Trends-July 2008
With Washington abuzz about the fall presidential election, the Federal Reserve dodging rumors of recession-fed inflation, and news outlets awash with images of flood-ravaged Midwest farms and independent truckers protesting rising fuel costs, this year’s annual State of Logistics Report echoed prevailing political and economic circumstances – with some difficult-to-swallow truths, easily digestible speculations, and a ready dose of optimism.
The current state of the logistics industry is rooted in the fact that soaring transportation and inventory carrying costs, conflated with deteriorating domestic consumer demand, have shifted businesses and their supply chains into safe mode – or “Surviving the Slump,” as Rosalyn Wilson titled her annual presentation at the National Press Club in Washington, D.C., June 18, 2008, sponsored by the Council of Supply Chain Management Professionals (CSCMP).
The U.S. economy grew by just 2.2 percent in 2007, the poorest performance in five years, according to Wilson. Weakening economic prospects as a result of the housing market collapse, rising fuel costs, and credit squeeze led to less consumer spending, which fell 3.1 percent from 2006.
With higher inventory and transportation outlay, total business logistics costs were nearly $1.4 trillion in 2007, an increase of $91 billion over the previous year, marking the fourth-consecutive year of record growth. Logistics costs as a percent of GDP rose 10.1 percent, up from 9.9 percent a year ago, and matching figures from the late 1990s.
Despite these sobering statistics, a panel of industry executives corralled by CSCMP to share their own interpretations of Wilson’s report, as well as their experiences operating in today’s marketplace, offered less dire accounts of where the logistics segment is heading.
“It’s not a frightening time to be in this business, it’s an exciting time, a time of change,” observed John Gray, senior vice president, policy and economics, Association of American Railroads. “Fuel is an underlying issue. In terms of capacity the railroads have had a breather, a chance to continue to invest in infrastructure – which takes time. There are a lot of changes, as well as unprecedented opportunities.”
Rick Jackson, chief operating officer of retailer Victoria’s Secret Direct, was equally sanguine: “It’s a great time to be in supply chain management. The spotlight is turned on,” he said.
That spotlight is illuminating both successes and failures. Some U.S. businesses are capably adapting their supply chains to insulate themselves from recessionary pressures. But the stakes have undoubtedly been raised.
Freight transport pricing has been climbing for the past two years. During 2006’s relative calm, companies were broadly challenged with tightening supply lines, investing in new technology and strategies, and working with logistics partners to squeeze out inefficiencies in a lengthening supply chain.
Even as capacity softened, carriers were able to pass along fuel surcharges to customers and maintain respectable balance sheets. Through 2007 and the first quarter of this year, however, mounting fuel costs and more competition for less business has largely neutralized industry profitability.
“Pricing power is now firmly in the hands of shippers, not carriers,” observed Wilson. “As in 2006, fuel surcharges made up most of the industry’s revenue gains. However, there are far more reports of companies unable to fully recover increased fuel costs, either because their market will not allow them to pass surcharges through or because of the lag as fuel prices climb daily.”
Transportation costs rose six percent in 2007 as carriers continued to cope with institutionalized and rising fuel prices, an overabundance of capacity, diminishing demand, and increased competition across modes.
While all transport segments feel the oil barrel burden, the trucking industry has been hit hardest. Small owner operators, without the benefit of size and scale, face the ominous task of eating fuel costs to hang onto business.
In turn, over-the-road shippers continue to explore alternatives to long-haul truck moves, utilizing more cost-competitive modes and configuring distribution networks to leverage shorter transport distances – which has indirectly brought more competition into the short-haul trucking market.
SUPPLY CHAIN CONUNDRUM
The surging price of fuel alone has exacerbated ongoing efforts to reduce total logistics costs throughout the supply chain. But plummeting consumer confidence and falling import volumes have created a supply chain conundrum beyond managing transportation.
While trucking costs in 2007 were up 5.6 percent, compared to 6.7 percent across other modes, inventory carrying costs rose faster than transport spend for the fourth year running, climbing nine percent and accounting for 44 percent of the increase in logistics costs (compared to 52.3 percent for transportation). Warehousing costs rose nearly 10 percent as more businesses hedged the risk of running too lean by holding more stock.
As U.S. shippers exhaust cost-cutting measures on the transportation side, many are looking elsewhere to divine new means for streamlining the supply chain. In her 2006 report, Wilson observed that businesses were proactively positioning inventory farther back in the supply chain to more efficiently and economically match supply to demand and avert risk. In 2007, they had no choice.
“Inventory optimization is again a key issue. It seems like the more we evolve in this industry, the more the problems come back to the same key areas,” said Wilson. “Inventory optimization was paramount in the 1980s and 1990s and we conquered it. Now it is at the forefront again, but the issues are much more complex and more difficult to solve.”
Amidst these challenges, businesses are turning toward inventory management tactics to counter rising transportation costs and meet strategic growth goals.
Having better control of and visibility into product dispersed across the supply chain provides shippers with greater flexibility to explore new, slower, and potentially cheaper transportation options, as well as selling opportunities in emerging consumer markets.
With the devaluation of the U.S. dollar, rising global demand for exports has somewhat offset declining domestic freight movements, which favors staging inventory in a more calculated manner.
TAKING STOCK OF INVENTORY
Inventory management is a critical part of Whirlpool Corporation’s global business, given all the permutations of where product can be located in the supply chain, commented Brian Hancock, vice president supply chain, during the State of Logistics Report’s industry panel discussion.
“We’re looking at inventory from the retailer back to the manufacturer,” he said. “Retailers are more reluctant to carry stock nowadays. So we are utilizing and leveraging size and scale to put in place inventory management techniques to better align production with demand. Globally, we hold more inventory because supply chains elsewhere are less sophisticated.”
By contrast, other companies have successfully applied technology to mitigate demand peaks and troughs. “We have not seen a significant spike in inventory levels as we are doing a better job at forecasting demand,” said panelist Kevin Smith, senior vice president supply chain and logistics, CVS Corporation.
“We have taken visibility down so low that manufacturers are not producing more than we need,” he said. “Power and energy drove industrial growth in the 20th century; in the 21st century success will be driven by an abundance of information, and substituting information for inventory.”
Elsewhere, the inclination to control inventory farther back in the supply chain has helped Victoria’s Secret weather a turbulent retail sales environment.
While brick and mortar growth stagnates, direct channel business is booming. Victoria’s Secret Direct’s global sales have doubled over the past 12 months, which COO Jackson credits to the company’s international expansion, the devaluation of the U.S. dollar, and attention to supply chain management.
“We are tightly tied to sourcing vendors,” he said during the panel discussion. “It’s especially important in tough economic times to take a disciplined approach to inventory management. We source globally; transport all products to Columbus, Ohio; pre-package items at the point of origin so we can bypass nodes and deliver direct to consumers. Essentially we’re placing inventory closer to market.”
BANKING ON WHOLESALE
Reflecting this trend line, the volume of wholesale inventories surpassed retail inventories for the first time in December 2007 and has continued into the first quarter of 2008, according to Wilson.
Stockpiling product is an inherent consequence of a sluggish economy. But what is particularly striking in today’s market, given the advances global businesses have made in streamlining processes, is that inventory turn efficiency has dropped.
“While much of the recent increase in inventories is attributable to changes in the way we are handling stocks in the global environment, in 2007 we began to see inventory buildups attributable to unsold products as the economy slowed,” reported Wilson. “The significant order lead times required when sourcing offshore have led to a less nimble system that cannot make adjustments immediately.”
Efforts to more accurately track consumer purchasing patterns and manage inventory closer to supply are helping businesses respond more efficiently to demand variability – as well as rationalize transportation costs. The need for greater global scalability is also impacting how businesses configure and operate stateside distribution networks.
“The move to more regionalized distribution centers continued in 2007, with many more firms announcing plans to relocate or open new centers serving smaller markets,” said Wilson.
The current fuel crisis is compelling manufacturers in fast-moving consumer goods product industries to look differently at distribution models – considering eight, 10, or 15 distribution points to serve domestic markets more efficiently. “We’re also seeing a transition to more long-haul rail and interest in second-tier distribution markets,” noted panelist Cliff Otto, president of 3PL Saddle Creek Corporation.
CVS, for example, has scaled its distribution network to be more responsive to changing demand patterns. “Some time ago we made the decision to move toward smaller distribution footprints closer to markets we serve, shortening the length of hauls. At first it was a capacity issue, now it’s an economic one,” said Smith.
CHALLENGES AND OPPORTUNITIES
As economic downturns come and go, businesses are predisposed to think and act in the present. Shippers are bent on reducing transport costs, often seeking out spot capacity and partners on price alone; carriers are downsizing their fleets and restructuring go-to-market strategies to offer more value-added services.
An emerging reality, which Wilson highlighted and panelists affirmed, is that short-term myopia is setting the table for a major capacity pinch when the economy rebounds.
“Poor industry performance is leading to a loss in capacity, as companies first idle and then sell off their excess equipment or leave the market altogether,” reported Wilson.
“Adding to this is a drop in plant and equipment investment as companies put off spending. The diminished industry capacity will have serious repercussions when the economy turns around, probably returning us to the backlog and bottleneck crisis we experienced just a few years ago.”
Such a development would aggravate latent concerns largely masked by a soft market – driver shortages, aging infrastructure, and congestion – and severely compromise and constrain industry’s capacity to meet consumer and market expectations. Fuel price angst will be further compounded by greater competition for capacity, leaving carriers with the upper hand and shippers with little recourse.
While the United States may be on the precipice of recovery, a number of issues need to be addressed with regard to capacity – including Hours of Service regulations, the trend toward shorter length hauls and increased lag times and congestion, according to Jim O’Neal, president of O&S Trucking.
“We are headed for a major capacity crunch that might make 2004/2005 seem like a cakewalk,” he said during the panel discussion.
Economic concerns notwithstanding, panelists were largely optimistic that the trucking industry is capable of meeting these challenges with further investments in technology, facilities, and infrastructure.
In some regards, the Federal Reserve’s reluctance to officially label the current economic downturn a recession mirrors the pluckiness of the logistics segment. When all indications point to a looming crisis, creative companies turn challenges into opportunities.
Case in point: CVS’s Kevin Smith preferred to view Wilson’s “surviving the slump” descriptor in a more positive light: namely “squatting to jump” – and presumably from an airplane with a parachute than from a bridge.
“There are opportunities for companies to capitalize on business advantages. A lot of these current issues are cyclical. But many global economies have strong GDP growth,” he concluded.
“Positioning and planning for the future is contingent on how we strategize for a surge in business, not a slump.”
State of Logistics: 2007 Trends By Mode
AIR FREIGHT
While the airfreight industry recorded a drop in tonnage over 2006, revenue grew by $3 billion during 2007, an increase of 8.9 percent. Carriers have been aggressively raising rates and implementing surcharges to cover rising fuel prices, reported analyst Rosalyn Wilson at her annual State of Logistics Report presentation.
They are also downsizing fleets in under-performing domestic lanes, expanding services in thriving global markets, or considering strategic outsourcing alliances, as DHL’s recent domestic air cargo partnership with UPS illustrates.
TRUCKING
Of all modes, the trucking industry has been on the most precipitous downward spiral, with volumes dropping for the second consecutive year. Trucking costs increased by $36 billion in 2007, up 6.1 percent over 2006 levels. While large carriers are holding their own, small operators are dropping off at a meteoric pace.
Close to 2,000 trucking firms failed in 2007, and an additional 935 companies went out of business in the first quarter of 2008, reports Avondale Partners industry analyst Donald Broughton. Capacity and driver shortage concerns will become even more manifest when the economy rebounds, according to Wilson.
MARITIME
Maritime and domestic water traffic rose a modest 3.4 percent in 2007. However, all three components of this sector—rivers and canals, Great Lakes, and ocean shipping—showed declines in ton-miles carried in 2007. The shift in container trade focus from West Coast to East Coast is gradually becoming apparent.
While traffic through the nation’s ports grew 2.6 percent in 2007, the Port of Los Angeles experienced a 1.4-percent decline in TEUs. Conversely, the Port of Savannah marked a record year with container volumes topping out at more than 2 million TEUs, an increase of nearly 27 percent from 2006.
RAIL/INTERMODAL
U.S. railroads didn’t top 2006’s record-breaking tonnage year, as drops in domestic volumes due to the housing and construction market collapses took some steam out of the industry’s momentum.
Still, the sector marked its second-best tonnage year and the cost for rail transportation rose 7.4 percent in 2007, with revenues for Class I railroads up $3.6 billion, according to Wilson. As further evidence of the industry’s positive outlook and increasing appeal to long-haul domestic shippers, freight revenue per ton-mile increased to 2.99 cents, from 2.84 cents in 2006.
A Tale of Two Markets
Recent U.S. intermodal shipment trends reflect broader challenges facing both global and domestic shippers in today’s uncertain economy.
While intermodal revenue for international shipments continues to track a downward path, domestic shipments are showing a noticeable uptick, according to The Intermodal Monthly Update published by FTR Associates, Nashville, Ind., and Gross Transportation Consulting, Port Washington, N.Y.
International volumes in April edged down 0.1 percent from year-ago levels, while domestic volume surged 9.6 percent. Year-to-date figures tell a similar story: international volumes are down 3.9 percent while domestic volumes have increased 3.7 percent.
This dichotomy illustrates the different factors influencing import and domestic sectors. International performance is hindered by the weak economy, a devalued dollar, and freight diversion from intermodal to all-water routings.
By contrast, sky-high and still increasing fuel prices have stoked interest in domestic intermodal loadings. The overall economic outlook remains cloudy for the intermodal industry with high oil prices and the weak dollar negatively impacting the international sector in the near term, the report concludes.
Logistics Education Inside the Quad Cities
As transportation, distribution, and logistics become likely sectors to replace lost manufacturing capacity abroad, some Midwest economic development consortiums are taking an innovative grassroots approach to building a viable labor pool.
The Quad City Economic Development Group, for example, is creating a logistics education network tailored to the region’s unique business needs.
Within the past year, both Eastern Iowa Community College District and Blackhawk College have collaborated to solicit and receive a $1.5-million grant from the U.S. Department of Labor to develop a comprehensive logistics education curriculum for the area.
The “Joined By A River” grant supports varying aspects of logistics and supply chain learning, from non-credit classes for entry-level warehousing and transportation disciplines to undergraduate and graduate degree programs in supply chain management.
The “Joined By A River” grant is sponsored by the local community colleges, The Quad City Development Group Industry Roundtable, and the private sector, which together help develop key aspects of the integrated logistics curriculum.
In turn, there is widespread industry support for recruiting and hiring students from the program.