995 when the company was quasi non-existent in the international air- and ocean freight business. Eight years later under his leadership the Danzas air- and ocean freight business was amongst the largest and most profitable businesses in this field.

McKinsey Study 2004

And this was not the first time in his career that Renato turned an ailing freight forwarding business into a profit machine. In his 65 years long career he did it over and over again. He has been a guarantor for industry leading profitability and one of the most successful managers that this industry has ever seen.

How did he do this? How did he turn thin air into amazing profits? This text summarizes his main success principles. They fall into two categories. The first category includes all known principles of good management. Like for example that management is the profession of achieving results. Renato has an exceptional hunger for outstanding results. His workweek consisted of seven workdays that lasted from 7am until at least 7pm. No holidays, no vacation. An insane workaholic. Extremely organized, structured, and dependable. In control of every key performance indicator (KPI) and every other detail of the business. An excellent manager of people. In summary: A master of schoolbook management routines combined with an insatiable hunger for success.

The second, and probably more interesting category of Renato’s success principles includes all those that result from his unique intuitive grasp of the economic drivers of the freight forwarding business. These principles are simple and timeless. Applying them with rigor are no regret moves that guarantee profit improvement under all circumstances. They are:

1. Earn a few more $ with each file

Gross profit per file is by far the main driver of profitability in freight forwarding. Therefore, the most successful freight forwarding companies have a culture of file profitability obsession. In Kuehne & Nagel the file ledger, the so-called A-List, has held a quasi-sacred position. I dedicated an entire article to “The Magic of the File Ledger”.

 At this point, please note that the relevant KPI is “gross profit per file”. Many times, I was confronted with the opinion that revenue or gross profit per kg or per container are more relevant performance indicators. They are not! Focusing on them is a waste of time. The unit of work for a freight forwarder is the file because one file equals one customer order. Therefore, the file is the unit that a forwarder can and must financially optimize.

 File profit improvement starts with meticulous and high precision accounting and control of revenue, cost of sales, and gross profit. This is a pivotal activity for every operator. Knowing the gross profit of each file in detail and hunting every penny like a maniac. Where are the pennies? They are in the obvious areas of high selling and low buying rates. Yet these rates are very much market controlled. They are not the items that make the real difference. These are different ones like:

a. Fees and incidentals

Aggressively charge for every conceivable activity and service – of course without antagonizing the customer. When done intelligently a lot of money can be made with:

• Exchange rate conversions
• Demurrage and storage fees
• Special delivery fees
• Emergency services, e.g., for spare parts and other time critical parts
• Brake Bulk and deconsolidation fees
• Other value-added services like pick & pack or labeling
• Non specified fees of about 2-3 US$ per file. Usually, customers don’t object to additional fees of this magnitude.

 b. Optimal capacity utilization

Make sure to load every air freight pallet, every container, and every truck optimally, i.e., make full use of their weight and volume limits. Doing so is a significant value driver. Therefore, it is astonishing to see that many forwarders today still don’t have systematic planning and measurement systems in place to optimize capacity utilization.

c. Avoidance of revenue leakage and double costs

Complete invoicing is another significant source of additional gross profit per file. Reinforced by auto-invoicing of standard rates the invoicing of above-mentioned fees and incidentals is often forgotten. In our experience gross profit improvements of up to 5% are possible with the help of computer aided avoidance of revenue leakage.

Further improvements are possible with systematic detection of double resp. erroneous vendor invoices.

d. Other measures

In total, there are six measures to increase the gross profit per file. In addition to the three ones mentioned above these are: increase selling rates, decrease buying rates, and optimize shipment routing. Good freight forwarders work on all of them.

2. Sell the right services to the right customers

Essential for the profitability of the business is the customer mix. The business of large multinational customers (MNC) provides stable base loads albeit at lower margins. It is recommendable to have a significant portion of MNC business for the following reasons:

• To be able to offer a consistent reliable service on important tradelanes
• To have bargaining power with major long-haul carriers like airlines and shipping lines
• To be able to provide uplift in peak periods

To assure the above, about 30% of the total business volume (in terms of chargeable weight for airfreight, sea freight LCL, and consolidated road and rail freight, and in terms of TEU for sea freight FCL and road freight FTL) should consist of MNC business. Gaining MNC business is highly competitive. Usually, MNCs award their business in a structured bidding (RFQ) process. In this context freight forwarders often offer their services at or even below their costs.

They do so in the expectation to complement the MNC business with higher yielding business from small and medium size customers (SMC). Ideally, this SMC business is sold to the consignee at destination. Selling at destination usually includes a larger range of services. Beyond the freight portion these can include drayage, deconsolidation, customs clearance, delivery, or other value adds. By routing the freight to the origin operation, destination selling puts at least two operations of the company into the business. Ideally, about 60% of the total business comes from SMCs. SMCs often do not award their business through a formal RFQ process. Instead, forwarders acquire this business through a well-structured field sales approach.

To maximize profitability of destination sold SMC business, the cooperation between the origin and destination branch must be perfectly organized. Destination should coordinate the sales process with the origin branch to optimize capacity buying and cargo mix. The origin branch supports the destination sales process with qualified sales leads and well-coordinated customer communication.

To optimally incentivize the cooperation between origin and destination financially, companies implement a perfectly functioning profit-sharing system. Industry best practice in this context is a file-based system that shares the full (i.e. door-to-door or end-to-end) gross profit of each shipment. Sharing formulas can be 50/50 or a slightly higher percentage for the location that sold the business to the customer. For further information about industry best practice profit sharing refer to my article “Freight Forwarding: Profit Sharing – A Long Tale”.

Below pyramid depicts the recommended optimal customer and business mix.

Customer and Business Mix

3. Manage general expenses (SG&A) with absolute rigor

This point sounds obvious. However, doing it consistently is difficult as there is the constant push and temptation for additional expenses to sneak in. More salespeople are needed to build a new tradelane. More operators are needed to preserve quality and customer service. The accounting department is overwhelmed with additional requirements. Managing these constant demands is a tough job. To avoid boring you with obvious statements, I would like to end this article with four specific SG&A management measures that have proven to be quite effective:

a) Measure and manage productivity at every level of the company

This means, measuring it down to department level of each branch. The relevant KPI in this context is “files per Full Time Equivalent (FTE)”. Publicize the respective productivities broadly so that managing them becomes a competition between country and branch organizations.

b) As global CEO approve every FTE hire personally

This may sound like administrative overkill. However, I have seen this practice in the largest organizations of our industry. This rigid practice annoys the hell out of lower-level managers. Yet it is the only practice that works to keep hiring under control. After all, personnel expenses are by far the biggest SG&A item.

c) Manage the office space tightly

Have a clear policy on sqm per FTE for all office locations and make sure that this policy is always adhered to.

d) All other expenses and overhead allocations

It goes without saying that all other SG&A items must be managed with absolute rigor as well. In this context make sure to have strict delegation of authority guidelines in place.

Finally, a few words on overhead allocations. In our experience it is best practice to allocate the full cost of every indirect function (or cost center like e.g., sales, finance, HR, IT) and of every management head office (e.g. global, regional, or country head-office) down to every product (or profit center) on branch level. The expectation is for everyone to generate a decent profit after overhead allocations. Industry best practice is an EBIT (after all allocations) of 30% of gross profit. The KPI EBIT % Gross Profit is called conversion rate.

 As stated, all measures mentioned here are timeless no regret moves to maximize the profitability of every freight forwarding company. Due to its low capital intensity freight forwarding has been one of the most profitable businesses in the world. Industry leading companies are more profitable than even Apple (see article). Your company can become one of them.