There can be no doubt that we have been smitten in our minds by e-commerce, which is reshaping even the furthest reaches of the economy. How much it is discombobulating supply chain management is vividly depicted in the 28th Annual State of Logistics report.
The report, issued by the Council of Supply Chain Management Professionals, (who are its co-sponsors, along with Penske Logistics), is based on research conducted by the worldwide management consulting firm of A.T. Kearney Inc., which gathered data and opinions from a wide range of sources, including in-depth discussions with logistics consultants, academics, and service provider and shipper executives.
Trends identified back in 2015 are continuing to reshape logistics practices and can be expected to remain strong for the foreseeable future, the Kearney researchers found. “We suggested last year that consumers have become the driving force behind logistics spending, and this year’s results confirm the powerful impact of rising consumer demand for e-commerce deliveries.”
As the researchers point out, 2016 was the second year in a row in which overall spending on logistics slid lower. After registering only a modest reduction in 2015, last year saw a sharper drop. Logistics costs in the U.S. declined 34 basis points as a percentage of nominal Gross Domestic Product, reaching levels not seen since the great recession of 2009-10.
In 2016 total business logistics costs fell 1.5%, year over year, to $1.392 trillion, after rising at a 4.6% compound annual rate from 2010 to 2015. This includes costs stemming from transportation, inventory and other supply chain services.
Although past reports have touted the reduction in logistics costs compared to GDP as a sign of progress due to increased efficiencies, the drop also can be seen as evidence of unhappier trends this time around. The researchers believe the decline reflects overcapacity, lower volumes and rate pressures in several sectors, although demand and prices rose in some of the others.
“At the midpoint of 2017, we see a backdrop of economic and political uncertainty,” the researchers state. “An array of mixed signals vexes decision-makers, who see consumer confidence rise while GDP growth disappoints, and government officials struggle to take clear action related to stimulating growth, addressing infrastructure requirements and trade policy.”
Much of the decline in logistics costs also can be traced to the precipitous drop in coal, oil and natural gas hauling by railroads (somewhat reviving this year), and competitive factors that helped control most trucking costs—especially in the truckload segment—with the notable exception of package delivery.
Another important factor is that energy prices no longer play the primary role in logistics costs. Although they increased in 2016, energy prices remained relatively low and it is believed they will stay low for some time to come. In addition, the energy-sensitive modes of railroads and pipelines saw their rates and volumes stall or drop as oil prices remained at historically low levels.
Where We Are Headed
The upshot for the third-party logistics (3PL) industry appears to be “a prolonged bout of cognitive dissonance, coupling frustration over subpar growth with the optimism reflected in rising stock market values, technology investments and consumer confidence data,” the researchers said.
The global economy emerged from a sluggish 2016 poised for faster growth, but expectations collided with reality at the beginning of this year when U.S. GDP rose only 1.4% in the first quarter.
As this article was being written, Federal Reserve and other estimates predict a 1.9% rise for the second quarter, the same as the 1.9% GDP which was registered in the second quarter of last year. International and domestic political turmoil also have joined economic uncertainty to bedevil executives trying to plan logistics strategy, according to the researchers.
“Demand patterns are shifting, technological advances are altering industry economics, and new competitors are challenging old business models,” they said. “This year could bring significant moves that reshape individual sectors and even the industry as a whole. Major business combinations, large-scale shifts in distribution flows, deep capacity cuts, massive infrastructure investments—anything is possible.”
Some of this turmoil manifests itself in the uneven nature of the economic recovery. The stock market, manufacturing output and employment numbers have performed very well so far this year. The National Retail Federation has forecast that when the final figures for July and August are in, they will end up being two of the busiest months ever seen for retail imports at major container ports, possibly setting a new record as merchants enter the back-to-school period and start stocking up for the holiday season.
You won’t hear cheering among traditional retailers because of the heavy toll that e-commerce growth has taken on the industry’s brick-and-mortar stores, emptying shopping centers and posing seemingly insurmountable challenges to former industry leaders who are now flailing about, desperately searching for ways to compete in a world where the busiest storefronts are now made of pixels.
Add to that automotive sales so disappointing this year that at best they can be termed not as bad as expected. In addition, concerns have been raised about the staggering housing market’s potential negative drag on the economy in the second half of this year.
“The conflicting signals leave shippers and logistics providers with little clarity on economic fundamentals for the remainder of 2017,” the researchers observed in June. “Further complicating the outlook are variables such as currency exchange levels, interest rates and political trends. Against that uncertain backdrop, executives must make vital decisions about capacity, pricing, technology deployment and strategy.”
Warehouses among the Winners
For the first time in the 28-year history of the annual State of Logistics report, researchers chose to separate out the third-party logistics warehouse industry for special attention and analysis previously paid to trucking, railroads, and ocean and air freight carriers.
These 3PL operators profited from the economic cross-currents that buffeted inventory management in 2016, resulting in a 1.8% increase in public and private warehousing storage expenditures to $1.44 billion last year. One result is that inventory management costs are just as important as the financial carrying cost of inventory.
But even that 1.8% increase is deceptively low. Until last year, storage costs grew at a compound annual rate of 4.7%, but a 54-basis-point drop in weighted average cost of capital pulled down overall inventory carrying costs by 3.2%. That 4.7% figure shows the progressive growth in inventories fueled at least in part by the greater role warehousing plays in e-commerce.
Further evidence of burgeoning warehouse demand is the shrinking of space availability, which fell to a historic low of 8.2% by the fourth quarter of 2016, driving rental rates up 6.9%. The record didn’t last long: availability dropped to a new low of 8% in the first quarter of 2017, and according to the industrial real estate firm CBRE, that figure dropped to 7.8% in the second quarter—the lowest level since 2001.
The warehousing industry will enjoy a 3% annual growth rate through 2021, the Kearney researchers predict, but warn that is not all good news. Profit margins have not grown beyond 3%-6% for third-party warehouses because they continue to face pressure from rising labor costs, increasing pressure to invest in buildings and management systems, and persisting political uncertainty, the researchers note.
At the time the report was written, 21 states had raised their minimum wage substantially, boosting warehouse wages above today’s average of about $11.80 per hour. Because labor represents 50% or more of warehouse costs, owners may try to recoup the increase by raising rates. “That worries customers, who would prefer that operators offset rising costs by improving productivity,” the researchers said.
The report recognizes that the level of investments needed to develop sophisticated omnichannel systems, floor automation and seamless warehouse and transportation management systems are exerting great pressure on warehouse companies that operate on slim margins, but emphasizes that they are essential to future success.
“Warehouse operators maximize the benefits of technology when they use it end-to-end,” the researchers said. “Sophisticated warehousing software and cloud-based services reach beyond the warehouse, gathering upstream order information and downstream transportation data. Players throughout the supply chain benefit as seamless connectivity creates a fully integrated system capable of responding quickly to constantly changing customer needs.”
The year ahead will challenge warehouse operators to navigate these trends while building holistic, flexible networks capable of providing the rapid order fulfillment today’s consumers have come to expect, the researchers said.
Another service sector that has profited from the e-commerce boom is package delivery carriers. Spending on package delivery services jumped 10% in 2017. “We suggested last year that consumers have become the driving force behind logistics spending, and this year’s results confirm the powerful impact of rising consumer demand for e-commerce deliveries. Parcel and express delivery has surpassed railroads as the second largest logistics sector behind motor freight,” the researchers observed.
Learning to Move Fast Enough
One problem for the third-party warehouse industry in the U.S. is that it is sharply divided between a handful of giant corporations and the vast majority who are small, family-owned businesses meeting specific industry segment and regional needs. Keeping up with rapidly growing technological and space demands represents significant challenges for most of these smaller operators.
But it is not just physical plant and systems development that require a more rapid response; grappling with how supply chain management is being reshaped and learning new management skills are essential as well.
A recent study by the MPI Group points out that distribution centers (DCs) and warehouses often fail to apply management practices that could improve their operations. For example, only 53% of facilities have a continuous improvement program in place—and that is the most frequently used practice among such companies.
MPI found that only 41% of them have adopted lean thinking, a much lower implementation rate than among manufacturing operations. A majority of warehouse operators train each employee only 20 hours or less annually.
“The new data suggests that manufacturers, distributors and retailers are losing millions of dollars annually simply because their DCs and warehouses haven’t implemented easy-to-use strategies that already improve customer service and profitability in many other industries,” says John Brandt, CEO of the MPI Group.
The Kearney researchers also took note of other difficulties facing all 3PLs, both asset-based and non-asset based. Outsourced logistics spending rose 3.6% from 2015 to 2016, reaching $166.8 billion. Early indications this year show that demand is continuing to rise with the strengthening economy, although growth has slowed since 2014.
“As demand grows, the industry is evolving away from a transactional business model focused on discrete services such as transportation management or warehousing and toward a one-stop-shop model for end-to-end logistics solutions,” they observed.
Their conversations with shippers reveal that demand for one-stop logistics services is strongest among small companies that spend less than $30 million a year on logistics and large shippers that spend more than $300 million.
Smaller shippers say one-stop shops offer access to larger volumes across various transportation modes, while large shippers hope single-source providers can better manage complex worldwide logistics networks and global profit requirements, the researchers found. Less interested in a one-stop shop model are mid-sized shippers with sufficient volumes to handle the function in-house and a desire for greater control of their logistics.
“As the world becomes more complex and interconnected, businesses need to focus on their core competencies and form value-driven partnerships in other areas, such as supply chain management,” says Miguel Gonzalez, director of global logistics for DuPont.
“The report reflects the reality we live in. The right external relationships are more important than ever, with so many new technologies on the horizon,” he added. “I see great potential benefits from automation, artificial intelligence, big data, blockchain, and other advances. Unfortunately, we in logistics still haven’t overcome our tendency to embrace innovation slowly, if at all.”
This could be a pivotal year for logistics, the researchers stressed: “Demand patterns are shifting, technological advances are altering industry economics, and new competitors are challenging old business models.” They foresee logistics moving toward a fully digital, connected and flexible supply chain optimized for e-commerce and last-mile, last-minute delivery.
The next-generation supply chain will enhance fulfillment capabilities and drive efficiencies through technologies ranging from Big Data and predictive analytics to artificial intelligence and robotics, they added. “Inevitably, winners and losers will emerge as companies that make the right technology investments and strategic choices outperform others.”
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.