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SHIPPING COST COMPARISONAIR vs SEAFREIGHT

How to justify airfreight

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Introduction

This article describes why and when airfreight should be used instead of seafreight fordistributing goods. The assumption is that a central manufacturing organization is used which

has the choice of sending goods via air or by sea to international distribution centers orcustomers.

Sending by sea keeps transportation costs low but at the expense of high warehousing andinventory carrying costs. Airshipments cause higher transportation costs but result in lowerwarehousing and inventory carrying costs.

The basic objective is to meet the customers delivery requirements at lowest costs. Thedecision, shipping by air or sea, involves a trade-off between reduced transit time by airversus the higher cost to ship.

Logistics costs

Very often logistics decision were done which lead to sup-optimizing logistics costs, e.g.reducing airfreight cost by a certain percentage. In a lot of cases if airfreight must be reducedinventory costs at the receiving sites go up.

Normally the following cost elements are involved in transport decisions:

TotalCost Transportation Transit PlantInv WhseInv

RxDICDT

365

ICQ

2

IC Q

2

R rate per unit

D annual demandI annual carrying cost percent

C product cost at plant

C product cost at warehouse(C R)

'

'

= + + +

= + + +

=

=

=

=

= +

The variable T in the above formula represents the transit time in days. For ease ofcalculation only transportation and transit costs are considered. Bear in mind receiving usingair freight carry less inventory.

Value Density ( Value per Unit Weight )

The weight and cost of an item can justify centralized stocking with air shipments. The moreexpensive an item is, the higher the inventory carrying costs will be.

If the total costs, transportation and transit, for air- and sea shipments will be compared, thatmode of transportation should be selected which results in lower total costs. Only consideringtransportation costs is misleading. The inventory costs during transit must be considered aswell.

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As a decision variable the cost ( or price) of an item can be derived. To do the calculation weneed for each destination the freight cost by air and by sea and the correspondingtransportation times.

AirFreight SeaFreight SeaInv AirInv

FreightDeltaUnitCost ICC T_ Sea

365

UnitCost ICC T_ A ir

365FreightDelta UnitCost T_Sea T_ Air

ICC

365

UnitCost365 FreightDelta

ICC DaysDelta

<

<

<

>

b g

With the above formula the unit cost ( or the price ) of an item becomes the decision variablefor air-freight.

Example

Lets assume that for an item we need a decision to ship by air or sea. The inventory carrying

costs is 30%, the transit time by air two days and by sea eight days. For each destinationfreight costs must be available per item and weight.

The table below calculates now the item price ( = unit cost ) at the break-even point. At thispoint the freight increase equals the inventory saving. So each price higher results in lowertotal cost justifying air-freight!.

SHIPPING DAYS Air: 2 Sea: 8 ICC: 30%

Weight

Rate Inv Rate Inv Freight(+) Inv(-) Item-Price Unit1 $11.50 $3.20 $1.91 $12.79 $9.59 -$9.59 $1,944.64 $1,944.64

2 $12.50 $3.38 $2.37 $13.51 $10.13 -$10.13 $2,054.14 $1,027.07

3 $13.50 $3.57 $2.78 $14.29 $10.72 -$10.72 $2,173.78 $724.594 $14.50 $3.77 $3.20 $15.07 $11.30 -$11.30 $2,291.39 $572.85

5 $15.50 $3.99 $3.54 $15.95 $11.96 -$11.96 $2,425.22 $485.046 $16.50 $4.21 $3.88 $16.83 $12.62 -$12.62 $2,559.06 $426.51

7 $17.50 $4.41 $4.28 $17.63 $13.22 -$13.22 $2,680.72 $382.96

8 $18.50 $4.60 $4.70 $18.40 $13.80 -$13.80 $2,798.33 $349.799 $19.50 $4.79 $5.12 $19.17 $14.38 -$14.38 $2,915.94 $323.99

10 $20.50 $4.99 $5.53 $19.96 $14.97 -$14.97 $3,035.58 $303.56

Air-Freight Sea-Freight Break-Even Air vs Sea

For example a 5 kg shipment whose average value is around $500 per kg should be shippedby air. The break-even is $2,425.22. For this price the increase in freight cost is equal to thetransit inventory cost savings. Prices higher than the break-even price justify air freight!

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Proof of Formula

In the example given the break-even price for 5 kg was $2,425.22. A price of $2,000 mustthen be shipped by sea because air transportation would be too expensive. On the other handitems with a price greater than $2,425.22, the break-even price, should be shipped by airbecause we achieve acost reduction.

The table comparesthis scenario and itturns out that an itemwith a value of $2,000should be shipped bysea and an item with avalue of $3,000 shouldbe shipped by air.

The picture belowshows the break-even price BEP and the possible savings for air-freight.

Summary

It could be proven that the unit cost or price of an item within a certain weight class can andshould be used for decisions regarding air vis seafreight.

A I R $2,000.00 $2,425.22 $3,000.00Freight $15.50 $15.50 $15.50Inventory $3.29 $3.99 $4.93Air-Total $18.79 $19.49 $20.43

S E A $2,000.00 $2,425.22 $3,000.00Freight $3.54 $3.54 $3.54Inventory $13.15 $15.95 $19.73

Sea-Total $16.69 $19.49 $23.27

Cost-Delta $2.10 $0.00 ($2.84)

SEA AIR

A I RFreight

more

expensive

neutral

cheaper

-$2.84

+$2.10

$2,000.00 $2,425.22 $3,000.00

UnitCost

BEP