The state of freight
Logistics sector looks to rebound from poor 2009 as firms carry out efficiency initiatives.
By Eric Kulisch
U.S. companies spent $244 billion less to transport and store their goods in 2009 than the previous year. But the 18.2 percent decrease was directly related to the recession rather than new innovations that made the logistics sector more productive, according to the annual State of Logistics report released June 9 by the Council of Supply Chain Management Professionals.
Logistics costs as a percentage of the overall economy plunged to 7.7 percent last year ' the lowest recorded figure in the report's 21-year history ' from 9.3 percent in 2008. Transportation and inventory carrying costs fell 20.2 percent and 14.1 percent, respectively. Combined with the $50 billion drop in 2008, total logistics costs declined $294 billion during the recession to $1.1 trillion after increasing more than 50 percent in the five years leading up to the economic crisis.
Shippers saved money on transportation last year, at the expense of carriers, because demand for shipments plummeted and rates were lowered to attract customers. Transportation costs as a percent of gross domestic product fell to 4.9 percent from 6 percent. Low freight volumes were especially pronounced in the domestic trucking sector where tonnage dropped 8.7 percent compared to already low 2008 levels. Freight declines for motor carriers actually fell 18 percent between the middle of 2006 and the middle of 2009, making it the second-worst trucking recession since the Great Depression. During that period, motor carriers engaged in aggressive price cuts to hold onto customers.
Meanwhile, inventory investments decreased $89 billion due to a 4.6 percent drop in inventories and a 10 percent drop in the inventory carrying costs, such as warehousing expense (Inventory carrying costs fell 13 percent in 2008). Extremely low interest rates for commercial paper resulted in an 89 percent drop in the interest component of inventory costs. The inventory-to-sales ratio, benefiting from an inventory draw down and a sales rebound in recent months, is at a relatively balanced 1.23 after jumping to 1.48 in early 2009 when consumers sharply reined in purchases.
Rosalyn Wilson, the report's author, predicted during a presentation at the National Press Club in Washington that logistics costs would tick upward in 2010 due to inventory replenishment, a rise in interest rates, tight transportation capacity and higher rates.
Modest demand will continue to keep warehousing costs in check (down 2 percent in 2009) through most of 2010 as high vacancy rates are reflected in lower rents, she said in the report. The tightened credit market and high vacancy rates have put most warehouse construction on hold.
Industrial property developers in some markets are cutting lease deals at half of the amount they were able to command in 2007, said Kris Bjorsen, managing director of supply chain and logistics solutions for the industrial real estate unit of Jones Lang LaSalle, during a panel discussion of the State of Logistics report.
Lower levels of freight spending were reflected in the domestic third-party logistics industry, which saw gross revenue decrease 16 percent, or $20.1 billion, to $107.1 billion, according to a report in May by Armstrong & Associates. It was the first yearly decline since 1995. During that 15-year period the compound annual growth for 3PLs is 12.7 percent.
International freight forwarders suffered the most revenue loss, with gross revenue down 23.7 percent as ocean container and air freight volumes sharply fell. Price cutting by 3PLs contributed to an 18.9 percent decline in net revenue. But the sector fared the best in terms of profits ' down 6.3 percent ' because it has limited operating and capital expenses.
Value-added warehousing and distribution only suffered a 5.3 percent reduction in gross revenue but sector profit was down 25 percent. Gross revenue for dedicated contract carriage and domestic transportation management fell 16 percent and 15.1 percent, respectively.
'We anticipate a significant recovery for 3PLs in 2010,' said Armstrong & Associates, a market research and consulting firm. 'Many first quarter results suggest a recovery that will restore the third-party logistics market to 2007 levels ($119 billion), and we predict 13.4 percent growth in gross revenue and 8.3 percent growth in net revenue in third-party logistics for 2010.'
Truck, Rail Capacity. As the economy improves, Wilson said, shippers will experience difficulty finding sufficient truck capacity in the face of widespread failure of smaller motor carriers, fleet rationalization by other trucking companies and shortage of qualified drivers. Carriers in all modes are being extremely cautious about bringing back sidelined conveyances and hiring new drivers until they are confident demand has permanently turned the corner and they can secure solid profit margins operating additional equipment.
About 2,000 trucking companies went out of business in 2009 on the heels of 3,000 liquidations in 2008. The pool of available trucks shrank 12.5 percent last year, according to American Trucking Associations' estimates cited by Wilson. Donald Broughton of Avondale Partners predicts that another 2,000 motor carriers will exit the industry in 2010 because of higher operating costs and low demand.
Cost pressure on trucking companies, many of them small mom-and-pop operators, is expected to come in the form of higher repair frequency as deferred maintenance runs its course and tighter safety enforcement by the Federal Motor Carrier Safety Administration later this year forces carriers to fix problems to maintain a good safety score or prevent the loss of their operating authority.
Lenders are also beginning to repossess trucks again instead of extending credit terms or taking partial payments. Last year banks let defaults slide because the used truck market had collapsed and they didn't want to be stuck with assets they couldn't resell, trucking industry officials say. This year the used truck market has rebounded as carriers seeking to quickly beef up their fleets, along with strong overseas sales, have depleted supply. Banks now feel they can get value for assets by calling in a note, according to industry officials.
'The capacity in the trucking industry is now much more in line with demand, but as demand grows, there is not sufficient parked capacity to quickly respond. There is a large inventory of used trucks which could be picked up, but tight credit is going to hamper large investments in new trucks,' Wilson wrote.
Tighter capacity is reflected in the fact that contract prices are expected to increase more than 10 percent and spot market prices will be 20 percent to 30 percent higher this year, not including fuel surcharges, No'l Perry, managing director of FTR Associates, said at the National Industrial Transportation League's spring conference in Washington on June 10. The gap between base and spot rates will be twice the normal 5 percent to 8 percent. The pricing suggests that the capacity shortage will be particularly acute in the random freight market that is the brokers' domain, as customers with ongoing carrier relationships are better positioned to receive service, he added.
Small, independent fleets will be needed to provide the surge capacity because many large carriers exited that segment of the market years ago, but small businesses may not be able to get the financing needed to buy new trucks, Perry said.
The railroad industry also took equipment ' locomotives and railcars ' out of service to reduce costs during the recession. As of December 28.8 percent, or almost 450,000 freight cars, were in storage, down from almost 32 percent of the fleet midway through the year. Railroads normally have 2 percent to 3 percent of cars in storage.
'The big difference between the loss of capacity in the trucking sector and the loss in the rail sector is that the rail equipment has been merely sidelined and is readily available to return to service when demand rises,' Wilson wrote.
Recent data, however, indicates that the red-hot freight activity during the first four months of the year has slowed a bit, as high unemployment and other factors continue to weigh on the economy. Truckload business, for example, slowed in May, primarily due to an early peak in summer demand, according to Morgan Stanley's monthly truckload index.
The market for refrigerated and flatbed trucks is stronger now than for dry van.
The American Trucking Associations' truck tonnage index, adjusted for seasonal influences and only representing member companies, decreased 0.6 percent in May ' the first month-over-month drop since February. Tonnage increased 7.2 percent compared to May 2009, continuing a six-month trend of better year-over-year results. Year to date, tonnage is up 6.2 percent compared with the same period in 2009 when the economy hit rock bottom.
'Despite the month-to-month drop in May, the trend line is still solid,' ATA Chief Economist Bob Costello said in a statement. 'There is no way that freight can increase every month, and we should expect a periodic decrease.'
FTR Associates, a freight econometrics firm based in Nashville, Ind., forecasts truckload volume will increase 6 percent in the second half of the year and 5 percent in 2011.
Morgan Stanley said it still expects a strong second half for truckload carriers, but contract pricing may not increase quite as much as many originally expected. The volume cool-down suggests that a severe capacity crunch may not materialize to the extent feared, the investment bank said.
Several motor carrier executives, however, said they have not seen any evidence that demand is moderating.
Freight railroads, however, also began to see declines in all major commodity groups in May on a weekly sequential basis, according to statistics from the Association of American Railroads. It reported that May rail traffic was a mixed bag, with intermodal traffic rising for the third straight month, but carloads slightly down from April and March. Overall, rail traffic continues to show marked improvement from easy comparisons at the height of the economic downturn in 2009, but is still below 2008 numbers. Railroads during the first 24 weeks of the year handled 6.8 million carloads, up 7.2 percent from 2009, but down 13.4 percent from 2008; and almost 5 million intermodal units, up 11.7 percent from 2009, but down 7.3 percent from 2008.
The number of railcars brought out of storage slowed for the first time in several months, with railroads putting just 747 cars back into service in May.
Intermodal volume reached 227,985 trailers and containers for the week ended June 19, up 21.2 percent from the same time last year, but down 0.2 percent from 2008. The weekly figure is the highest since early November 2008.
Most of the rebound in carload volume came at the end of last year and carload shipments will be relatively flat in 2010, said Larry Gross, a partner at FTR Associates.
The weekly declines raise questions about the durability of the recovery, he said.
In fact, the Department of Commerce on June 25 revised downward its measure of economic growth in the first quarter to 2.7 percent because of slower consumer spending and a rise in imports. Anemic job growth, a decrease in orders for manufactured goods, and a weak housing market are all signs in June economic data that the economy is losing steam. Economists anticipate that business spending will also taper off in the second half as companies bring their stockpiles in line with sales. The increase in factory output this year is mostly attributed to businesses replenishing inventory after the recession and less by consumer demand.
Experts consider 2.7 percent growth good under normal circumstances, but say it is relatively weak for a recovery following a steep recession. They predict that unemployment, at 9.5 percent in June, will remain above 9 percent through the end of the year. The only reason the unemployment rate fell in June is because so many people gave up looking for jobs. Economists say that a healthy U.S. economy should add about 200,000 jobs per month, but the private sector only added 83,000 jobs in June.
FTR Associates agrees with consensus analysis that the U.S. economy will grow about 3 percent during the next 18 months. But Perry cautioned businesses to be prepared for significant volatility from quarter to quarter. Growth could be about 3.8 percent in the good months and about 2.5 percent in the weak ones.
Perry, who predicted the 2008-2009 recession two years ahead of time, said the finance sector in the near future will rate the United States as a bad creditor because of its huge public debt, which, in combination with other sovereign debt problems, will lead to a rise in interest rates and precipitate another severe recession this decade.
'The successful competitors the next 10 years are the people who can deal with the extreme swings in both government activity and the economy,' he said.
Drivers In High Demand. Logistics professionals say the impending shortage of drivers should be of greater concern than the lack of available equipment. They are worried that the aging population of truck drivers could leave them without sufficient drivers to operate trucks and move cargo as freight demand increases in coming years.
From 2007 to 2009 more than 142,000 drivers left the trucking industry, according to Wilson's report.
'We're looking at probably the worst driver shortage in history by 2012,' Tom Nightingale, chief marketing officer for Con-way, said in an interview. Motor carriers may have 300,000 to 400,000 unfilled driver positions 30 months from now, barring a double-dip recession, he added.
The problem starts with the fact that one in six over-the-road drivers are above the age of 55 and there isn't enough fresh blood in the pipeline.
Many workers who turned to trucking during the recession are expected to return to their previous occupations as the economy improves. The construction industry is often a source of drivers when the economy slows down, as dump truck drivers and other workers look for alternative jobs, but there has not been as big an influx as hoped given the unemployment rate is still hovering near 10 percent, some trucking executives say.
A lot of motor carriers have downsized their in-house driving schools and many independent driving schools have gone out of business, slowing down the qualification process for new drivers, Leo Suggs, chairman and chief executive officer of Greatwide Logistics, said June 22 at the eyefortransport 3PL Summit in Atlanta.
'Just because you can drive a dump truck doesn't mean you can back up a 53-foot trailer into a tight dock,' he said in a follow-up interview.
The high unemployment rate and slow economy is discouraging immigrants, a more recent source of labor for trucking firms, from coming to the United States. And those that want to come are stymied by much stricter rules on work visas.
Retaining or finding new drivers is also complicated by the onset of Comprehensive Safety Analysis (CSA) 2010, the Department of Transportation's new safety measurement program that decouples fitness ratings from periodic compliance reviews, and instead targets investigations on companies and drivers based on current data of their moving violations and roadside inspections. The new federal safety initiative is expected to decrease the pool of available drivers as unsafe drivers are squeezed out and more attention is paid to hours of service limits.
The industry had to hire 150,000 drivers per quarter in 2007 just to keep up with attrition, and has since reduced its hiring capacity by one-third, Perry said. He predicted trucking will be short 200,000 drivers next year and lose another 300,000 due to the tougher regulations, for a total shortfall of 500,000 drivers. A precise estimate is difficult at this point, but even with a slow recovery, Perry said he is confident the driver shortage will be worse than the one in 2004, when the economy was at its peak and more restrictive hours of service rules kicked in.
Trucking industry officials say they support CSA 2010 in principle because the scrutiny by law enforcement, shippers and insurance companies could drive out of business companies without strong safety programs. But they still worry that the tougher standards will negatively impact the supply of eligible drivers.
Why buy trucks, they say, if there are no people to drive them.
Greatwide Logistics is turning away freight because it can't get enough used trucks and drivers in short order, said Vincent Gulisano, the company's chief customer officer, during a break at the 3PL Summit. 'Without a doubt we've lost revenue opportunities.'
Company drivers and owner-operators can be found, but the motor carrier has to expend a lot more effort to recruit them, he added. Greatwide helps owner-operators by steering them to programs or companies that provide affordable credit and health care, and discounted maintenance and fuel.
Suggs said the industry would benefit from reaching out to high school graduates before they try other careers, but federal law limits commercial vehicle operators to persons over the age of 21 for interstate travel. States allow 18-year-olds to drive within their borders, but insurance companies frown on drivers younger than 23 to 25 years of age.
A 6.6 percent reduction in driver pay during the recession through the first quarter of 2010, based on a Morgan Stanley survey, will also make driver recruitment more difficult, according to Wilson.
The trucking industry will have to raise pay levels to attract more drivers, which will create pressure on carriers to raise rates on shippers, said Sidney Brown, CEO of NFI, a full-service, asset-based logistics company in Vineland, N.J.
Domestic hauls have led the intermodal industry during and after the recession while international volumes declined along with trade, and Gross said the driver shortage will accelerate the mode-shift trend from trucking to intermodal.
Response Strategies In the past four years, many retailers began operating on leaner inventories by pushing responsibility for holding inventory to their suppliers, and the trend picked up pace in 2009, according to Wilson.
Now manufacturers are doing the same thing with their vendors. Companies didn't take inventory out of the supply chain as much as move it upstream. The danger with cutting into safety stocks is that manufacturers sometimes have to shut down production lines when they don't receive raw materials or parts in time, and retailers can experience stock outs.
Manufacturers, like carriers, are trying to gauge when to restart idle capacity and begin building inventory. Some have experienced shortages.
Specialty glass and ceramics maker Corning Inc. said in its first quarter earnings report that profits were hurt when it had to pay higher transportation costs to ship emissions-control filters by air because low supplies constrained it from quickly firing up new production lines and getting products to customers.
Flextronics International, a major electronics component supplier in Singapore, said parts shortages were greater than anticipated during its fiscal fourth quarter ended March 31.
Freight forwarders say a number of their customers have expedited shipments by air freight to keep shelves stocked in the face of heavier customer demand and delays in ocean shipping because of capacity shortages among container lines. The shift was illustrated by FedEx, which reported that its international package volume increased 23 percent in the fiscal fourth quarter ended May 31.
'Last year, manufacturers took overall inventory levels down as low as we've seen in years. But when you talk to them they did it in a rather unscientific way,' Simon Ellis, practice director for global supply chain strategies at IDC Manufacturing Insights, said in an interview.
Companies now realize that 'low inventory doesn't always mean productive inventory' and are expressing strong interest in inventory optimization tools, he said.
Perry said the trend of falling inventory-to-sales ratios in recent decades may be slowing because businesses have probably exhausted most innovative inventory-reduction ideas. He predicted in a follow-up e-mail that inventory levels won't substantially improve until Web-enhanced retailing kicks in years from now.
Retailers also responded to the drop in consumer spending last year by prioritizing their product mix on lower-cost products. The new logistics trend resulted in reduced product selection in many stores.
Logistics professionals within organizations were able to convince the marketing side that they didn't need to sell so many variations of the same product and should eliminate shelf space for slow sellers, which has helped control inventory levels, said Thomas Speh, a professor of distribution at Miami University in Ohio.
'A lot of research shows that when you come out of a recession that only about 10 percent of cost saved becomes sustainable,' he cautioned.
'I hope we don't go away from lean strategies and SKU rationalization. My concern is that we'll forget some of those lessons and go back to our old ways.'
Supply chain executives say retailers have begun expanding their merchandise selection as the economy improves, but are doing so much more carefully than in the past.
Costs will leak back into the system at companies that tried to cut costs across the board, but those that surgically targeted complexities in their trade networks will be better off, said Donald Ralph, senior vice president of supply chain and logistics at Staples.
BNSF Railway, for example, created large engineering teams to analyze how freight moves through its terminals and then visited 8,000 customer locations with an eye towards helping them improve the operation of their facilities, according to John Lanigan, the railroad's chief marketing officer. The company also continued to look at its overall cost base and determine costs that are truly fixed and ones that can be made more variable. And it moved people around the company to get them out of their comfort zones to make sure business process changes stick over the long term.
'And we believe those kind of programs are very sustainable coming out of a recession,' he said.
Penske Logistics also involved functional teams of personnel from sales, operations, information technology and engineering with customers to a greater degree than before, 'because we really had to take deep dives into their operations to pull out all the waste possible,' President Vincent Hartnett said.
The collaboration needed now is for shippers to provide railroads, truckers and ocean carriers with an estimate of their expected freight demand and orders so carriers can manage capacity. But getting such information is difficult because cargo owners are so cautious about the direction of the economy, Lanigan said.
'What we're asking, and almost begging our customers is to give us any kind of forecast,' he said. Manufacturers and retailers are reluctant to project two to three months ahead, and in some cases are only providing weekly projections, he added.
'We have a lot of latent capacity idle right now. So we're in great shape to handle whatever comes to us as a company and as an industry. But it's not an overnight thing' to bring back furloughed workers and parked equipment, Lanigan said.
The ability to maintain lean inventories hinges on the performance of the transportation and logistics network, the former trucking industry executive noted, and customers now expect carriers to maintain the on-time delivery standards they achieved in 2009 when volumes were lower and freight flowed with few bottlenecks.
Covidien, a maker of medical devices and supplies, has adapted to the need for a more efficient supply chain by automating its distribution centers around the world to make them much more productive, said Peter Sturtevant, vice president of supply chain solutions and transportation.
Speh cautioned that all the efforts to rationalize supply networks and cut inventory to the bare minimum 'have opened up supply chains to more risk. We cut a little of that agility out.'
Successful companies have reduced some risk during the past two years by engaging in more near-shore sourcing to cut down on extended supply chains and use close-by suppliers so they can react faster to market changes, Hartnett said.
There is also a lot of activity in major corporations directed toward supplier risk management and planning ahead to eliminate supply chain surprises, the Penske chief said.
Many of Penske's customers are most worried about their second and third-tier suppliers and whether such component providers will survive, have available credit to support operations, or are willing to invest in additional production capacity, he said.
During the economic downturn, large manufacturers and merchandisers accelerated the process of consolidating their supplier base with the goal of having fewer, better and more financially viable partners, according to Hartnett.
Relationships between the remaining vendors, including logistics providers, and customers are becoming deeper as the parties work together on jointly improving operations and sharing the resulting value, security, reliability and risk management.
Many Penske customers have an executive in charge of managing supplier risk with responsibility for evaluating their financial health, doing on-site visits and actively promoting improvements in their operations.
'We didn't have that five years ago,' Hartnett said.