The big squeeze

In 2016, the title of the annual "State of Logistics Report" was "Logistics in Transition: New Drivers Behind the Wheel." That title referred to the growing influence of consumers over when, where, and how their e-commerce orders are processed and delivered.

The 2018 report, "Steep Grade Ahead," might just as easily have been called "Carriers Grab the Wheel Back." With a healthy economy and strong consumer spending driving demand for transportation services and low unemployment rates exacerbating a labor shortage, capacity is tight, and carriers find themselves in a position of strength. After years of downward pressure on rates, carriers in several modes were able to raise rates in 2017. And although shifting U.S. trade policies have introduced uncertainty, the forces that affected rates and capacity last year "show no signs of easing in 2018," the report's authors say. In short, it's likely to remain a seller's market for a while.

Article Figures

[Figure 1] U.S. business logistics costsEnlarge this image

[Figure 2] U.S. business logistics costs as a share of nominal GDPEnlarge this image

Meanwhile, the shifting demand patterns, technological advances, and new competitors cited in previous reports have not gone away. In fact, startup activity in logistics technology reached the "highest levels in recent history," the 2018 report says. These trends suggest shippers will turn to technology in their quest to offset tightening capacity, forestall rising costs, and improve risk management.

The "State of Logistics Report," now in its 29th year, is issued by the Council of Supply Chain Management Professionals (CSCMP) and presented by Penske Logistics. Written by the global management consulting firm A.T. Kearney, the report provides an overview of industry trends and U.S. business logistics costs for the previous year. It also includes a review of macroeconomic factors affecting logistics costs, analysis of each major logistics sector, insights from industry leaders, and discussion of important trends and their potential implications for the future. (For more information about the report, see the associated sidebar.)

Growth is good, but ...

A review of the report's major findings reveals a tale of economic expansion that has created some problems for shippers. U.S. gross domestic product (GDP) grew by 2.9 percent in 2017. While that growth was favorable to the economy as a whole, the resulting demand for transportation and logistics services outpaced supply in every sector last year, according to the report.

The supply/demand disconnect was a major factor behind higher logistics costs in 2017. As shown in Figure 1, total U.S. business logistics costs rose 6.2 percent year-on-year. Costs rose for all three cost components: transportation, inventory carrying costs, and "other costs." Transportation saw the greatest increase, jumping 7 percent year-on-year. Within that sector, trucking and rail experienced the biggest hikes, at 7.8 percent and 8.2 percent, respectively. Transportation includes truck, rail, water, air, parcel, and gas and oil pipeline movements.

After declining by 4.1 percent in 2016, inventory carrying costs turned sharply upward, rising 4.6 percent last year. That swing was fueled by rising interest rates, which helped to push up inventory financing costs by 5 percent, and by low vacancy rates for warehouse space, which boosted storage expenses by 4.2 percent. Inventory carrying costs include storage costs; financial costs (the weighted average cost of capital for U.S. public companies multiplied by the value of total business inventory); and "other" costs (obsolescence, shrinkage, insurance, and handling).

The third major component, simply labeled "other costs," rose 4.9 percent in 2017. This category includes carriers' support activities (such as arranging transportation and packing and crating) and shippers' costs for wages, benefits, and technology that directly support logistics activities.

All told, total U.S. business logistics costs hit $1.5 trillion in 2017. That equated to 7.7 percentof the U.S. gross domestic product of $19.4 trillion, up a tad over the previous year's figure of 7.6 percent (see Figure 2).

Transportation: Capacity still shrinking

A "rare combination of strong demand and stagnant capacity" caused by a worsening driver shortage, record-low unemployment rates, and disruptions caused by hurricanes Harvey, Irma, and Maria, were among the factors that exerted upward pressure on pricing in 2017, according to the report.

As shippers vied for access to limited capacity, carriers raised their rates. Trucking costs overall rose 7.8 percent, with full truckload up 6.4 percent and less-than-truckload rising 6.6 percent. Spot rates jumped by 20 to 30 percent, and contract prices rose 5 to 15 percent, according to the report. Rising revenues, the report says, allowed carriers to order more trucks, invest in mergers and acquisitions, and enjoy "a return to normal profitability after years of subpar returns." But as their revenues rose, so did their operating costs, most notably wages and diesel fuel prices.

Shippers are deploying an array of tactics in a bid to assure capacity, according to the report. Some are becoming the efficient "shippers of choice" favored by carriers, while others are relying on freight brokers. Still others are leasing dedicated fleets to lock in capacity. In fact, spending on private and dedicated fleet (up 9.5 percent) experienced the biggest increase of any transportation sector. The growing cadre of online load-matching platforms also is helping shippers marry loads with trucks.

One company that's using technology to deal with tight capacity is Corning Inc., a manufacturer of glass-based products. Corning is "heavily investing" in predictive analytics, global trade management software, and other supply chain technologies, said Cheryl Capps, vice president global supply chain, at a press conference where the "State of Logistics Report" was released. That effort has paid off, allowing Corning to prevent any deterioration in service to its customers, she said.

Similar to the effect it had on motor carrier costs, the expansion of electronic commerce sparked increased spending on parcel and express services. Spend for parcel and express services rose 7 percent to $99 billion in 2017. FedEx, UPS, and the U.S. Postal Service all put through price increases averaging about 5 percent. UPS also imposed peak-period surcharges that ranged from 27 cents to 97 cents, depending on the service, says the report.

Even higher prices are looming. One reason is that oversized shipments, the fastest growing e-commerce segment, are difficult for parcel carriers to handle. "More hikes seem likely as carriers seek to recover the high costs of delivering bulky merchandise," the report's authors predict. Longer-term, parcel carriers must also recover the costs of investing in technology and in last-mile solutions that meet consumers' rising service expectations. For example, labor costs, which rose 9 percent in 2017, represent about 75 percent of last-mile costs, according to the report.

Railroads did well in 2017, as robust economic growth and increased demand from shippers seeking alternatives to truckload enabled rail carriers to raise their rates. Overall, spending on rail shipments rose 8.2 percent last year. Carload costs rose 7.3 percent. But the big winner was intermodal, where spending jumped 10.7 percent. Price hikes for intermodal, coal, and chemical shipments, coupled with new efficiencies and increased train speeds and lengths helped to improve operating ratios.

Still, the rails continue to face a competitive challenge from truckload carriers, particularly when it comes to service quality. The number of service complaints to the Surface Transportation Board in 2017 was 144 percent over the number of complaints filed in 2016, notes the report. One factor was the disruptions caused by last year's flooding and hurricanes. Service has also suffered because intermodal demand is growing faster than railroads can add capacity, said Erik Hansen, vice president intermodal for the Kansas City Southern Railroad, at the press conference.

Although U.S. ports handled a record 23 million ocean containers last year, spending on water transportation rose just 1.1 percent in 2017. Kearney's researchers attributed that slow rise to price cuts aimed at encouraging shippers to use East Coast ports and a lack of pricing discipline among carriers that kept some rates at or below last year's levels. But rates on some lanes have started to bounce back as demand growth, at 5 percent, exceeded capacity growth of just 3.9 percent. Overall, it was a remarkably good year for container carriers, which recorded profits of $7 billion after posting combined losses of $3.5 billion in 2016, according to the report.

The good times may not last. After several big mergers among container lines, the five largest carriers control about 64 percent of the world container market. There likely will be enough excess capacity to keep things competitive, the authors observed, adding that unstable U.S. trade policy and the prospect of trade wars could affect shipping volumes and pricing.

Like parcel shipping, the airfreight business has also benefited from e-commerce. Volumes rose by 9 percent last year, with spending on air freight up 3.1 percent. That rise was largely powered by the semiconductor, pharmaceutical, and electronics industries, but online orders played a significant role as well.

Despite growing demand, air cargo capacity rose by just 3 percent, according to International Air Transport Association (IATA) estimates. Demand pressures are encouraging the traditionally tech-averse airlines to adopt new technologies such as electronic air waybills and real-time tracking. A dearth of cargo space translated to higher rates for shippers. Airfreight prices rose 4 percent last year on major East-West routes, a welcome development for airlines that must contend with rising jet fuel prices, their largest cost driver. "With jet fuel pricing now trading over 50 percent above last year's levels, and airline CEOs determined to maintain yields, air shippers shouldn't expect rate relief in 2018," the report forecasts.

Warehousing and 3PLs: Innovate or die

In addition to reviewing each of the various transportation modes, the report also analyzed the general state of the warehousing and logistics service provider market. According to the report, e-commerce is reshaping warehouse networks, facilities, and operations. To meet shrinking delivery lead times and reduce order delays and stock shortages, e-commerce shippers are moving goods closer to their end customers, including in costly urban areas. They're also adding overflow capacity and increasing inventory levels and safety stocks.

Together, these conditions are driving up demand for warehouse space. Availability tumbled to a historic low of 7.3 percent in the first quarter of 2018, according to a CBRE report cited in the "State of Logistics Report." Meanwhile, rental rates rose 5.9 percent last year. At the same time, labor is increasingly hard to come by, and costs, competition, and consumer expectations keep escalating,

In the response to these challenges, the report says, warehouse operations "must innovate or die." For many, that means investing in automation, a necessity for e-commerce delivery options such as ship from store or in-store pickup of online orders. Robotics and goods-to-person systems also promise to help warehouse operators handle higher order volumes in a tight labor market. Now is a good time to invest in automation: New tax laws allow businesses to accelerate the write-off of the cost of new equipment and buildings for the next five years.

Similar opportunities and challenges are facing third-party logistics providers (3PL), many of which are warehouse operators. Between 2017 and 2019, the U.S. 3PL market is expected to grow at a 5.5 percent rate, to $195 billion, according to the research and consulting firm Armstrong & Associates, the source of most 3PL data in the report. But the capacity, cost, and labor challenges facing the warehousing industry are also having an impact on 3PLs. The survivors will be those "innovative 3PLs that can help shippers improve supply chain efficiency and reduce total cost of ownership," the report's authors wrote.

A high priority for 3PLs will be to win more omnichannel fulfillment work—the fastest growing business segment. To do so, however, requires costly investments in warehouses and distribution centers, as well as better management of assets, expediting last-mile deliveries, and improved inventory control across multiple nodes. But the automation and digital technologies that enable efficiency and collaboration also create new competition and the threat of disintermediation for traditional 3PLs. It's a risk they must take, in the authors' estimation. "Amid these opportunities and threats, one thing is clear: technologies underpinning the Fourth Industrial Revolution (from blockchain and IoT [Internet of Things] to 3D printing and quantum computing) also hold the key to strategic collaboration between shippers and 3PLs in the coming decade," they write.

Five trends will shape the future

After summing up this year's important findings, the report forecasts five long-term trends that will shape the future of logistics. These include:

1. Consumers' expectations for fast delivery of e-commerce orders will continue to challenge retailers, carriers, and logistics service providers. In response, warehouses will continue to get smaller and move closer to customers, while competition for both unskilled and technically literate labor will raise wages for traditional industry jobs.
2. Technological disruption will intensify in the next few years. Four categories of technological innovation in particular—the "sharing economy," the Internet of Things and big data, on-demand logistics, and autonomous and automated equipment solutions—will have the greatest impact. In the near term, artificial intelligence, autonomous mobile robots, the "Uberization" of freight through supply and demand matching, and blockchain applications will create disruptions while bringing new efficiencies and lower costs to supply chains.
3. The U.S. transportation infrastructure will continue to badly need repair. As the aftermath of hurricanes, floods, and snowstorms has shown in recent years, the resilience of the nation's transportation infrastructure is a concern not only for individual companies but also for the U.S. economy.
4. Transportation regulations will exacerbate already tight capacity. The authors focused on the new requirement that most vehicles have electronic logging devices (ELDs), which electronically track compliance with driver hours-of-service regulations. Smaller fleets that did not have ELDs and may previously have skirted regulations are reporting reductions in miles traveled per day of up to 15 percent.
5. Worries about trade wars and threats of "tit-for-tat" tariffs will continue to create business uncertainty. While it's too early to tell how this will play out, shifting policies are unsettling international traders. Prolonged uncertainty and higher costs will cause them to rethink global supply chains.

All signs point to a costly scenario for logistics in the coming year—the "steep grade ahead" of the annual report's title. With carriers in control as demand outstrips supply, shippers are trying to "create capacity" by improving efficiency. At the same time, rising e-commerce volumes are shifting attention to the supply chain. "Companies that recognize and capitalize on this trend will succeed, with smart technology investments and astute strategic choices separating winners from losers," the authors conclude.

A change in thinking may also be in order. "[O]ur approach has shifted; now we are looking at transportation and logistics as an investment, as opposed to a cost," said Sylvia Fouhy, vice president customer experience, North America, for the health-care products giant Johnson & Johnson, at the "State of Logistics Report" press conference."Rising demand and costs has brought us to a pivot point where we must change our strategy. We're not in it for the short haul, we're in it for sustainability."