What it means
Logistics costs are large, but the dollar amount alone says little about efficiency. A distributor that spends $900,000 may be doing very well if it has $10,000,000 of sales and very badly if it has $3,000,000.
The ratio puts the spend in proportion to the business. Typical values vary a great deal by industry, because heavy, bulky or low-value products tend to have a high ratio while light, high-value products tend to have a low one.
A ratio therefore means little unless it is compared with similar companies or with the same company in earlier periods. Companies use the ratio to spot trends.
A rising ratio may mean fuel and carrier costs are up, warehouses are underused or the product mix has shifted toward bulky items. A falling ratio may reflect better route planning, higher volumes spreading fixed costs or tougher carrier contracts.
The definition matters. Some companies include only transport and warehousing, while others add inventory carrying cost and order handling.
Before comparing ratios from different sources, check that the numerator contains the same items and that the denominator is the same measure of sales, such as net revenue. The ratio is a measure, not a goal.
Cutting it by slashing service levels can lose sales and cost more profit than it saves. Many firms therefore track it alongside on-time delivery, order accuracy and customer satisfaction.
Seasonal swings can distort the ratio. A peak period may bring premium freight and temporary labour, while a quiet period leaves fixed warehouse costs spread over low sales.
Looking at a rolling twelve-month ratio smooths these swings and shows the underlying trend.
In practice
Real-world examples
Example 1
A building materials supplier sells heavy goods such as bricks and cement. Its logistics cost ratio is 18%, far above the 6% of a company selling electronic components. The CFO does not compare the two, because the products are so different, and instead benchmarks against other building materials suppliers with similar delivery distances and order sizes.
Example 2
A grocery wholesaler tracks its ratio each quarter. When it rises from 9% to 10.5%, the finance team finds that a fuel surcharge and half-empty delivery routes are to blame. Rescheduling the routes brings the ratio back to 9.4%.
Example 3
A cosmetics brand compares its ratio of 7% with a peer at 5%. The gap prompts a review of its packaging, which turns out to be heavy and costly to ship. The operations team also finds that several small orders are sent separately when they could be combined into one parcel. A redesign using lighter materials reduces the ratio to 5.8% over the next year. On annual sales of $20,000,000, the 1.2 percentage point improvement is worth $240,000 of extra operating profit.
Think of it
Think of the logistics cost ratio like the fuel efficiency of a delivery van. Just as litres per mile tell you how much petrol you burn to travel a certain distance, this ratio tells you how much money you burn in transport and storage to generate a pound of sales.
Formula
Calculation
Logistics cost ratio = Total logistics cost / Net sales x 100%
A distributor has total logistics cost of $900,000 and annual net sales of $6,000,000. The ratio is 900,000 / 6,000,000 = 15%. If it can cut logistics cost by $120,000 to $780,000 with sales unchanged, the new ratio is 780,000 / 6,000,000 = 13%. The two-point improvement adds $120,000 to operating profit.Case study
Seen in the real world
Larkspur Garden Supplies is an illustrative, fictional online seller of plants and pots. Its logistics cost ratio had crept from 11% to 16% in two years while sales grew. The owner assumed that growth would lower the ratio and could not understand the opposite trend.
The finance manager looked at the details, splitting the ratio by product line and by delivery postcode. Most of the increase came from bulky ceramic pots, which were costly to ship and often arrived broken, triggering free replacements that were shipped at the company's own expense. By changing packaging, setting a minimum order value for heavy items and dropping two fragile lines, the ratio fell to an illustrative 12.5% within a year, and profit rose despite lower sales of those items.
Watch out
Common mistakes
- Comparing ratios across industries or with competitors without checking that logistics cost is defined in the same way.
- Reducing the ratio by cutting service levels so far that customers leave, which lowers the ratio in the short term but costs far more in lost revenue.
- Using gross sales instead of net sales, which flatters the ratio when there are many returns or discounts.
Questions
People also ask
What is a good logistics cost ratio?
It depends on the product and industry, so compare with your own history and similar businesses, and not with a universal figure.
Does a falling ratio always mean better efficiency?
Not always, because it can also result from higher selling prices or a change in product mix.
How often should the ratio be reviewed?
Many companies track it monthly or quarterly, and look at it by product line, customer group or region to find exactly where the costs arise and which part of the supply chain deserves attention first.