A long and winding road to recovery

Despite sluggish economic growth, U.S. business logistics costs continued to rise in 2011. Logistics costs last year amounted to $1.28 trillion—an increase of $79 billion, or 6.6 percent, over 2010's total. (All monetary figures in this article are in U.S. dollars.) Costs rose in large part due to increased truck and rail rates along with higher costs for warehousing.

Those were among the findings detailed in the Council of Supply Chain Management Professionals' 23rd Annual "State of Logistics Report" presented by Penske Logistics, titled The Long and Winding Recovery. The longest-running study in the field, the "State of Logistics Report" authored by Rosalyn Wilson provides an accepted measure of the size of the U.S. transportation market and the impact of logistics on the U.S. economy. (For more about the report, see the sidebar.)

Article Figures

[Figure 1] U.S. logistics as percentage of GDPEnlarge this image

[Figure 2] Calculation of 2011 logistics costs (in U.S. $ billions)Enlarge this image

[Figure 3] Total U.S. business inventoriesEnlarge this image

[Figure 4] U.S. inventory-to-sales ratioEnlarge this image

To determine how efficiently supply chains are moving the United States' output of goods, the report compares logistics costs against the overall economy. In 2011, logistics costs as a percentage of nominal gross domestic product (GDP) rose to 8.5 percent in 2011, up slightly from 8.3 percent in 2010.

In the 1990s, as the nation's supply chain was shaking off the yokes of rail and truck regulation and bringing free-market processes to bear on the marketplace, a ratio in the single digits was hailed as a breakthrough in logistics productivity. Over the past three years, however, a low ratio has come to underscore a significant decline in shipping expenditures and transportation costs as shippers and carriers downshifted in response to a severe decline in economic activity. In fact, the lowest point ever recorded in the past 30 years was a figure of 7.9 percent in 2009 during the recession. (The report was first issued in 1989, but the first edition included data dating back to 1981.) Figure 1 shows logistics costs as a percentage of GDP for the most recent 10-year period.

Carrying cost breakdown
The report breaks down overall logistics expenditures into three major components: inventory carrying costs, transportation costs, and administrative costs. Inventory carrying costs rose in 2011 to $418 billion—a 7.6-percent hike from 2010. Carrying costs reflect the amount of interest paid on inventory, the expenses for holding inventory in storage (taxes, obsolescence, depreciation, and insurance), and warehousing costs. (See Figure 2.)

The value of the nation's business inventories (which includes agriculture, mining, construction, services, manufacturing, and wholesale and retail trade) rose to $2.1 trillion last year, resulting in much of the increase in overall carrying costs. In her report, Wilson pointed out that U.S. business inventories increased in all four quarters of 2011 such that "inventory levels are now close to the levels that were experienced at the height of the recession, ending the year at the highest point since the third quarter of 2008." (See Figure 3.)

Although inventory levels went up, the interest rate that companies had to pay on that inventory decreased. To determine interest, the "State of Logistics Report" uses the annualized commercial paper rate, which reflects the interest that businesses pay to borrow short-term capital. The commercial paper rate in 2011 fell to the near-historic low of 0.09 percent from .13 percent in 2010. Hence the interest component of carrying costs totaled only about $3 billion.

Taxes, obsolescence, depreciation, and insurance rose 8.2 percent in 2011 to reach $294 billion. Wilson said the hike there was directly related to the growth in inventories. The final component of inventory carrying costs—warehousing expenses—totaled $120 billion in 2011, up 7.6 percent from 2010. That increase occurred because rents for warehousing space have gone up with the rise in inventory levels.

Although the value of inventory rose, the inventory-to-sales ratio (which measures the percentage of inventories a company currently has on hand to support its current level of sales) remained steady. The inventory-to-sales ratio stood at 1.27 at the end of 2011. This is a marked reduction from the high levels in 2009, when the ratio spiked to 1.48 as final sales dropped dramatically during the recession. (See Figure 4.)

The current ratio underscores retailers' success in keeping their inventories lean and requiring their suppliers only to deliver the product they need at that point in time, according to the report. Wilson said the ratio is likely to remain stable as retailers leverage better processes and increasingly sophisticated information technology to more accurately calibrate inventories with end-consumer demand.

Transportation costs rising
Transportation, the second major component of U.S. logistics costs, rose 6.2 percent in 2011. Transportation costs totaled $806 billion in 2011, up from $786 billion in 2010. Higher rates for motor and rail carriers along with those for forwarders were the contributing factors in the hike. As a result, transportation accounted for 5.8 percent of overall GDP in 2011, although that's still below the historic norm of 6 percent.

Wilson noted that trucking, the largest component in the transportation sector, exerted more control over rates than in past years. According to the report, truck rates increased by 5 to 15 percent in 2011. As the result of these rate increases, intercity motor carriage totaled $431 billion in 2011, compared to $403 billion the previous year, and local motor freight reached $198 billion, up from $189 billion. Overall spending on trucking services in 2011 amounted to $629 billion, a $37 billion increase from the prior year. The increase in spending was driven by the higher rates and not due to an increase in volume; with the exception of December, shipment volumes were flat for most of 2011.

Despite higher rates, the trucking industry struggled to cover its operating costs. Truckers dealt with increased driver pay, rising insurance premiums, high diesel fuel prices, and the need to purchase new equipment.

Railroads also were able to increase rates for their services last year. Rail revenue went from $60 billion in 2010 to $68 billion in 2011. Total carloads for the year increased 2.2 percent from 2010 to reach 15.2 million, while intermodal volume rose 5.4 percent to reach 11.9 million containers and trailers. Wilson noted that intermodal has recovered 84 percent of its 2006 volume, reflecting the strong growth in this area.

As for domestic and international water transportation, revenue dropped slightly from $33 billion in 2010 to $32 billion in 2011. Although rail and motor carriers were able to extract rate increases, ocean carriers were not able to do so, in large part because vessel capacity exceeded shipper demand for water movements. In fact, a decline in ocean freight demand—especially during what turned out to be a nonexistent peak pre-holiday shipping season—led to a relatively small gain in containerized volumes, the report said.

Oil pipelines generated $10 billion, the same amount as in 2010 and 2009. Revenue for the airfreight industry dropped slightly from $33 billion in 2010 to $32 billion in 2011. Wilson noted that extra capacity in the airfreight industry led to a decline in loads and downward pressure on rates. Freight forwarders, which include third-party logistics service providers, generated $35 billion in 2011, up from $32 billion last year.

Aside from inventory carrying and transportation costs, two other factors figure in Wilson's computation of business logistics costs. Shipper-related costs, which include the loading and unloading of transportation equipment as well as traffic department operations, totaled $10 billion in 2011. Administrative expenses—which are computed by a generally accepted formula that takes the sum of inventory and transportation costs and multiplies it by 4 percent—amounted to $49 billion.

Looming capacity problems
As for the future, Wilson said most economists have concluded that the economy will not recover at a faster pace. She expects that GDP will stay below 3 percent this year. When the economy does finally recover, Wilson said, shippers would likely confront reduced shipment capacity from motor carriers. Although railroads will be there with additional capacity to pick up some of the shipment demand, shippers should be prepared for fewer trucks, fewer drivers, and fewer trucking companies in the marketplace. "I urge everyone to begin making contingency plans for the day you cannot get a truck," she said.

This article includes reporting by Senior Editor Mark Solomon.