The Implications of $4/gallon Fuel

Rising fuel prices have dramatically changed the game in terms of supply chain sustainability. Fuel cost is driving firms to look at strategies such as placing production at customer plant sites, increasing product density, postponement of product finalization and initiatives to reduce the need for transportation. Here's an insightful overview of the possible effects of rising fuel costs on your supply chain.

David J. Closs, Michigan State University

In a Logistics Quarterly editorial two years ago ( How Diesel Drives Supply Chain Design” Logistics Quarterly 12:1. (January 2006)), Dan French and I discussed the logistics impact of increasing fuel costs without knowing how soon it might happen. While it was clear that fuel prices were increasing, we thought that a 100 percent increase in fuel prices would be a number of years off. The editorial suggested that doubling of fuel prices would result in firms shifting to an increased number of distribution centers to optimize the trade-off in cost between inbound and outbound transportation.

The reality of $4/gallon fuel has introduced a number of issues that logisticians must now learn to address. This takes us from familiar trade-offs that we are accustomed to handling to a totally new environment. Figure 1 illustrates the dramatic increase over the last four years, and doesn't even reflect the rise within the last year to over $4/gallon for diesel fuel. While logistics and supply chain managers are accustomed to system adjustments based on changes in fuel cost, changes to supply chains today must be much more radical. Some of the major considerations are discussed below.

FIGURE 1 U.S. DIESEL FUEL PRICES SINCE 2000 (in USD per gallon) (Source: U.S. Department of Energy)

While we in North America are just beginning to understand the implications of substantial increases in fuel price, there are four that are particularly relevant for logistics and supply chain managers. First, as suggested in the prior editorial referenced above, global and domestic supply chain networks need more in-depth review to re-assess the trade-offs. While the production or inventory cost has driven sourcing, production and inventory decisions in the past, increasingly level production cost and relatively in-expensive interest rates have placed relatively more emphasis on transportation cost for supply chain design decisions. The result is a stronger requirement to design processes to ship shorter distances, particularly when smaller or less-than-vehicle load shipments are involved. The implication is that logistics and supply chain managers need to proactively monitor their networks with the potential of considering more distribution, consolidation, or cross-dock facilities.

Second, fuel price increases are dramatically changing the modal differences in cost per ton-mile. While there are many factors other than fuel cost that impact $/ton-mile, the substantial increase since the late 90s stresses the need for regular modal review. There are many creative shifts to more fuel efficient modes such as rail and water. The increased use of short-sea shipping illustrates this application as well as reducing congestion. While there are numerous challenges associated with rail transportation today, leading firms are identifying the situations where rail can provide a cost advantage without severely impacting service.

Third, road, port, rail and airport congestion is increasing. Not only does this congestion slow down inventory, resulting in increased inventory carrying cost, it also consumes valuable fuel and increases pollution. While fuel cost and pollution have been problems in the past, today's dramatically higher fuel cost and concerns for pollution have raised the levels of concern. Specifically, supply chain and logistics managers need to directly consider the potential financial and social impact of congestion on their supply chain design decisions. Strategies such as consolidation (even with competitors) and diversion through low congestion sites (airports and ports) are becoming more the norm rather than the exception. To reduce the impact of congestion on their firms, logistics and supply chain managers need to investigate creative alternatives such as inland port clearance and alternative freight airports.

Finally, increased fuel prices have dramatically changed the game in terms of supply chain sustainability. While sustainability is often associated with minimizing environmental impact and carbon footprint, increased fuel cost is driving firms to remove or modify historical movements. Strategies such as placing production at customer plant sites, increasing product density, postponement of product finalization and exchanging commodity products with competitors to reduce the need for transportation are some of the creative practices being used. Significantly increased fuel prices have substantially changed the economics associated with these practices.

Increased cost related to fuel and congestion offers logistics and supply chain managers both challenges and opportunities. The challenges include significantly higher costs in functions that we directly manage. As an example, fuel prices and alternative fuel demand has resulted in food price increases of 10-15 percent. Such cost increases in a slowing economy place a spotlight directly on logistics to try to minimize the impact. The result is the opportunity to identify, evaluate and implement alternatives that would have been overlooked or not considered before. The combination of the spotlight and the potential for alternatives opens up opportunities to visibly demonstrate the increasing importance of logistics and supply chain management in firm strategy and in creating sustainable enterprises.