Can we hold the line on logistics costs?

There's no doubt transportation costs have been rising, but how significant is that rise in the context of total logistics costs? The brief answer, based on the 16th annual State of Logistics Report, is "not much."

Transportation costs were on a steady incline each year up to 2002 when, following the dual impact of the September 2001 terror attacks and a protracted economic downturn, total transportation costs dropped from $609 billion to $582 billion (just below the 2000 level).

For 2004, total U.S. transportation costs were $636 billion (Table 1), or 62% of the $1.015 trillion total logistics cost — a record high, narrowly surpassing the $1.006 trillion cost in 2000.

A key difference, though, is that while logistics costs in 2000 represented 10.2% of the U.S. Gross Domestic Product (GDP), this year's percentage matched last year's record low of 8.6%. Rosalyn Wilson, author of the State of Logistics Report, admitted she was surprised to see that the relationship of logistics costs to the GDP remained unchanged from last year, as she fully expected to see the percentage creep back over 10%. Frankly, that's a testament to how efficient shippers have gotten in managing their supply chains.

In the last 20 years, logistics costs have spent more time above the 10% mark relative to GDP. A quick dip to 9.9% in 1993 was followed by a return to double digits for the next five years. But, despite record fuel costs and extremely tight transportation capacity, logistics costs have remained below the 10% mark. In fact, the 8.6% recorded for 2004 is the third year below 9%.

Business inventories have seen some ups and downs during the period, but though total U.S. business inventories reached a record $1.627 trillion in 2004 (Table 2), as a percentage of GDP, they stand among the lowest numbers for the last 20 years. Economic growth, the consumption side of the equation, has been strong, which helped moderate the effect of logistics cost increases and higher inventory levels. Put another way, the inventory-to-sales ratio, which measures sales against inventory levels, is at a record low 1.3 months of supply.

Wilson examined the last five years of data and revised some figures based on improved sources. Using those figures, rail transportation, for instance, showed a 10.5% increase over 2003 levels.

While some volume statistics or earnings data may vary from Wilson's number, she points out that the State of Logistics Report (which is sponsored by the Council of Supply Chain Management Professionals) uses actual costs shippers are paying, including surcharges and fees. So this and the 6.3% increase in intercity motor carriage — from $630 billion to $670 billion (Table 3) — reflect the impact of rate increases, fuel surcharges, accessorials and other fees paid by shippers.

But increased volumes are clearly at the heart of the jump in rail spending in 2004. Wilson is quick to point out that intermodal volumes set records nearly every week during 2004. The $4 billion rise to $42 billion in 2004 may look substantial compared with rail figures that took nearly a decade to increase by that same amount, but Wilson reminds us that North American railroads are operating near capacity, indicating volumes account for much of the increase.

The State of Logistics Report also reflectsa slight rise in domestic air freight. Volume trends examined by some industry sources indicate a shift from domestic air to ground transportation, suggesting that rising carrier costs and rate increases passed on to shippers could be responsible for much of that increase. (Just after the State of Logistics Report was issued, British Airways announced it would institute a fuel surcharge, estimating it would spend $2.86 billion for fuel in the current fiscal year.)

As part of the revision process, however, 2003 figures on spending for freight forwarding services were revised from $10 billion to $16 billion in 2003 (Table 4). The increase in 2004 to $18 billion is significant as a 12% rise, but far less surprising than it would be compared to the unrevised figure.

Warehousing costs saw little change in the historical revisions, but showed a significant rise in 2004. After tracking in the upper $70 billion range for a number of years, adding $1 billion about every other year, warehousing costs jumped $4 billion in 2004 to $82 billion. This was due in part to the increased inventories, says Wilson, and also to the capacity/ demand dynamics of the marketplace. More was spent on public warehousing in 2004, Wilson points out, and vacancy rates are down from 11% to 9%. Companies are building new private and public warehouse facilities, she continues.

Value-added warehousing and distribution performed by third-party logistics providers (3PLs) stood at $31.5 billion of the $89.4 billion total 3PL market, as reported by Armstrong & Associates Inc. The total 3PL market grew by 16.3% from $76.9 billion, according to the Armstrong numbers.

Wilson comments that the current model for measuring warehousing represents a difficult task because the industry has two major segments — public and private — and there are limited data available on a regular basis for the public portion. "The private portion will be imputed and benchmarked when periodic studies are completed," she says.

"There was a concern that third-party providers were not adequately accounted for in the model," Wilson notes. "Many of the services provided by these companies are included in other categories," she points out. Those services include a reported $8.7 billion for asset-based domestic transportation management, $25 billion for non-asset domestic transportation management, $21.2 billion for international transportation management, and another $3 billion for 3PL software.

What lies ahead? We asked James Valentine, senior research analyst with equity research firm Morgan Stanley, to fill in some of the gap between the 2004 figures in the State of Logistics Report and current trends in transportation from the midpoint in 2005.

On the rail side, says Valentine, pricing continues to be fairly strong because the railroads have, for the first time in 80 years, run out of capacity. As a result, the North American railroads are not using incremental pricing as their pricing tool — a practice they've followed for decades. "That is having a profound effect on railroads' ability to pick up pricing," he notes.

Volumes have slowed at bit, continues Valentine, both in terms of industrial commodities and intermodal. He sees this as more of a normal growth curve vs. a "red hot" market in 2004. As we enter the last months of the year, comparisons will be more difficult because of the significant growth that occurred in 2004.

Unlike some prior comparisons where spikes occurred during the earlier period, the growth in 2004 was a result of demand from businesses and consumers, not the result of a one-time event, says Valentine. Some of the 2004 growth may have been pent up demand from the prior two to four years that got concentrated into 2004, but so far in 2005, economic growth has continued.

On the truckload side, the incredibly tight capacity situation and lack of equipment and drivers could be starting to swing the other way, says Valentine. The situation hasn't normalized, but Valentine feels it has passed the peak and this should help moderate pricing. Rates will continue to rise, he believes, but not as strongly as in 2004.

Less-than-truckload (LTL) carriers benefited quite a bit from the issues facing the truckload sector, and some of the freight they gained in 2004 has begun to return to truckload. Those problems (namely, insufficient supply of equipment, lack of drivers and impact of Hours of Service rules) are beginning to moderate, and the unprecedented volume growth some carriers saw — 10% to 15% in some cases — won't continue in 2005.

Here also comparisons are difficult. With uncharacteristically high volume growth in 2004, the "flat" growth carriers are talking about in their quarterly results might be more accurately viewed in the context of the overall growth of the last couple of years. In the final analysis, the volumes are still up.

On the parcel and small shipment side, Valentine describes it as a mixed bag. The shift from air to ground has continued,-in part because of high fuel surcharges that affect the air side. Some shippers prefer to tell customers that instead of next-day delivery, they will get delivery in two to three days, but the transportation cost will be cut in half.

If there's an overarching theme that will come out of 2005, says Valentine, it will be the impact of rising fuel costs. Oil started the year somewhere around $45 a barrel and was over $60 a barrel at presstime. Shippers were actually moving from truckload to intermodal because of the pricing differential, and that's due to fuel costs and fuel surcharges. The same thing is driving domestic air parcel and heavy air freight to move to LTL.

Consumer behavior, in this instance, is different from freight. Higher fuel prices have not significantly deterred drivers, but they have been the impetus behind mode changes for freight. Whether or not oil reaches predicted levels of $70 or $80 a barrel and whether or not prices remain at current levels or take a sudden dip, fuel costs will continue to be a factor. With volumes remaining strong and growing, consumption by the freight industry doesn't appear to be headed for a decline any time soon. The supply side is currently constrained by refining capacity, and that is not something that can be changed overnight either.

Table 1. U.S. Business Logistics Costs — 2004 ($ billions)

Transportation Costs

Intercity Motor Carriage ...........................$335
Local Motor Carriage ...........................$174
Rail .............................$42
Maritime .............................$22
Domestic Waterway ...............................$5
International Air ...............................$9
Domestic Air .............................$22
Forwarders .............................$18
Oil Pipelines ...............................$9

Total Transportation Costs .....................$636

Carrying Costs (based on $1.49 billion total business inventory)

Interest ..............................$23
Taxes, Obsolescence, Depreciation, Insurance ............................$227
Warehousing ..............................$82

Total Carrying Costs ......................$332
Shipper Related Costs ..........................$8
Logistics Administration Costs ........................$39

Total U.S. Logistics Costs ...................$1,015
Source: 16th Annual State of Logistics Report

Table 2. Inventory Performance — 10-year Trend ($ billions)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Value Total Business Inventory $1,211 $1,240 $1,280 $1,317 $1,381 $1,478 $1,403 $1,451 $1,494 $1,627
Inentory Carrying Costs $302 $303 $314 $321 $333 $374 $320 $300 $300 $332
Source: 16th Annual State of Logistics Report

Table 3. Significance of Motor Carrier Costs ($ billions)

2004 2003 2002 2001 2000
Intercity Motor Carriage $335 $315 $300 $333 $323
Local Motor Carriage $174 $167 $162 $161 $158
Total Motor Carriage $670 $630 $600 $666 $646
Motor Carriage
% of Total Transport Costs
80.0% 80.3% 80.2% 81.1% 81.7%
Motor Carriage
% of Total Logistics Costs
50.1% 51.1% 50.3% 51.1% 47.8%
Source: 16th Annual State of Logistics Report

Table 4. Transport Costs — 5-year Trend ($ billions)

2004 2003 2002 2001 2000
Intercity Motor Carriage 335 315 300 333 323
Local Motor Carriage 174 167 162 161 158
Rail 42 38 37 37 36
Domestic Waterways 5 5 6 7 8
Maritime 22 21 21 21 18
Domestic Air 22 21 20 19 19
International Air 9 8 7 6 8
Forwarders & Other 18 16 14 11 10
Oil Pipeline 9 9 9 9 9
Total 636 600 576 604 589
Source: 16th Annual State of Logistics Report


Armstrong & Associates Inc.

British Airways

Council of Supply Chain Management Professionals

Morgan Stanley

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