Recession resets logistics landscape
Study shows freight costs fell in '08 as businesses adjust supply chain strategies
By Eric Kulisch
Logistics costs for U.S. businesses fell $49 billion in 2008 to $1.3 trillion, or 9.4 percent of Gross Domestic Product, according to the 20th annual State of Logistics report released June 17 by the Council of Supply Chain Management Professionals.
In 2007, logistics costs rose to 10.1 percent of GDP, capping a five-year period in which spending on freight transportation, warehousing and supply chain management rose 50 percent. 2008 is the first time in six years that total logistics costs decreased.
Previous decreases in logistics spending compared to economic growth during the past quarter-century typically indicated efficiency gains achieved by the logistics sector. But the 3.5 percent decline in logistics costs in 2008 was primarily due to the economic crash and the reduced amount of freight being moved and stored, according to the report authored by analyst Rosalyn Wilson.
A major factor holding down logistics costs was a 13 percent reduction in inventory carrying costs, as interest rates for commercial paper dropped to half (2.38 percent) of the 2007 rate, Wilson said. A 2.2 percent drop in inventories as businesses replenished fewer goods also contributed to the lower carrying costs, including taxes, obsolescence, depreciation and insurance. But a reflection of the poor economy is that the inventory-to-sales ratio jumped at the end of 2008 as a slump in sales prevented companies from drawing down their inventories to meet new demand levels.
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CSCMP President Rick Blasgen, speaking at an event earlier in the month hosted by the RAND Corp., said that low interest rates have covered up for poor inventory planning, and that companies now need to collaborate better with suppliers on demand forecasts in order to further lower total logistics expenses.
Rising interest rates and an expected uptick in inventory levels will cause a slight rebound in inventory costs for 2009, Wilson predicted during a press conference in Washington. Inventory levels and costs have probably bottomed out, but any changes will be gradual as interest rates and the economy slowly recover, she said.
FedEx Corp. CEO Frederick W. Smith said during his company's fourth quarter earnings conference call the same day that customer inventories are beginning to match sales activity, which should lead to more restocking and increased shipments for the delivery company.
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A continuation of lean manufacturing and retail inventories will likely force more shippers and logistics providers to consider converting excess warehouse space into cross-dock facilities, said Clifford Otto, president of Saddle Creek Corp., a privately held Lakeland, Fla.-based third-party logistics provider.
Interest in cross-docking coincides with another recent trend in which companies are decentralizing distribution facilities and moving them closer to regional markets. The shorter lengths of haul are intended to provide more responsive customer service and reduce transportation costs as diesel fuel and other trucking costs rise.
'I think that creates an opportunity to do more cost effective distribution while using traditionally higher cost modes like less-than-truckload,' Otto said at the press conference.
Hub-and-spoke LTL carriers that consolidate multiple customer shipments for long hauls and then resort them on local delivery trucks, typically build long, narrow buildings with lots of docks on each side to minimize travel distance from inbound to outbound vehicles.
Now, some warehousing operators that use multiple trucking providers or their own fleets are replicating those operations to find an alternative use for idle space while helping shippers move products to market more quickly and reduce storage costs.
Cross-docking can take several different forms, from direct transfer between trucks to temporary staging on the warehouse floor to customized reconfiguration in which different products are staged from one to three days and then consolidated to create a store shipment.
Saddle Creek has converted two conventional warehouses to partial cross-dock facilities in which shipments flow around a corner of the building. The manufacturer delivers bulk shipments to the distribution center and Saddle Creek breaks them down for delivery to stores, or local depots in the case of food and beverage products.
Saddle Creek has also specifically designed some full-scale cross-dock facilities for customers.
Otto said some manufacturers are deciding to stratify their product distribution based on the regional distribution strategy. The smaller distribution centers contain the 20 percent of fast-moving inventory that represent 80 percent of their volume and larger, national warehouses store the remaining stock keeping units (SKU) that sell more slowly. These products are picked to order or routinely shipped once or twice a week to the smaller DCs.
'That way you don't have to store every SKU at every single location. You cross-dock the slower-moving SKUs with the faster-moving stuff at the warehouse,' Otto elaborated after the event.
Traditional warehousing will also decline as companies improve supply chain efficiency and collaborate with upstream and downstream partners to better forecast orders, said Paul Avampato, vice president for process redesign at Kraft Foods North America.
Transport Supply/Demand. Transportation costs were relatively flat (up 2 percent) from 2007 levels, propped up in the first half of the year by high fuel surcharges, according to the State of Logistics report. Transportation's share of logistics costs almost held steady at 6.1 percent of GDP versus 6.2 percent last year, while inventory costs fell to 2.9 percent compared to 3.5 percent in 2007. Trucking costs were only up 1.3 percent, while rail transport costs were 10.5 percent more last year in large part because railroads were slow to roll back fuel surcharges as oil prices plunged in the second half of the year. The cost of warehousing rose 9.5 percent in 2008 as goods stayed on warehouse shelves longer, Wilson said. Trucking and rail rates were down substantially as carriers tried to retain customers amid falling demand for service and abundant capacity.
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| Rosalyn Wilson analyst and author, State of Logistics |
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| 'We will not return to pre-recession levels until probably late 2010. Freight volumes will begin to rise consistently in the fourth quarter of 2010, but carriers will still find it difficult to raise rates.' | |
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Truck tonnage in the second quarter was off 6 percent from the same year-ago period. In May, truck tonnage contracted 11 percent compared to 2008, according to the American Trucking Associations. That was the best year-over-year result in three months ' an indication of how bad things are ' and represented a modest 3.2 percent increase in the organization's monthly tonnage index from April of this year.
Wilson forecasts that the United States would experience a slow, U-shaped recovery, which means 'we will not return to pre-recession levels until probably late 2010. Freight volumes will begin to rise consistently in the fourth quarter of 2010, but carriers will still find it difficult to raise rates.'
The transportation analyst and statistician said companies should use the temporary lull in economic growth to restructure their supply networks and strengthen relationships with transportation providers to prepare for a return of consumer demand, which she judged will not return to the same levels experienced prior to the recession because people have become accustomed to saving more and home values that allowed them to cash in on their equity for lifestyle purchases have reversed.
In the past two years, Americans have gone from about a 1 percent savings rate to saving almost 5 percent of their income. Every 1 percent of savings takes $100 billion out of economic circulation, according to economists.
A survey of more than 5,000 Americans by business turnaround specialist Alix Partners also found that lower levels of spending could be structural and last for almost a decade after the recession ends. Respondents said that their spending will return to just 86 percent of pre-recession levels, which equates to a 10 percent drop, or more than $1 trillion per year, in GDP.
Alix Partners acknowledged that respondents may have inflated how much they intend to save given the immediacy of the crisis, but said that Americans' attitudes toward risk and saving have fundamentally changed.
Wilson and others warn that so much trucking capacity has been removed from the market during the recession that any spike in freight demand next year could lead to serious equipment shortages for shippers. Although the economic downturn officially began in December 2007, the freight sector began experiencing recessionary effects as early as the second half of 2006. Truckload capacity was down 7 percent in 2008 alone as more than 3,000 small carriers went out of business and larger companies continued to idle their fleets or sell used equipment overseas.
The truckload sector will be the first to experience a capacity crunch because it has shed the most equipment and drivers. But if the country experiences a slower recovery instead of a V-shaped one, then the trucking industry should be able to meet demand, Otto said. LTL carriers have more slack in their systems.
But John Lanigan, vice president and chief marketing officer at BNSF Railway, said he expects consumer spending to return to previous levels once people regain confidence in the economy.
'I have 23 and 26-year-old kids. They can't wait to start spending again. We have conditioned our society to buy stuff. It's only a matter of time. That savings rate is going to go up and it's going to burn a hole in the pocket of the people that save it,' he said.
The focus on maintaining tight inventory levels and adding more distribution nodes places a premium on shorter transit times and reliable service. The requirement ostensibly favors trucking as the preferred freight mode for shippers. But Lanigan argued that railroad intermodal service has improved to the point that it is very competitive with over-the-road trucking on short-haul routes.
U.S. railroad executives say that on certain lanes where there is enough volume and truck-rail transfer facilities, short routes of 500 miles or less can make sense, especially as fuel costs increase. The railroad industry mantra is that one ton of freight moves 436 miles on one gallon of diesel fuel. Truck conversion may accelerate with the passage of any energy legislation that would raise fuel prices by capping carbon emissions and require industry sectors to buy and trade pollution allowances, said Charles Eisele, senior vice president of strategic planning for Union Pacific, at the RAND event.
BNSF, for example, is experimenting with intermodal service on corridors such as Houston-to-Dallas, a traditional truck market, Lanigan said.
The western railroad has taken advantage of the slack demand to re-examine every business process from freight pickup to delivery and every step in between to improve its service levels, he said. Some employees who might have been laid off as part of corporate cost-cutting efforts have instead been assigned to process improvement teams tasked with finding ways to better operational efficiency.
In the first quarter, the railroad announced it had sliced 12 hours off the average transit time for intermodal shipments and that its on-time performance hit 95 percent ' the highest in its history.
The goal of the efficiency initiative is to maintain the service levels even when volumes increase again, Lanigan said.
More shippers are turning to intermodal as a cheaper alternative to truck transport, notwithstanding a 17 percent drop in intermodal traffic through the first half of the year due to the economic slump.
Limited Brands Inc., for example, has used intermodal transport inbound from the factory to its distribution center in Columbus, Ohio, for product lines that are less time sensitive, but is starting to use intermodal for the line-haul portion of outbound moves from the DC to West Coast stores because of the increased service reliability, said Rick J. Jackson, executive vice president of Limited Logistics Services.
(For more detail about railroad efforts to attract regional intermodal freight business, read 'Sweetening the 'sweet spot' ' June American Shipper, pages 38-41.)