The Economics of a Transport and/or Delivery Business

Providing your own transport or delivery services gives you the ability to sell directly to your customers and a new revenue stream. Delivery services may also add in a set of new expenses. This article outlines the economic principles involved with delivery services, and it will illustrate how to factor in the costs and benefits of delivery and transport services.

Delivery services are emerging on farms, markets, and CSAs everywhere. They provide a revolution in customer convenience and in the case of COVID-19, they are a situational demand of necessity. When considering adding any type of delivery, hauling, or door-to-door service into your agriculture or farming operation, it is important to steward scarce resources to ensure the viability of the new service. Regardless of the size of the delivery model chosen, the fixed and variable expenses must be separately thought through.

Expense items are costs, they can be first organized into various categories dependent on their relationship with production (delivery services in this example). In other words, the inputs either vary with production or they remain fixed regardless of whether production takes place or not.

For the new hauling or delivery venture to be beneficial, it will need to either be profitable in itself or bring in a big enough improvement in your product's price to be able to subsidize the additional enterprise's expense. If the improvement in revenue is insufficient to cover this additional expense from the transport, then it might make sense to look at whether or not an external party could provide transport for cheaper than you can.

The difficulty with providing a transport and or delivery service is that there are additional expenses and many working parts which require additional management, and if the costs are greater than the revenues gained, then it will not make business sense to pursue.

Build a Financial Model

When considering a new delivery enterprise, first commit to building a cost recovery model to establish transportation cost at various volumes, which will help in determining running costs to help you determine a margin (or breakeven point) you will need to make the venture viable. Second, tailor a customer service model where consumer-driven concepts such as existing resources, customer retention, and customer experience are considered to help deliver results. Revenues gained from starting a delivery service in an existing farming business make for an attractive option for customers to choose, and in some cases, delivery is an inevitability. Here is an example of how to work out the costs of adding a delivery service enterprise to a farm or business. 

Delivery Cost Recovery Model; The figures below are used for illustrative purposes only; individual farm data should be used for your own budgeting and considerations. Dobrowsky, Wodehouse, 2020.

Run Costs Per Mile, Variable Expenses

As shown in the table above, variable costs (highlighted in yellow) or the running costs of the truck would be factors such as tire costs, fuel, and oil costs, labor costs, repairs, and maintenance, or in other words, costs that vary with the miles you have driven. These items change as volume increases. When working out fuel cost and tire usage, the way the truck is driven can result in either efficient (lower fuel consumption and tire wear) or inefficient operation (higher fuel consumption and tire wear) which would then not only be important factors in determining the running costs but also important factors to keep an eye on.

This is because an improvement in the averages of these metrics will relate to improved efficiency and lowered average total costs of the delivery or hauling enterprise. The route chosen can also have an impact on efficiency, with regard to steep roads, for instance. The important part, however, is that you should be sure to take all the variable costs into account when determining a break-even analysis of the new venture.

Ownership and Fixed Expenses

Besides the variable expenses in operating the delivery services, it is also important to add the fixed expenses (see delivery cost model) to the sum when determining the total cost of the new enterprise. These are often called ownership costs or indirect costs. They include factors such as insurance costs, such as freight and liability insurance, and spoilage insurance must be factored in in some instances, any vehicular licensing fees, registration fees, taxes, depreciation, and any financing charges.

Although these costs are fixed, in the sense that you will have to pay them no matter how many miles your truck does in a month, you can still divide them by miles driven to get a proportion of overhead costs per mile. Overhead is another way to describe the fixed costs. With both the variable and fixed costs calculated, it will help you determine the true cost of owning and operating the delivery fleet.

Break-Even Point = Fixed costs / Gross profit

The break-even point is the level at which total sales (deliveries) are equal to total costs. Break-even analysis is a critical tool that allows farm managers to understand the relationship between prices, volume, and costs (Blade Parkin, 2011).

When determining the break-even of the new enterprise, it would be important to start off with questions such as;

1. How many miles and deliveries are planned for the week and month?
2. How many stops per day and week can my team accomplish?
3. How many miles per week must my delivery fleet drive to break even?

Once you have the fixed and variable expense figures, you will firstly be able to work out a data table for what the overhead per mile costs will be (divide overhead costs by the number of miles expected to be driven) as well as what the running costs of delivery service would be. Also, hidden costs, usually non-cash costs such as cargo size, route variances, downtime, volume, and load capacity are important to consider for impact. This will then give you a total cost per unit of product delivered. If this is at least the same (breakeven) or lower than the increased price per unit of product, then the addition will be beneficial to your business and might be worth some further consideration.

In the short run, say a few weeks or months, it might not be profitable to add a delivery service; however, in the future as overhead expenses are absorbed by volume and time, at least a break-even point, and hopefully, an additional profit margin is likely to occur. The paradox in times of duress is: how to offer an affordable, or perhaps even free delivery service, and keep prices very close or even the same?

Split Deliveries and Logistical Route Efficiency

In order to be able to estimate delivery costs per mile, it is important to first estimate how many miles a trip will need to be and it will be best to plan a route with each stop in close proximity to one another on a given day will increase profitability for example; rather than driving out to same neighborhood each time an order is placed, sum these into one run. Carefully preplan the delivery run to ensure mileage efficiency and timely delivery for customers.

Mentor and lead your employees so they know the routes quickly and timely. Provide them with navigation and other safety precautions like a cell phone and a full tank so that they can succeed. Remember, they represent the values of the farm, and when delivering, they are the face of the farm; employees should look professional, clean, and their attitudes should reflect the culture of the farm, even when they take the farm to the customer.

Marketing and Advertising for the Delivery Services

Farm businesses can incur huge marketing costs to ensure potential buyers know about the value of the product and services. The expense of marketing should be included in the delivery selling price. One can use a percentage of the delivery price to budget for marketing expenses. By educating customers about the quality and excellence of the product, or by persuading people to switch from farm pick-up to delivery services, the farm can expect to increase the demand for its own products.

Assuming customers desire a great deal, if all farms are advertising the delivery service, it might enlarge the entire market. This, in turn, may increase the number of delivery service providers, which inadvertently decreases demand faced by any one firm (Blade Parkin, 2011). 

Use a model such as Porter's Five Forces to think through and examine external factors to match your resources wisely.  The Porter Five Forces model is a strategic tool for analysis that first appeared in a Harvard Business School publication by Professor Michael E Porter. Although it was first published in Harvard Business Review in 1979, the model remains viable today. It shows how a new business must investigate market elements such as the threat of new entrants, the threat of substitutes, rivalry among competitors, and the bargaining power of suppliers and buyers. This model can help assess the attractiveness of the delivery service business to customers and as a viable enterprise to the business.

Marketing means being visible to customers and getting the word out using a multichannel approach with realistic goals of new customer acquisition and retention. Keep in mind that people need to be reminded that they still have access to products of the same quality and nutrition formerly offered face to face, and the delivery service must eventually stand on its own.

Innovative and Revolutionary Tie-in Services

These are additional services that tie in to delivery services. They may range from a parking lot pickup or doorstep drop-off delivery services… or a we-pick-we-deliver platform of services offered to customers. Thinking through the costs and benefits of these differentiated services is also helpful for viability. Adding credit options for customers to pay for products and services with credit cards is also an innovative service.

Remember, if the delivery enterprise is meant for the long run, think these cost variables through deeply. In the event that the services come and go, your strategy may be more on the lines of necessity to use what resources are already on the farm for vehicles, etc., for customer access to products. Other ideas might include maximum or minimum order size; for delivery; or a standing order delivery time; or even a revolving weekly sales run where a route is determined, and goods are delivered regularly to customers.

Lead the Farm's Mission and Goals

In light of the cause and effect business assessment illustrated in this article, the type and size of delivery service must be relevant to customer needs, and it should have a value proposition to meet customer needs. There are many factors that are relevant to a delivery or hauling enterprise, and the effects of one on another provide different outcomes.

Regardless of the experience level one has in starting a farm delivery service or hauling enterprise, to ensure future viability, the cost recovery model and the enterprise need to consider budgeting. The total revenue and total costs must be covered from this perspective: account for the fixed and variable expenses. And it must be beneficial.

For more information on financial budgeting and profitability analysis, contact the Energy Business and Community Vitality team at Penn State Extension, John P. Wodehouse at jpw20@psu.edu or visit Penn State Extension's Financial Management webpage.

Sources

Bade, R., & Parkin, M. (2011). Essential Foundations of Economics. Boston: Pearson.