As sourcing from China surges, import traffic growth is straining U.S. West Coast ports and inland distribution infrastructure. More shipments are arriving late. Transit time variability is driving up costs. Importers are holding more inventory in safety stock to protect against the vagaries of their extended supply chains. As much as half the air freight from China to the U.S. could be upgraded ocean freight that's flying to ensure schedule integrity.
That's a high price to pay for low-cost manufacturing.
Looking into the future, consumer goods alone are expected to grow 3 million TEUs from 2005 to 2010—a 60% increase in volume. Intermediate goods should grow 1.4 million TEUs or 70% in volume during the same period.
Half the volume of ocean container imports comes through West Coast ports (Los Angeles/Long Beach, Oakland, Seattle/Tacoma). Those ports are already congested and operate at or close to full capacity during peak periods. Efficiency improvements are marginalized by constraints and bottlenecks in inland transportation.
Import growth, coupled with insufficient new investments in port and inland transport infrastructure is actually decreasing reliability and driving up total supply chain costs. Even at conservative growth estimates, West Coast ports will be operating at full capacity year-round as early as 2007. Larger ships offer a lower cost on port-to-port transit, but they increase landside congestion as they unload greater numbers of containers during a single port call.
Intercontinental supply chains are inherently longer (5,000-8,000 miles) and more complex than domestic supply chains. Moreover, intercontinental supply chains typically involve multiple independent transportation and logistics providers to complete door-to-door transport. An example of how this looks extending from plants in China to distribution centers in Ohio is shown in the chart below. By their very nature, hand-offs from one provider to another create opportunities for delay and potential service failures.
Firms that source from Asia consciously accept higher supply chain costs in order to capture greater savings in production costs. However, many shippers are learning the hard way that "hidden costs" of Asia-anchored supply chains are so large they can impact overall company performance. Foremost among these hidden costs is variability in doorto-door transit times.
Because a growing number of shipments are not getting through on time, many shippers are forced to recover using increasingly expensive air freight or to bear the higher cost and lost flexibility of larger safety stocks. Some U.S. retailers can attest to the measurable bottomline impact of Asian supply chain problems. For these shippers, total supply chain costs seem to be headed inexorably upwards even if port-to-port rates decline due to overcapacity in transpacific lanes.
Historically, shippers have had few viable options to reduce the financial impact of slower and less predictable ocean transit times:
- Less than containerload (LCL)— Multiple shipments are combined into a single ocean container.
- Full containerload (FCL)—A customer purchases the use of an entire 20-foot or 40-foot container.
- Air freight.
The vast majority of transpacific trade can't bear the cost of air freight, which can be 7-10 times that of ocean transport. The steady stream of "emergencies" resulting from delayed ocean shipments represents big business for air freight carriers. MergeGlobal estimates emergency upgrades of ocean shipments account for roughly half of eastbound transpacific air freight tonnage.
Thus most shippers are forced to depend on an increasingly fragile ocean transport system. What other options do service-sensitive shippers have?
Use alternative ports. One option is to ship via all-water routings to ports on the U.S. Gulf Coast and East Coast. These routings are constrained by limited capacity (inability to handle post-Panamax ships) and rising tolls through the Panama Canal along with operational challenges (channel depth and bridge clearances) at many East Coast ports.
Upgrade LCL to FCL. LCL is the most economical way to move smaller consignments, but it comes at a cost of 15% to 20% longer transit times and lower on-time delivery rates—both due to the requirement to consolidate and deconsolidate shipments at either end of the ocean voyage. For this reason, many shippers use FCL service even though their consignment may occupy only a fraction of the space in the container.
Upgrade from rail to truck for inland delivery. Trains are the most economical way to move goods from arrival ports to interior points in North America, but the rail system has bottlenecks of its own. The fastest way to get goods from port to consignee is via a dedicated truck.
The hard reality for most ocean shippers is that they must continue to rely on increasingly congested West Coast ports. The fragility of the ocean system creates significant inefficiencies for shippers. Shippers bear a higher transportation cost per unit when they pay for a dedicated container (FCL) to move relatively small consignments. Worse, FCL shipments that move through the inland rail network are subjected to another, and often much worse, set of bottlenecks and delays—which further drive up shippers' total supply chain costs.
Need should be driving an intermediate solution; and it has. Over the years, there have been a number of proposals to launch new intercontinental transportation systems based on technologies such as "fast ships." While these ideas are intellectually interesting, and several have been studied seriously by at least one of the big integrated carriers, the fact is that no new-technology transport system has been introduced. The main reason is that such solutions are capital intensive and no firm with adequate capital has been comfortable with the basic question of "if we build it, will they use it?"
If you can't move the ships faster, can you move the freight faster? The alternative to faster ships is a more efficient process using existing infrastructure. Targeted shipments could receive expedited processing at origin and destination ports. Then the shipments could link with an efficient landside network for delivery. That's the concept developed by APL Logistics and Con-way Freight.
APL Logistics and Con-way jointly announced OceanGuaranteed in August and launched in early September (See "Ocean Service Will Compete with Air," pg. 14). A key to the service is the control APL Logistics can exercise over terminal operations at origin and destination. Its landside operations are integrated with its sister company APL Liner for the long-haul ocean move. Once the shipments arrive at the Port of Los Angeles, they are introduced into Con-way's domestic lessthantruckload (LTL) network.
APL Logistics and Con-way are targeting efficiency improvements where land and water meet. More predictable transit times, regardless of how they are achieved, would permit inventory takeouts that free up working capital and reduce inventory carrying costs (including the risk of write downs).
The key to making extended supply chains work is to look at total distribution cost (TDC). TDC is neither new nor controversial. The basic idea is that shippers should not seek to minimize only the transport costs, but rather to minimize the sum of transport-related and inventory-related costs. For example, the least expensive way to move import goods is via standard ocean service. If those goods are perishable, inventory write downs may more than offset transportation cost savings. Sometimes perishability is more critical than physical spoilage. Demand for toys and fashion apparel can fall significantly in a matter of weeks as customer tastes change.
Even in the same origin-destination markets, the TDC calculus can vary widely across different commodities due to differences in product value, product perishability (economic as well as physical), demand variability and/or the economic consequences of a stockout.
Historically, it has been hard for shippers to apply the total distribution cost concept in day-to-day decisionmaking. It is difficult for managers to argue in favor of higher visible expense (transport cost) to achieve less-visible and often debatable, savings elsewhere in the supply chain.
Consider how difficult it is to quantify and defend the value of lost sales when a particular product is out of stock. How many customers wanted to purchase the unavailable item? Were these sales lost forever, or merely delayed? Were the sales diverted to another channel or to another (competing) supplier? Is the customer relationship lost forever, or merely smaller than it would have been if the sale had been completed? Answers to these questions usually can't be proven definitively, yet they have a large impact on perceived inventory-related costs.
The analytical challenges are significant but the situation is improving as companies capture more and better data on their businesses. New enterprise resource planning systems allow companies to capture cost data for different components of the supply chain. As a result, many firms have a fuller understanding of their supply chain costs. Inventory-related costs are rising steadily, and firms should become progressively willing to spend more on transportation to minimize overall distribution costs.
David Hoppin is managing director and co-founder of MergeGlobal, Inc. He has has 16 years experience in strategic consulting for clients in the air freight, containership and freight forwarding/ logistics industries. (Additional reporting by Perry Trunick.)