Facing ongoing turmoil in the freight transportation industry, the entire logistics sector is undergoing nothing less than “The Great Reset,” say the authors of the 34th annual State of Logistics Report, published by the Council of Supply Chain Management Professionals.
“To a large degree, the period studied by this year’s report—the calendar year of 2022 and the early months of 2023—has been about getting back ‘in sync,’” which was the theme of last year’s SOL report. Much of that period has seen roiling disruption of the transportation sector, including a plunge in the freight rates of different modes and a spate of bankruptcies in the trucking industry.
“Concessions that were given during the pandemic are getting clawed back,” observes Marc Althen, president of Penske Logistics, which sponsors the report for CSCMP and supports the research that is conducted each year by experts who work for the A.T. Kearney consulting firm.
Other events also have contributed to the supply chain turmoil, ranging from rampant inflation, labor disruption and banking weaknesses, to political controversy and technological advances. The extent of this disruption can be seen in the most notable measurement created by the State of Logistics (SOL) researchers over the decades since the report began as a way to assess the success of trucking deregulation—the percentage of the economy that is devoted to expenditures on logistics.
The higher that expenditure, the worse the sector is performing; it’s as simple as that. The most recent measurements don’t look good. In 2022, business logistics costs, also known as USBLC, was at $ 2.316 trillion or 9.1% of nominal GDP—the highest percentage in the report’s 34 years—and grew 19.6% year-over-year (see Figure 1).
“The demand-supply balance shifted much more dramatically this year when compared to last year,” explained Sean Monahan, A.T. Kearney partner and the report’s co-author. “In 2015 it was a dark story if you were a carrier. There was a lot of excess capacity in the marketplace. We saw that starting to turn around in 2016 and continued to accelerate into 2017.”
The Kearney researchers said the theme for last year and this one so far “has more fundamentally been about the resetting of relationships, assumptions and practices for a world transforming. A central feature of this transformation is a shift among logistics executives from strictly transactional perspectives to a more strategic and holistic sense of their function’s role.”
Their opinion is that the explosive growth of e-commerce and direct-to-consumer sales during the COVID-19 lockdowns have meant that order fulfillment has become increasingly complex, fragmented and vulnerable, and the more recent deceleration of that growth has provided a welcome breather.
“The deceleration in e-commerce growth should give shippers and carriers some room to build strategic plans until other causes of complexity arise,” they believe. “Inventories are ample, and the quirky demand spikes of the quarantine era have leveled off for now.”
The changes wrought by new demands created by the pandemic also changed how Americans view the supply chain, which before had been almost entirely out of sight and out of mind—and that includes many corporate executives who previously took supply chain management for granted in many cases because it had been working so smoothly. (That, of course, excludes executives like Amazon’s Jeff Bezos, who recognized that the supply chain could be a competitive advantage).
“That development is the major shift in the role of logistics itself across the entire economy,” the researchers observe. “Before the pandemic, logistics was still largely considered a side function. Now, however, it’s widely seen as a core determinant of service and revenue outcomes, and a strategic differentiator.”
Transportation Faces Reckoning
The segment of the logistics chain suffering the most is transportation service providers, and especially hard hit are truckers. In addition to the decline in rates, the industry continues to feel the effects of an ongoing truck driver shortage,
But t the researchers expect the days of uncertainty, overcapacity and rock-bottom rates inevitably will come to an end. “It will be interesting to see if the market returns to pre-pandemic tendencies or if the pandemic left a lasting impact on shell-shocked shippers,” they say. “If, on the other hand, the hard lessons of the pandemic seem to be sticking, it’s likelier that shippers would maintain their preference for high service and dedicated capacity arrangements.”
In regard to the truck driver shortage, the researchers say it’s not entirely clear whether the true problem is actually a shortage of qualified drivers, driver turnover, or suboptimized planning. They perceive indications that rate shifts and the move away from a spot market that had afforded some drivers a measure of freedom as owner-operators during the pandemic are forcing many drivers back to the large carriers—or out of the market completely.
The report urges carriers to explore ways of enhancing the utilization of their workforce. Based on Kearney studies, on average, over-the-road carriers use about half of drivers’ available hours, and of that number, 10% to 25% is unproductive movement. The authors contend that carriers should deploy routing optimization solutions to reduce unproductive driver time. “Efficient implementation could nearly double the labor capacity through improved planning of driver time and reduce empty miles through optimization,” they argue.
In addition, they say carriers will need to look beyond strictly monetary compensation to determine what other levers they can use—such as consistency in pay and workload—that might correspond more closely with the priorities actually influencing drivers’ decisions to take or leave a position with any specific company.
When it comes to the nation’s freight railroads, while things may look good on the surface to investors, the researchers did not mince words when it came to criticizing rail management’s obsession with cutting costs at the expense of service and business growth.
In 2022, Class I railroads saw operating income increase by 8% year-over-year, and total revenue by 14%—but these gains were largely attributable to price increases. But while rate hikes boosted railroads’ income and revenue, rising costs undermined operating ratios. Aggregate carload volume for Class I carriers was static in most categories.
The sector also suffered from service-related issues, including increased terminal dwell, ongoing congestion, network speeds that still lagged pre-pandemic velocity levels, and some high-profile derailments. “Looking ahead at the sector’s future, it’s hard to avoid a stark conclusion: rail should be doing better,” the authors state. “Its up-and-down outcomes of recent years are difficult to square with what would seem to be its significant structural advantages.”
Without mentioning it by name, the researchers underline the damage that has been done by the industry’s adoption of the Precision Scheduled Railroading operations model and its obsession with cost cutting and maintaining low operating ratios above all else.
“It’s a mindset that tends to emphasize short-term financial results, while frowning upon the strategic risk taking that might generate longer-term prosperity (including non-core growth investment). It prioritizes here-and-now efficiency at the expense of lasting resilience, and competition among rail companies over the kind of mutually beneficial collaboration that could advance the entire sector against its modal rivals.”
Adhering slavishly to a management philosophy of doing-more-with-less is not an adequate prescription for healing the sector, the researchers assert. “What is necessary is a far more growth-oriented approach, an intention to ‘do-more-with-more.’ At the very least, that means reestablishing sustained volume growth. But in order to achieve this, companies will need to get more comfortable with making fundamental changes to the way they do business. Incremental fixes won’t do.”
Growth will require sustained and consistent service levels, and a level of capacity sufficient to absorb new volumes, they contend. Top management needs to dedicate investments allowing railroads to both compete for a greater portion of freight, and to expand that market over time. This includes investments in technologies to enhance visibility, improve decision-making, and facilitate interconnection with other modes.
To build a more prosperous future, it is of vital importance for railroads to reverse their present adversarial relationship with their customers, the report’s authors argue. “At this moment, then, railroads and shippers have a converging interest in both innovation and collaboration. It’s a moment that both sides would do well to seize.”
Managing the Inventory Mess
As companies raced to meet demand for consumer goods during the pandemic, inventories skyrocketed and demand for warehouse space grew enormously. In 2022, however, that demand waned, resulting in overstock. Warehouse vacancy rates fell sharply, to as low as 2.9%—well below pre-pandemic levels, which tended to hover around 6.5%.
These historically low vacancy rates resulted in higher rents, while new construction continued at a healthy rate. However, as available space is increasing, companies are hesitating to occupy it as they try to get rid of excess inventory and make use of their existing space more efficiently, the researchers found.
Net absorption peaked in the second quarter of 2022 but then decreased nearly 20% by the fourth quarter, they point out. As a result, pricing and availability is expected to be more favorable for shippers in 2023.
One factor negatively impacting warehouse owners and third-party logistics (3PL) providers was that overoptimistic retail forecasts driven by earlier pandemic surges in e-commerce resulted in an inventory glut that stretched over several industries, and which companies are still trying mightily to shrink over the course of this year.
Many retail companies adopted aggressive inventory management practices to reduce “days on hand,” the standard measure of how long it takes to sell inventory, they noted. Those measures included discounts and promotions, liquidation sales, repurposing and recycling, and even the outright donation of lingering goods.
Also helping this year is the fact that customers are still buying, particularly through digital channels, in spite of inflation and economic uncertainty, but that could change. “We have seen in recent years just how suddenly consumer appetites can shift, and how vulnerable the warehouse sector has been to such sharp adjustments in demand,” the SOL researchers observe.
Even if consumers keep buying, the continued strength of the retail market and smarter inventory management is not likely to be enough to fill up all of new construction that remains in the current pipeline, they believe. In fact, a very high proportion of warehouse construction now in progress—83%—is speculative in nature.
“Our sense is that the recently constructed square footage and the availability of lease-break options are likely to result in a level of warehousing supply that will outstrip projected demand,” they say. “Under such a scenario, companies will look for alternative ways to make the most of all this excess square footage, or to get out of it entirely.”
They say potential courses of action for warehouse owners include consolidation through square footage reduction; the repurposing of warehouse space for other operations, including manufacturing; and, where feasible, the subletting of space to other companies.
One challenge that continues to bedevil both private and 3PL warehouse operators is the difficulty in finding the workers they need. Labor at warehouses continued to be a scarce resource, as the hourly cost for workers rose steadily throughout 2022. The year concluded with the nationwide average hourly wage of warehouse workers at $16.16 per hour, with the low range at $10.26 and high range at $25.43. This represented a 7% increase from the already inflated 2021 labor rates.
In the case of 3PL warehouse operators who offer a wide range of logistical support services in addition to warehousing, the future continues to look bright because of a growing need for those services, especially ones that help customers optimize their supply chains by maximizing transportation efficiencies and improving inventory management. The pressure to innovate is on for both customers and service providers.
The challenge for smaller 3PL warehouse companies will be keeping up with the necessary investments in technology, ranging from warehouse robots to take some of the pressure off having to meet labor requirements, to sophisticated computer systems for analyzing data and better managing the entire supply chain, from sourcing raw materials to delivering shipments to the ultimate customer’s front door.
This more sophisticated and broadly encompassing range of service has been dubbed fourth-party logistics (4PL) and is the space all 3PLs increasingly need to occupy, the researchers explain. This exerts pressure on smaller providers to adopt more sophisticated transportation management systems (TMS) and warehouse management systems (WMS).
4PLs strive to ideally manage all aspects of their client’s supply chains and act as the single interface between the shipper and multiple logistics service providers, the researchers point out. The more advanced ones go even further and help shippers design their supply chain.
“For 3PLs, moving into a 4PL role can be an attractive prospect; it inherently deepens the relationship with the customer,” they stress. “As shippers increase their trust in the 4PL model, they allow providers to manage more of their freight.”
Contributing editor David Sparkman is founding editor of ACWI Advance (www.acwi.org), the newsletter of the American Chain of Warehouses Inc., as well as a member of the MH&L Editorial Advisory Board.