Index-Based Pricing Models in Strategic Freight Procurement

Summary. This extended abstract addresses index-based pricing models between shippers and carriers in strategic freight procurement. The increasingly unpredictable transportation cost developments, caused by a variety of different international crises, led to the need for shippers and carriers to find an equitable form of collaboration. Index-based pricing models are one way to regulate the price adjustment between shipper and carrier during the contract period due to cost developments. However, one obstacle to agreeing on such models is to find the correct index for the respective cost component that is adequate for both shipper and carrier and reflects the actual cost development of the carrier. In semi-structured expert interviews, we investigated which strategies are used to reflect volatile cost developments, how index-based pricing models work, and where problems are seen in this context. Furthermore, a broader study can lead to confirmation or further classification of the results. The abstract describes index-based pricing models with focus on road freight, but the mechanism will work for other transportation modes as well.


Introduction and Motivation
In most cases, transportation services are outsourced by shippers to carriers.If there is a contract between the shipper and the carrier, it is a contract market.On the other hand, a demand-based agreement to take over transportation takes place on the spot market.Because 2023 International Scientific Symposium on Logistics the spot market is based on current costs and is updated daily, long-term contracts face the challenge of how to respond to volatile and unpredictable cost developments during the contract period.(Caplice 2007;Brilka and Clausen 2021;Acocella and Caplice 2023) Volatile and unpredictable developments in transportation costs mean that shippers and carriers are increasingly grappling with the form of price adjustment during the term of the contract as part of their cooperation.If shippers and carriers do not find a form of regularity in terms of price adjustment during the contract period, it will be necessary to renegotiate on an ongoing basis due to cost developments.This constant renegotiation of prices increases the transaction costs of collaboration.(Williamson 1979(Williamson , 1985) ) Index-based pricing models are one way to regulate the price adjustment between shipper and carrier during the contract period due to cost developments.In previous literature, index-based pricing models are based on a general index that assumes a market-based cost development.An example is the paper by Acocella, Caplice and Sheffi (2022a) and Acocella, Caplice and Sheffi (2022b).In practice, a more detailed look at cost developments in terms of individual cost components has so far only been found in relation to fuel costs (Cordes 2022).Literature distinguishes between fixed and variable costs with respect to conventional transportation services.The following  Cost allocation over time shows that the variable cost components, driver wages and benefits, subsumed under labor in Adzija and Kukhtas (2022) book, and in particular fuel or diesel costs, are subject to greater fluctuations over time than fixed or other variable costs.The fixed cost components are a part of the analysis that does not necessarily need to be subject to price adjustment through indexation, as the fixed cost components are generally less subject to fluctuating price trends over the contract term than, for example, the variable cost components of fuel and labor.Cost allocation differs depending on the type of transportation.A groupage shipment has a different cost allocation than a FTL.
For each of the cost components presented, with emphasis on the variable cost components, an index can serve as the basis for regulating the price adjustment.As described, this is well known in practice for the cost component fuel, e.g. as a fuel or diesel floater.In order to explain how such an adjustment mechanism can look, this is illustrated in the following figure using a diesel floater:  According to the diesel floater example, the carrier would increase its originally agreed freight rate by e.g.1% if the diesel price in the average price index reached €1.66 per liter (gross).
An index can also serve as the basis for such a mechanism for labor costs, for example.If such a mechanism is agreed for almost all cost components based on an index over the term of the contract, transaction costs are kept low by appropriate renegotiation.However, one obstacle to agreeing on such models is to find the correct index for the respective cost component that is adequate for both the shipper and the carrier and that reflects the carrier's actual cost development.This is where the extended abstract comes in and attempts to shed light on the application and associated challenges in practice through semi-structured expert interviews.

Research Methodology
This extended abstract is based on the systematic literature review of Dellbrügge et al. (2022), which addresses strategic freight procurement.This already distinguishes between design options derived from the literature with respect to the treatment of price adjustments over the contract term.Specifically, the topic of index-based pricing models has been conceptualized with the papers of Acocella, Caplice andSheffi (2022a, 2022b).Based on this, a literature search has conducted in the following manner: preview and scanning, selection and skimming as well as data organization and evaluation.In this way, the specific issue of index-based pricing models has been approached.
The research design follows the comments of Kallio et al. (2016) and Finkbeiner (2017), summarizing guidelines for semi-structured expert interviews.We chose the qualitative research approach of semi-structured expert interviews because it allows us to illuminate and discuss a topic from different perspectives and thus to classify the topic comprehensively.Based on the statements from the interviews, we obtain a comprehensive assessment of the suitability of index-based pricing models to counteract volatile cost developments over the contract term, but also a critical appraisal including the challenges.
We focused on asking open-ended questions, avoiding closed questions, and having as wide a range of interviewees as possible in terms of company size, position in the company, age, and gender.Furthermore, the interviewees are from both sides, shippers and carriers, so contractual partners are represented in the interview study.We contacted the interviewees by email or phone and invited them to one-hour interviews, in person or online.

Interview Results
Through the interviews, we were able to gain a critical understanding of index-based pricing models and how shippers and carriers view them in the field.We have summarized the results of the interviews in five key aspects, but before doing so, we would like to briefly place them in the overall context of the cooperation between shipper and carrier.
In most cases, contracts are concluded between the parties.Contract terms in the transportation sector are usually 1 to a maximum of 3 years.Contract terms vary depending on the complexity and requirements of the service.Another fundamental aspect from the interviews is that specific structures, volumes, truck utilization, weights and delivery characteristics should be recorded in the contract as a basis so that if the general conditions change, prices are adjusted accordingly because the basis for calculation has changed.In addition, only a few respondents described a mechanism for when a price adjustment due to a structural change takes effect, namely when there is an x% change in volume.To place this in the overall context, the respondents also mentioned that traditional negotiations or graduated prices could also be considered as a form of price adjustment during the term of the contract.The problem with negotiations is what happens if no agreement is reached.If no contractual arrangements have been made for such a case, a situation may arise in which no prices apply and the partnership fails.
Respondents unanimously agreed that index-based price adjustment mechanisms could, in principle, be considered as a form of price adjustment during the contract period.In this context, five core aspects of application emerged: • The index on which the price adjustment is based does not necessarily reflect the development of costs in the company itself.For example, it was mentioned here that a market-based index reflects the fluctuations in supply and demand for transportation capacity and thus the charter market, but not the cost structure of the company's own business.If the carrier works with its own trucks and its own drivers, it is not exposed to the fluctuations of the charter market.Another example cited here is the decoupling of the development of collectively agreed wages from the wages actually paid in the driver sector.Due to the shortage of drivers, truck drivers are paid significantly higher wages than the collectively agreed wage.• The intervals of price adjustment based on the agreed index determine which party bears the advantage or disadvantage of the downstream adjustment and, most importantly, for how long.At this point, respondents primarily mentioned the volatile cost developments since the COVID-19 pandemic, and specifically fuel costs.There is a difference between a service provider having to bear the increased costs for three months or one month until they are adjusted by the index.• With the introduction of further index-based pricing models, the cost components sometimes overlap.Due to the cost development since the COVID-19 pandemic, more index-based price adjustment models for energy or personnel costs have been agreed upon between shippers and carriers.In particular, indices that take energy costs into account sometimes overlap in their basis with indices for fuel.In this case, care must be taken in the agreement and application to ensure that the cost components of transport or handling costs on which the energy floater is based are correctly reflected.• The use of index-based pricing models reduces the need for entrepreneurial or commercial negotiation.Negotiation between shippers and carriers is nevertheless a point for successful cooperation that should not be underestimated, according to the respondents.Here, some respondents see a risk that the quality of cooperation could be weakened by using index-based mechanisms.• Index-based pricing models are a good way to adjust prices during the contract period due to transparency, traceability, and lower transaction costs.Despite some drawbacks, the advantages of index-based pricing models are highlighted, especially for models that are widely used in practice, such as the diesel floater.In the area of personnel costs or driver wage development, the rate increase of the collective agreement for the forwarding, logistics and transport industry in e.g.North Rhine-Westphalia; the collective agreement of the Association of German Temporary Employment Agencies or the increase of the minimum wage in Germany were mentioned as indices for a possible basis.In the area of energy costs, respondents used the energy cost index of the German Association of Industrial Energy Consumers (VIK e.V.) or self-generated indices.Finally, according to the respondents, the following indices can be used to show the overall cost development: Consumer Price Index; Model Calculations for the Evolution of Road Freight Transport Costs from the BGL or the Transporeon Contract Price Index.

Conclusion & Further Research
In summary, the semi-structured interviews indicate that the use of index-based price adjustment mechanisms in transport logistics is justified, but not equally useful in all cases.In particular, the search for indices that at least approximately reflect one's own cost development represents a high hurdle, especially in times of volatile cost developments.
In terms of further research, the identified core aspects should be verified by a subsequent interview study.A comprehensive model consisting of several indices for the different cost components can then be compared with the actual cost development of the companies.With the help of such a practical comparison, the gap between an index and the actual cost development can be considered and conclusions can be drawn.

Figure 1 :
Figure 1: Diesel floater example -based on a model used in reality by a carrier

Table 1
table illustrates the corresponding cost components: Leslie and Murray (2022)ts of trucking(Adzija and Kukhta 2022)Adzija and Kukhta (2022) describe in their book that approximately 70% of trucking costs are variable, leaving 30% as fixed costs.Leslie and Murray (2022), on the other hand, describe

Table 2
Respondents mentioned several cost indices as a basis for agreeing on price adjustment mechanisms.All indices have different advantages and disadvantages.An overall classification of them is beyond the scope of this paper.With regard to fuel or diesel costs, the following indices were mentioned by the respondents: Weekly EU Bulletin; Aral fuel price development; Shell fuel price development; diesel price information (large consumers) from Bundesverband 2023 International Scientific Symposium on Logistics Güterkraftverkehr, Logistik und Entsorgung (BGL) e.V.; fuel cost development from en2x -Wirtschaftsverband Fuels & Energie.