case study

ABSTRACT

Over-land Trucking and Freight has a long-established

and mutually beneficial business relationship with a major

international automotive parts company, FHP Technologies.

Management at FHP has approached Over-land with a

request to provide additional routes that are important to

the efficiency of its supply chain. Over-land’s management

wishes to nurture the business relationship with FHP but

is concerned about the available capacity to service the

new routes, potential risks, and profitability associated with

FHP’s request.

INTRODUCTION

Alan James founded Over-land Trucking and Freight in

1968 and has grown the business into a sizeable operation

with 90 trucks and 180 trailers. His largest customer, FHP

Technologies, has submitted a proposal to him to add

delivery routes that would improve the efficiency of FHP’s

supply chain. Alan was not certain that Over-land could

handle the additional routes since the company currently was

operating at (or near) full capacity.

FHP offered a total of $2.15 per mile (including fuel

service charge and miscellaneous fees) for the new route.

But Alan knew that to accept the offer he would have to add

more trucks and perhaps incur additional debt. The question

was whether the rates offered by FHP were high enough

to offset the associated risks of growing the fleet. Although

the business had been grown organically through the years

by reinvesting profits, it incurred debt from time to time to

replace older equipment (usually in blocks of five trucks).

Alan knew the slim profit margins associated with trucking,

coupled with a downturn in the economy, could spell disaster

if saddled with too much debt. See Exhibits 1 and 2 for the

company’s most recent statement of income from operations

and the balance sheet, respectively.

Roger Simmons, Over-land’s operations manager for the

past 16 years, had been reviewing the FHP proposal and

approached Alan. “Alan, we need to discuss this offer from

FHP. I think it is a great opportunity for our company, and

we need to find a way to make it work.” Within 10 minutes

Alan and Roger were in a closed-door meeting discussing

the pros and cons of FHP’s offer. Roger began by stating the

obvious: “Alan, this is a huge opportunity for us to grow the

business. Not to mention, as FHP becomes more dependent

on our services, we will be in a stronger position to negotiate

future rate increases. I know you are opposed to debt, and

I understand the risks of carrying more debt, but there is

more than one way to grow our fleet. If you would consider

using independent contract drivers, we could grow the fleet

enough to accept FHP’s offer without incurring more debt.”

Alan cringed at the thought of using independent

contract drivers. Although independent contractors owned

their own trucks, Alan viewed them as difficult to deal

with and not worth the headache. “Roger, I hear you, but

this new route will not last a week if we cannot give FHP

great service. Independent contractors call the shots, not

us. They own the rig and will sit at home if they want to. I

would rather deal with our own company’s rigs and drivers.

The rewards just do not justify the risks of damaging our

relationship with FHP.

I M A E D U C AT I O N A L C A S E J O U R N A L V O L . 7 , N O . 2 , A R T. 2 , J U N E 2 0 1 41

ISSN 1940-204X

Over-land Trucking and Freight: Relevant Costs for Decision Making* Thomas L. Albright

Naval Postgraduate School

Paul Juras

Babson College

Russ Elrod

Arab Cartage and Express Co.

*The views expressed in this document are those of the author and do not reflect the offical policy or position of the U.S. Department of Defense or the U.S. government.

This study source was downloaded by 100000797372553 from CourseHero.com on 05-29-2021 19:51:50 GMT -05:00

https://www.coursehero.com/file/11639879/Overland-Trucking-case-Due-April-10/

Th is

stu dy

re so

ur ce

w as

sh ar

ed v

ia C

ou rs

eH er

o. co

m

“But I am not sure we should take on any more debt at

this point to purchase additional rigs. The economy is in

the tank, and it is a bad time for us to leverage the balance

sheet any further. Roger, my success in this business was not

built by jumping on every offer that came along. Sometimes

you have to say no, even to your biggest customer. Unless

you can find a way to squeeze out more capacity within our

current fleet, I just do not think we can accept FHP’s offer at

this time,” Alan concluded.

As the two men left the room, Roger was convinced that

Alan was wrong. Roger knew that Alan was leaving money on

the table. He just needed to prepare a financial analysis that

would prove it. Was it possible to squeeze out more capacity

from an already fully utilized fleet? Perhaps they could shift

trucks from another account. Was taking on more debt truly

“risky” given the profit potential of this new route? Roger

knew he had to make a convincing argument before FHP

took its offer to another truck line.

INDUSTRY TERMS

• A tractor-trailer rig is a truck that consists of a tractor

attached to a trailer. The tractor typically is powered by a

diesel engine.

• A flatbed trailer is long flat platform with no sides.

• A dry van trailer is a boxed cargo compartment designed for

nonrefrigerated freight.

• Trucking companies often have a revenue-generating load

in one direction but need a revenue-generating contract

for the return trip. The return trip is known as a backhaul.

Often trucking companies contract with freight brokers to

acquire backhauls.

INDUSTRY BACKGROUND AND COST STRUCTURE

Trucking firms generate a variety of revenue types from

hauling goods for their clients. Presented next is a brief

overview of key types of revenues included in the 2013

income from operations of Over-land Trucking and Freight.

Line haul revenue is earned from hauling freight.

Fuel prices in recent years have been volatile. Because

trucking companies are exposed to fuel price volatility when

they sign a long-term contract with their customers, they

may charge an additional fee associated with fuel costs when

prices exceed predetermined levels. Thus, the primary

purpose of the fuel surcharge (FSC) revenue is to protect the

truck line from fuel price increases during the contract term.

Included in miscellaneous revenue are the following:

Storage fees are collected when Over-land stores a loaded

trailer on its lot for a customer.

Lumper revenue is collected if a driver assists with unloading

a trailer.

Certain flatbed loads, such as drywall, unpainted steel, and

some types of wood products, that would be damaged by

rain must be covered. Trucking companies typically charge a

tarping fee for such loads.

Additional insurance is required when transporting high-

value cargo. Practices vary throughout the industry. If a load

is above a company’s standard cargo insurance limits, many

companies simply will not haul it. Trucking companies

that are willing to bind additional cargo coverage normally

do so for a fee that covers only the extra cost of insurance.

(Alternatively, this revenue line item could have been

booked as a reduction to the “Insurance” expense account.)

Loads transported on flatbed trailers must be secured by

straps or chains. These types of loads often are associated

with higher worker’s comp claims. Thus an extra strapping

and chaining fee is charged only for a flatbed load.

If a truck sits idle at the dock for more than two hours,

customers can be charged a fee that is classified as detention

revenue. Placing a detention revenue clause in the contract

encourages customers to load trailers efficiently in order to

avoid further constraints on Over-land’s tractor capacity.

TYPES OF BUSINESS ARRANGEMENTS WITH DRIVERS

Over-land has potentially two arrangements with drivers.

They are classified as employees or as independent operators.

Employees receive traditional employee benefits and a Form

W2 for tax purposes. These persons are typically engaged in

work for the company that is considered “permanent.”

Alternatively, independent operators are not considered

employees and receive a Form 1099 (rather than a Form

W2) for tax purposes. These operators typically provide the

tractor but generally do not provide the trailer. In addition to

driver salaries and depreciation on trucks, expenses incurred

by independent contractors include:

• Tags (known as International Registration Plan (IRP)) –

The independent contractor buys the IRP tag for the tractor,

while the shipping company buys the tags for the trailer.

• IRS Form 2290 – Heavy Road Use Tax.

• Diesel fuel, engine fluids, and all maintenance-related

parts and items.

I M A E D U C AT I O N A L C A S E J O U R N A L V O L . 7 , N O . 2 , A R T. 2 , J U N E 2 0 1 42This study source was downloaded by 100000797372553 from CourseHero.com on 05-29-2021 19:51:50 GMT -05:00

https://www.coursehero.com/file/11639879/Overland-Trucking-case-Due-April-10/

Th is

stu dy

re so

ur ce

w as

sh ar

ed v

ia C

ou rs

eH er

o. co

m

• Physical damage insurance.

• Non-trucking “bobtail” Liability Insurance (needed for

when the truck is not transporting a trailer).

• Tolls and scale fees.

For an example of a publicly traded transportation company

that primarily uses independent operators, visit Landstar Trucking

Company’s website at www.nonforceddispatch.com/landstar.php.

For a description of a publicly traded transportation company

that primarily owns its rigs and employs company drivers, see

J. B. Hunt Transportation Services’ Form 10K at www.sec.

gov/Archives/edgar/data/728535/000143774914002605/

jbht20131231_10k.htm. Read the discussion in Item 1-Business.

Independent contractors generally control their own

working hours, unlike an employee. Further, independent

contractors’ work generally is considered temporary, rather

than permanent (unlike for an employee). In the trucking

industry, an independent contractor often signs a one-year

contract for a temporary job. But an employee is hired

permanently under the assumption that he or she will make

deliveries until further notice. This arrangement constitutes

a permanent job.

CAPACITY ISSUES AND INDUSTRY PRACTICES

Over-land Trucking typically assigns one driver to one

tractor. But this practice can constrain the available hours

the tractor can operate. For example, laws require a driver

to take a 10-hour break after 11 hours of driving. Further,

a driver cannot work more than 70 hours in an eight-day

period without taking a 34-hour break. To improve tractor

utilization by avoiding constraints based on legal driving

time requirements, some trucking companies use “slip

seating.” This is a practice that permits greater tractor

utilization by placing a fresh driver behind the wheel at

the end of the former driver’s shift. Slip seating is similar in

practice to an airline company that keeps its planes flying

longer by inserting fresh flight crews as the previous crew

goes off duty. It also is efficient to utilize “team drivers” that

are commonly husband-wife teams. One person drives while

the other sleeps. Relative to a single driver, this arrangement

basically doubles the amount of miles driven in a given

week. Typically, teams are paid more, but additional line

haul revenues offset the extra labor costs.

Another strategy to improve tractor utilization is to use

trailer pools, commonly referred to as “drop and hook”

systems. For example, trucking companies will leave an

empty trailer with customers, who will load it with products

as units are produced. When the trailer is filled, a tractor

arrives, drops an empty trailer to replace the trailer just

filled, then immediately hooks onto the loaded trailer and

departs. Tractor utilization improves because tractors are not

sitting idle while a customer loads a trailer. This approach is

economically feasible because trailers are far less expensive

to purchase and operate than tractors.

Most trucking companies keep some tractors “on

the fence” as spares, in case one breaks down. There is

considerable disagreement, however, over what constitutes

too many spares. Some owners believe a truck line should

put all available equipment on the road and rent a tractor

if a spare is needed. Others disagree and maintain a small

number of tractors in reserve. Currently, Over-land Trucking

and Freight keeps a small number of tractors and trailers out

of service but prepared for duty in case a rig breaks down.

Some managers believe this policy is an expensive luxury

and that some of these idle rigs could be used to add the

new routes requested by FHP. When estimating a tractor’s

practical capacity, management at Over-land use 85% of total

potential miles driven in a period. Theoretical (or 100%)

capacity utilization is virtually impossible in the industry

because of factors such as traffic and loading delays.

THE PROPOSAL AND RELATED ISSUES

Management at FHP has asked Over-land to consider adding

two dry van loads per week; each load would require 1,500

round-trip miles. Because FHP is a long-term client with a

strong financial position, the company’s management has asked

for a very favorable rate of $2.15 per mile including FSC and

all miscellaneous fees. Roger believes the potential volume of

freight from FHP can be used to grow Over-land’s business and

profitability. There is also risk associated with not taking the

new lines. If Over-land does not accept the new routes, another

trucking line will, thus building loyalty with FHP.

FHP is a stable, solvent company that presents no question

of collection, thus ensuring a reliable cash flow. If FHP decides

to restructure its supply chain in the future, Over-land could

find itself in the undesirable position of holding dedicated

assets (trucks and trailers) for routes that no longer exist. The

owner’s aversion to increased debt levels further exacerbates

concerns about acquiring additional fixed assets. Perhaps Over-

land could service the initial demand with existing equipment.

But, as additional routes are added in the future, Over-land

must acquire more tractor-trailer rigs or consider outsourcing the

miles by using independent contractors.

Exhibit 1 presents Over-land Trucking and Freight’s

income from operations for the year ending December 31,

2013. This statement is not prepared in accordance with

I M A E D U C AT I O N A L C A S E J O U R N A L V O L . 7 , N O . 2 , A R T. 2 , J U N E 2 0 1 43This study source was downloaded by 100000797372553 from CourseHero.com on 05-29-2021 19:51:50 GMT -05:00

https://www.coursehero.com/file/11639879/Overland-Trucking-case-Due-April-10/

Th is

stu dy

re so

ur ce

w as

sh ar

ed v

ia C

ou rs

eH er

o. co

m

Generally Accepted Accounting Principles (GAAP) but presents costs by behavior. Exhibit 2 presents Over-land Trucking and

Freight’s balance sheet for the year ending December 31, 2013.

I M A E D U C AT I O N A L C A S E J O U R N A L V O L . 7 , N O . 2 , A R T. 2 , J U N E 2 0 1 44

Exhibit 1 Income from Operations (All financial information in the case has been scaled and disguised for educational purposes.)

Over-land Trucking and Freight Income from Operations For the year ending December 31, 2013

Revenue FYE 12/31/2013 Per Mile

Line Haul $20,925,280 $1.86

Fuel Surcharge 4,950,160 0.44

Miscellaneous 450,120 0.04

Total Revenue $26,325,570 $2.34

Variable Expenses

Insurance 675,120 0.06

Fuel 8,775,190 0.78

Oil Lubricants 112,700 0.01

Tolls 112,550 0.01

Parts and Small Tools 787,630 0.07

Hourly Wages: Drivers 4,950,160 0.44

Trailer Pool Expense 255,120 0.02

Total Variable 15,638,480 1.39

Fixed Expenses

Insurance

General Liability 112,620 0.01

Physical Damage 225,010 0.02

Workers Compensation 226,000 0.02

Health Insurance 224,500 0.02

Security 111,750 0.01

Depreciation 2,137,500 0.19

Salaries, Benefits (Garage) 675,000 0.06

Salaries, Benefits (Office) 1,012,520 0.09

Bad Debt Expense 113,500 0.01

Permits 111,520 0.01

Rental Equipment 1,013,000 0.09

Payroll Taxes 562,500 0.05

Accounting Fees, Supplies, Computer Maintenance 112,350 0.01

Miscellaneous 337,510 0.03

Total Variable 6,975,280 0.62

Income from Operations $3,681,810 $0.33

Note: Per-mile values are based on 11,250,000 miles and have been rounded to two decimal places.

This study source was downloaded by 100000797372553 from CourseHero.com on 05-29-2021 19:51:50 GMT -05:00

https://www.coursehero.com/file/11639879/Overland-Trucking-case-Due-April-10/

Th is

stu dy

re so

ur ce

w as

sh ar

ed v

ia C

ou rs

eH er

o. co

m

I M A E D U C AT I O N A L C A S E J O U R N A L V O L . 7 , N O . 2 , A R T. 2 , J U N E 2 0 1 45

Exhibit 2 Over-land Balance Sheet

Over-land Trucking and Freight Balance Sheet For the year ending December 31, 2013

Assets

Current Assets

Cash $200,000

Accounts Receivable 300,000

Total $500,000

Property Plant and Equipment

Land 1,000,000

Buildings 3,000,000

Accumulated Depreciation Buildings (1,250,000)

Tractors, Trailers, and Equipment 18,650,000

Accumulated Depreciation (4,750,000)

Total $16,650,000

Total Assets $17,150,000

Liabilities and Equity

Current Liabilities

Accounts Payable 150,000

Taxes Payable 65,000

Current Portion of Long-Term Debt 35,000

Total Current Liabilities $250,000

Long-Term Liabilities

Notes Payable 1,865,000

Total Long-Term Liabilities $1,865,000

Total Liabilities $2,115,000

Owner’s Equity

Contributed Capital 3,550,000

Retained Earnings 11,485,000

Total Owner’s Equity $15,035,000

Total Liabilities and Owner’s Equity $17,150,000

This study source was downloaded by 100000797372553 from CourseHero.com on 05-29-2021 19:51:50 GMT -05:00

https://www.coursehero.com/file/11639879/Overland-Trucking-case-Due-April-10/

Th is

stu dy

re so

ur ce

w as

sh ar

ed v

ia C

ou rs

eH er

o. co

m

THE DECISION

Over-land’s management is considering the proposal from

FHP. There are many issues involving strategy, cost, risk,

and capacity. Prepare a recommendation to management.

Use the following questions to guide your analysis.

1. Assume Over-land could service the contract with

existing equipment. Use Exhibit 1 to identify the

relevant costs concerning the acceptance of FHP’s

request to add two additional loads per week. Which

costs are not relevant? Why?

2. Calculate the contribution per mile and total annual

contribution associated with accepting FHP’s proposal.

What do you recommend? (Use 52 weeks per year in your

calculations.)

3. Consider the strategic implications (including risks)

associated with expanding (or choosing not to expand)

operations to meet the demands of FHP. Analyze this

question from a conceptual point of view. Calculations are

not necessary.

4. After a closer examination of capacity, management believes

an additional rig is required to service the FHP account.

Assume Over-land’s management chooses to invest in one

additional truck and trailer that can serve the needs of FHP

(at least initially). Assume the annual incremental fixed

costs associated with acquiring the additional equipment is

$50,000. Further, FHP would agree to pay $2.20 per mile

(total including FSC and miscellaneous) if Over-land would

sign a five-year contract. What is the annual number of

miles required for Over-land to break even, assuming the

company adds one truck and trailer? What is the expected

annual increase in profitability from the FHP contract? (Use

52 weeks per year in your calculations.)

5. Over-land has business relationships with independent

contractors, though Alan is reluctant to use them. Another

possibility for expanding capacity is to outsource the

miles requested by FHP. One of Over-land’s most reliable

independent contractors has quoted a rate of $1.65 per

mile. As with question 4, assume FHP would agree to pay

$2.20 per mile if Over-land would sign a five-year contract.

Further, assume Over-land would incur incremental fixed

costs of $20,000 annually. These costs would include

insurance, rental trailers, certain permits, salaries and

benefits of garage maintenance, and office salaries such

as billing. How many annual miles are required for Over-

land to break even if the miles are outsourced? What is the

expected annual increase in profitability from the FHP

contract? What are your conclusions?

6 a. Why might Over-land use an independent operator if

the variable cost per mile is higher than if the company

had purchased a rig and hired a driver?

b. At what point would management be indifferent

between the scenarios illustrated in questions 4 and 5?

Based on your analysis, would you recommend adding

capacity by purchasing an additional rig or by utilizing

the services of an independent contractor? Why?

7. The case references J. B. Hunt and Landstar as two

publicly traded companies that have two very different

cost structures. This is true because the companies

practice two different philosophies for using (or not

using) owner operators (e.g., independent contractors).

Speculate about the company that may produce higher

profits in periods of high economic demand. Why?

Speculate about the company that may have a less risky

cost structure in poor economic times. Why?

8. All organizations have the potential to perform work,

which is determined by the types of resources and the

organization’s capacity. Effective use of resources can be

critical to a firm in any competitive market. In their efforts

to efficiently use capacity, managers may ask questions such

as: What portion of the available capacity is in use? Of the

capacity in use, what portion is used productively? How can

we increase the productive use of capacity? Why is a portion

of available capacity not in use? Can we eliminate unused

capacity? Over-land’s management is no different. In fact,

management is not exactly clear about how to view capacity.

Discuss the challenges that Over-land’s management faces

with defining and managing capacity. Consider various

definitions of capacity, such as theoretical, practical, normal,

and actual capacity. Based on the facts presented in the case,

prepare an estimate of capacity for Over-land (assuming one

driver per rig without slip seating or team driving).

I M A E D U C AT I O N A L C A S E J O U R N A L V O L . 7 , N O . 2 , A R T. 2 , J U N E 2 0 1 46

ABOUT IMA®

With a worldwide network of more than 70,000 professionals, IMA (Institute of Management Accountants) is the world’s leading organization dedicated to empowering accounting and finance professionals to drive business performance. IMA provides a dynamic forum for professionals to advance their careers through CMA® (Certified Management Accountant) certification, research, professional education, networking, and advocacy of the highest ethical and professional standards. For more information about IMA, please visit www.imanet.org.

This study source was downloaded by 100000797372553 from CourseHero.com on 05-29-2021 19:51:50 GMT -05:00

https://www.coursehero.com/file/11639879/Overland-Trucking-case-Due-April-10/

Th is

stu dy

re so

ur ce

w as

sh ar

ed v

ia C

ou rs

eH er

o. co

m

Powered by TCPDF (www.tcpdf.org)