January 2004 | Commentary | Viewpoint

The Full Cost of Cargo Losses

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All too often, supply chain managers do not properly calculate all the elements of cargo loss. As a result, they minimize the full impact on their bottom line. Most look only at cargo theft or damage to determine the financial impact on their company.

Many other factors, however, need to be considered when calculating the true financial costs of cargo loss, including supply interruption, higher insurance claim costs, expedited freight costs, lost revenues from cancelled deliveries, and more.

In addition, the supply chain managers' companies are not the only ones affected by cargo loss. The National Cargo Security Council (NCSC) estimates that the global financial impact of cargo loss exceeds $50 billion annually. That is a high price to pass on to your customers.

Calculating Financial Impact

In order to realize exactly what cargo loss does to the health of a business, all supply chain managers should be aware of what data to monitor and track. A simple formula can help them calculate the full effect of cargo theft on their cost of goods. All logistics managers should also develop an awareness of how the use of cargo security seals and a tracking system can significantly reduce their cargo losses.

The terrorist attacks of Sept. 11, and the West Coast port strike in the fall of 2002, stranded thousands of ocean containers for weeks and greatly exposed the business risks associated with global supply chain interruptions. Businesses relying on these interwoven supply chains quickly found out what happens when air freight or ocean containers come to a standstill, and manufacturing plants even shut down as a result of these major interruptions to cargo flow.

Supply Chain Interruptions

The big three U.S. automakers—General Motors, Ford and DaimlerChrysler—were among the major businesses that temporarily shut their factory doors after the Sept. 11 attacks. As their air shipments of needed parts were grounded, many of their plants had to shut down for hours, while others had to close their doors for days. As a result, fourth-quarter earnings in 2001 for these automakers dropped considerably.

This situation demonstrates how interruptions in the supply chain can severely impact a business. Stopping the delivery of cargo, however, is not the only factor that can adversely affect a company's ability to manufacture and deliver product. Cargo theft of this undelivered product can have as detrimental an effect on your business as supply chain interruption.

Regardless of whether cargo is transported by air, land, or sea, any time the cargo is at rest, it is at risk for theft.

Cargo Theft and Prevention

Cargo theft interrupts the flow of goods in your supply chain and your ability to deliver product. Cargo crime has more hidden consequences to your bottom line than you might realize. It is not just the loss of the cargo you need to account for, but also the cost of supply chain interruptions, extra customer contact and service, criminal investigations, expedited deliveries for replacement shipments, rising insurance rates and even lost business.

Crime prevention is a dynamic process. The challenge is to stay one step ahead of the criminal who is very skilled at adapting to a changing world. The critical factor in calculating the cost of security is creating a proper risk analysis that allows weighted evaluation of real and perceived threats, so the most significant issues are understood and properly addressed.

But how do you begin to calculate the full value of your cargo loss and put a number on it? How do you determine the true economic consequences and the impact on your bottom line? And how do you prevent the loss?

The use of cargo security seals and a tracking program will help alleviate the problem of cargo theft. But how much security and what type of security do you need to consider for your company to minimize your cargo losses?

Determining the Probability of Loss

In order to discern the right level of security for their operation, supply chain managers can use the following formula to help determine the impact of loss on their business:

To calculate the probability of loss, a business manager must be able to gather some historical data for a given period. Following are steps and examples to guide you in calculating and determining your Expected Value of Loss (EV).

Step 1. Probability of Loss

A good starting point is shipment and compromised load statistics from a single year. Figure your total number of loads compromised during a 12-month period, then divide that number by the number of total shipments during that same 12-month period.

For example, if you had 100,000 shipments, and 2,300 loads were compromised, this equals a 2.3 percent probability that a load was compromised.

To get a better picture geographically of where your cargo losses are occurring, conduct a regional analysis based on your supply chain routes. In general, shipments through Baltimore, Portland and Canada are safer than product shipped through Miami, Southern California or Mexico.

If your company keeps good records, then you know where your hot spots are and you can run the formula for each trade lane or corridor.

Step 2. Economic Consequences of Loss

If the typical value of your load is $250,000, and you have a 2.3-percent probability of compromise, then you are losing $5,750 for every load that leaves your dock. If your insurance does not cover this loss, or if you did not make some claims, you will need to add that number into the equation as well. Even if your insurance covers that amount, you still need to figure the other economic repercussions of cargo loss.

Look at your numbers for the following items using the same time period for determining the probability of loss:

  • Higher insurance costs due to higher claim loss experience
  • Expedited freight charges for replacement cargo
  • Additional manufacturing costs for replacement cargo
  • Lost revenues from cancelled deliveries
  • Costs for additional sales calls
  • Incremental criminal investigation costs

Not all will apply, and you may have additional expenditures resulting from cargo crime. You need to add these numbers together, and divide by the number of loads you had in the given time period.

For example, if your additional costs resulting from cargo crime come to $800,000, divide that number by the number of loads (100,000) and you reach $8 as your economic consequence of loss.

Step 3. Calculating Your EV

Now, we have all of the data to complete the formula. Our example yields the following:

Example: 100,000 loads with 2,300 compromises for a compromise probability rate of 2.3 percent, an annual economic consequence of $800,000 for the 100,000 shipments, and a per- load loss of $8.

Theoretically, with your Economic Value of Loss at $18.40, you will stay ahead of the game if you spend less than this amount on security for each load. And since that number assumes worse case scenario, a more moderate approach may be adequate.

If you spend an amount close to your prior year's economic consequences, however—about $8 per load in the above example—you would at least break even, but only if crime levels stayed exactly the same.

Unfortunately, worldwide cargo crime levels multiply each year, so using the prior year's probability of loss numbers could be misleading because your risk continues to increase. Your probability of loss may have been 2.3 percent last year, but may now be as high as 5.2 percent.

Predicting the coming year's crime level is difficult, but if you at least gather data from the prior year, and use the EV formula, you'll have a good base of knowledge. At least you will know your minimum cargo security requirement and this is a good start in keeping your cargo safe.

Start Now to Calculate Your Cargo Loss

Now is the time to capture all the data you need to monitor and calculate your company's true financial exposure due to cargo loss.

This will also bring attention to and expose the extent of cargo loss on your company's bottom line. The Economic Value of Loss will clearly support and provide justification for upper management to endorse a program to reduce cargo theft and crime.

By using cargo security seals, and a cargo seal custody and tracking system, you can help mitigate the dynamic risks you face in your supply chain.

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