By Clifford F. Lynch
Logistics Quarterly, May, 2005
Every good supply chain manager realizes that transportation expense is the
most significant component of the total cost of logistics; and at no time in
recent history has it been as significant as it is now. Increased fuel,
insurance, and engine costs, combined with new hours of service rules, an
improving economy, capacity constraints and driver shortages have resulted in
higher motor carrier rates. Fuel, the economy, and the lack of intermodal
capacity have caused rail rates to increase as well. In short, there is a rather
painful transportation cost environment and every indication that it will get
worse before it gets better.
Most firms have been very proactive in reducing warehousing and inventory
costs, but these savings are quickly paling into insignificance when compared to
rising transportation expenses. It is absolutely critical that the supply chain
manager turn his attention back to the transportation activity and develop
creative solutions to the dilemma of rising costs.
Some motor carriers and other logistics service providers share the concern
and have arrived at more innovative methods of trying to minimize shippers’
costs even as rates are increasing. They have found that establishing themselves
as network connectors or integrators can be an excellent tool to be exploited
for the benefit of both providers and clients.
While not a complicated concept, there is some lack of understanding of
transportation networks and how they can be valuable to the firms that utilize
them. Much of what has been written on the subject has been too academic to
inspire even a cursory reading by the average supply chain executive.
Exactly What Is a Network?
Many of us think of a network more in terms of the Internet or as a vehicle
to find a job, but the principle of the network is as old as mankind itself. Did
you ever wonder how early scholars and teachers, without benefit of radio,
television, telephones, computers or even mail service managed to spread their
teachings throughout the world?
In 1929, a Hungarian, Frigyes Karinthy, in a short story entitled
"Chains" advanced the theory that everyone in the world is tied to
everyone else by no more than five links. This concept has come to be known as
"six degrees of separation," and has been confirmed by subsequent
For example, sociologists estimate that most of us have about 300
acquaintances with whom we are on a first name basis. This suggests that we are
only a handshake away from 300 people, two away from 90,000, three away from
Over time, the concept has become so popular that a movie, Six Degrees of
Separation, was based on this principle in 1993.
Why not, then, apply this same principle to transportation through a network
Creating a Network of Networks
The value or potential of a network can be defined as the
possible connections between its members. The number of potential connections is
n (n-1) where n is the number of members in the network. However, if you connect
two networks via one connection, each member of each network has access to every
member of both networks. In the diagram below, each network has a value of
4x3=12 for a total of 24. Adding a single connection between the two networks
increases the network value exponentially. The number of members of the combined
networks is now 8 and the value of the new network is, therefore, (7x 8) = 56.
The value of these networks went from 24 to 56 by adding a
The Power of the Network
By now, you probably are thinking this is nothing more than
some kind of "shell game," but the power, or value, of a network has
been well defined by three basic "laws;" i.e., Sarnoff’s Law,
Metcalfe’s Law, and Reed’s Law. Each of these laws, in its own way,
quantifies network value based upon the connectivity within each.
Sarnoff’s Law, named for broadcast pioneer David Sarnoff,
states that the value of a (television) network grows in proportion to the
number of viewers. These are the networks where content is transmitted by one
and consumed by many. This is, of course, why the "value" of a
television network is substantially higher during the Super Bowl broadcast than
during reruns of Gilligan’s Island. That is why the network that broadcasts
the Super Bowl will reach over 130 million fans in the U.S. and 1 billion
worldwide and can, therefore, charge $2.5 million for airing each one of the
sixty-nine 30-second commercials. From a transportation perspective, one shipper
broadcasting instructions to many carriers in a one-way communication is a more
modest, but applicable comparison.
Metcalfe’s Law is one of two laws that have been singled
out as the reason for the success of the Internet. (The other law is Moore’s
Law, which states simply that processing power will double every 18 months.) Bob
Metcalfe, inventor of the Ethernet and founder of 3Com, maintains that the value
of a network grows as the square of the number of members (n2), and
describes networks where each member of the network can potentially communicate
with every other member of the network. It’s important to understand that this
deals with potential connections, not necessarily with actual connections. There
are networks where the value of the potential connections may be greater than
the actual connections due to security issues or business rules.
Research into the degrees of separation on the Internet has
indicated that any one document is only 19 clicks away from any other.3
Reed’s Law, developed by Dr. David Reed, explains what he refers to as
Group Forming Networks, and states that the value of these networks grows as 2n,
where n is the number of groups that can be formed in the network. Dr. Reed, in
an article titled That Sneaky Exponential — Beyond Metcalfe’s Law to the
Power of Community Building writes:
… perhaps the most important are supply networks that
allow access to and bidding among suppliers and distribution networks that
allow access to and competition among customers. The structure of these
networks or market spaces, especially the value of the connectivity and
relationships produced in these networks, can play a crucial role in
defining the value of your business.
If you can manage or influence the networks that connect
you to suppliers and customers to create more value for all concerned, that
extra value can be used as a competitive weapon. So paying attention to
network value is a crucial strategic issue, especially as businesses move
their customer and supplier relationships into the 'net.
Dr. Reed believes that as the density of the network
increases, the value of the network shifts from being defined by Sarnoff’s Law
to Metcalfe’s Law and then to Reed’s Law. Therefore, the networks that will
produce the greatest returns will be networks that support groups that encourage
collaboration among members of the network. This, of course, is the underlying
principle of the internet transportation exchanges.
The Conventional Paradigm
For the most part, the conventional transportation
relationships have been one-on-one. For example, as shown in the diagram below,
if three transportation providers want to handle shipments from three different
shippers to three receivers, they must make contact with those shippers who in
turn would have to connect with each receiver, a total of n(n-2) or 72 potential
connections (n=number of members in the network; i.e., 3 providers, 3 shippers,
3 receivers, or 9. The number of potential connections is 9(n-1) or 8 for a
total of 72.)
In this paradigm, therefore, creating a network with a value
of 72 requires 72 connections. At best this is cumbersome; and in the worst
case, the network simply collapses under its own weight.
The Modified Paradigm
How then can we reduce the number of connections while at the
same time maintain or increase the value of the network? What if a systems
integration process could be inserted between the parties: shippers, receivers
or suppliers, and transportation service providers? Each party could make one
connection to the integrator and we could still maintain the value of the
network. This would require only 9 connections instead of 72, yet the value of
the network would remain constant at 9x8 =72.
Once a new member connects one time to the integrator, it is
therefore connected to everyone in the network. This provides the opportunity
for each member to gain and give visibility into their supply chains and to
leverage the connectivity of the network. It also provides the opportunity for
collaboration among the various members of the network.
This modified paradigm is the basis for some of today’s
more sophisticated logistics service provider offerings. State-of-the-art
technology is available through a web-enabled portal, requiring no large
investment on the part of the shipper. In addition to avoiding a large capital
investment, shippers can
access to a managed network of trading partners already
connected to a system,
minimize implementation time,
reduce systems and support costs,
pay only for usage,
eliminate software obsolescence,
reduce transportation and inventory costs through
better management of supply chain functions.
The Integrator and Metcalfe’s Law
In the diagrams above, there are three classifications of
members: shippers, receivers, and transportation service providers. (It should
be noted here that these concepts apply equally to inbound or outbound
transportation movements.) In addition to these three, a fourth classification
includes freight forwarders, customs brokers, consolidators, warehouses,
transloaders, and distribution and fulfillment specialists. In its simplest
form, the supply chain consists of origins and destinations that create two
networks: a demand network and a supply network. The demand network is the
freight that has to be moved from point A to point B. The supply network is made
up of the transportation service providers and trading partners that execute the
movement of that freight.
The Demand Network
The demand network is comprised of either shippers or
receivers with their own origins and destinations. Each member of the demand
network has its unique independent set of origins and destinations, and when
each of these independent networks can be integrated, greater value is created
and greater opportunities exist. This is because many suppliers serve the same
customers. As an example, a bearing manufacturer may serve all major automotive
The Supply Network
The other network within the supply chain is the
transportation service provider’s network. Transportation service providers
have certain lanes in which they routinely operate: some local, some regional,
and some national. These are their preferred networks, influenced by such things
as maintenance centers, operating hubs, and driver domiciles. The transportation
service providers, when allowed to operate within their own networks, can offer
better rates than when forced to operate outside their networks.
As the demand increases, the members of the supply network
are presented with more opportunities to carry freight within their own
preferred network, reducing the number of empty miles and improving the
transportation service provider’s asset utilization. In addition, the
increased opportunities mean that the transportation service provider has to
spend less money looking for freight within his preferred network. The
transportation service provider is able to achieve savings from his cost of
sales and at the same time reduce the number of empty miles. These savings then
can be reflected in the rate structures.
For the members of the demand network, they get to take
advantage of the more efficient rate structures presented by the transportation
service providers and reduced administrative costs as a result of reducing the
number of required connections. In addition, as shippers and receivers are added
to the network, new possibilities for freight consolidation provide
opportunities for additional savings.
A limited number of more sophisticated logistics service
providers have been able to carry this concept a step forward and leverage the
value described by Metcalfe’s law (i.e., the value grows as the square of the
number of members). Those that have been able to do so have created the
opportunity for suppliers, shippers, receivers, and transportation service
providers to connect to a network of networks. In addition to potential freight
cost reductions, there are opportunities to better manage inventories, because
the providers have detailed visibility of products and shipments moving through
the system and can enable their customers to have this same access.
Such portals offer four basic features; i.e.,
. Customers, suppliers, and
receivers can update their core profile information and shipment data via
Order Management. Shipments can be tracked and
viewed via the Internet.
Shipping. Order information can be confirmed, and
shipping notices sent.
Receiving. Arrivals and unloadings can be recorded
The benefits usually will offset the cost of the service and
Reduced freight costs.
Visibility of the complete supply chain.
Ability to modify manufacturing schedules due to supply
Reduced inventory carrying costs.
Increased customer satisfaction.
At this point the average reader no doubt is thinking that
while this discussion may be interesting to someone, somewhere, there is little
practical application. Nothing could be further from the truth.
Schneider Logistics, for example, has leveraged the
advantages of the network principle into efficient, time-sensitive service to
the automotive industry. Service part shipments to dealers present constant
challenges in getting necessary repair parts to dealer garages when they need
them, usually with very little lead time.
Through its convergence network, Schneider, using its parent
company or other carriers, can bring parts from the manufacturer or its
suppliers to a parts distribution center; and from there, using engineered
routes, make the necessary deliveries to dealer facilities according to specific
delivery times. Further economies can be achieved by consolidating products of
There is constant visibility, regardless of which carriers
The value of Metcalfe’s Law to the automotive companies can
be seen in the income statement. The value will be reflected either in reduced
costs or increased revenue. So, how are these savings reflected on the balance
sheet? The answer is in working capital and its critical component - inventory.
If you can reduce inventory and the associated carrying costs, you can have a
positive impact on your balance sheet, freeing capital from operations to fuel
the growth of the business. The above-described program, for example, has
resulted in significant decreases in inventory.
A Virtual Community
Reed believes that Group-Forming Networks can create network value
even more rapidly than Metcalfe indicates. The virtual community created by the
network structure presents an opportunity for both real and potential
connectivity for transactions.5
This concept gives every company the opportunity to share information among its
suppliers, distributors, and customers and determine ways to collaborate on new
products and services. Such collaboration provides the potential to impact the
financial results of all the community members.
As each member gains and gives visibility to inventory in the supply chain,
the total inventory in the supply chain can be reduced.
The trend is becoming clear: seamless inventory management
from supplier to consumption. When a plant manager can see inventory on the
floor, in the yard, and in-transit to his plant or distribution center, he is
empowered with information to make better decisions about production, referrals,
freight diversions, expedited transportation, and safety stock management. From
a labor perspective the additional benefits of this visibility can control flow
into and within the yard and gain the ability to balance manpower requirements
on the receiving dock. 6
Performance Measurement and Management
An ancillary benefit of integrated networks is the ability to
measure and manage performance. It begins by leveraging the data captured during
the interactivity of network members. This information can then be translated to
a form of mutual performance score carding. Score carding is a fundamental
element of supply-based management; and the provider can build scorecards on
carriers, suppliers, and shippers. They can even measure the effectiveness of
electronic transactions between connected members of the extended enterprise.
The scorecard becomes the basis for improving performance for all members of
the network, particularly those who are direct trading partners.
Combining the value of integrated networks with the value of
information results in the real power of the network – a complex supply chain
where connected members receive mutual benefits and financial reward. It will be
difficult for the firm to realize these advantages independently, however. These
results can best be achieved through a provider that already has a viable
network. There are a number of providers that claim strong, far-reaching
networks; but in many instances, the reality does not live up to the perception.
Careful and informed due diligence is a must.
1 Barabasi, Albert – Laszlo, Linked –
The New Science of Networks, Cambridge,
MA 2002, pp 26 – 27, 33 – 34
2 Matthews, Robert, Six Degrees of
Separation, www.worldlink.com, p 2
3 Barabasi, Albert – Laszlo, Linked – The
New Science of Networks, Cambridge,
MA 2002, pp 33 - 34
4 That Sneaky Exponential – Beyond Metcalfe’s
Law to the Power of Community
Building, <http://www.reed.com/Papers/GFN/reedslaw.html>, accessed
January 7, 2002
Weapon of Math
Destruction link, accessed January 8, 2002
6 Braddy, Bill. "Creating New Avenues
for Cost Reductions." Inbound Logistics,