(The following story by David Hannon appeared at Purchasing.com on November 13.)
How you characterize the current state of the logistics industry depends a lot on your role within the supply chain. While carriers and logistics service providers across the modes report lower volumes and increased financial pressure, logistics buyers are reporting lower rates in many contract negotiations and, finally, decreasing fuel costs and surcharges.
But while lower rates are good for buyers in the short-term, an overly stressed carrier base reduces a buyer’s choice of providers in the long-term, and could reduce carrier investments in capacity and the infrastructure required when demand for freight comes back. With that in mind, logistics buyers need to analyze the current fundamentals in each mode before taking a sourcing strategy.
Trucking
Trucking carriers, often considered a bellweather for the U.S. economy, may be the mode hardest hit by the current economic slump. According to estimates by Avondale Partners, more than 1,800 trucking firms have left the market in the first half of 2008, on top of the 2,000 that left the market last year. While much of that carrier base shrinkage is due to slumping demand for trucking and tightening credit markets, Rosalyn Wilson, a panelist at the Council of Supply Chain Management Professionals (CSCMP) in Denver last month, pointed out that much of that equipment has left the U.S. market permanently to be sold in other regions and won’t be back when the trucking market does rebound.
“We can expect some very tight capacity constraints when the market comes back,” Wilson said. Panelist Thomas Escott, president of third-party logistics provider Schneider Logistics in Green Bay, Wis., added that despite the steep decline in trucking demand, the first quarter of 2008 “felt tight” due to the surprising lack of equipment.
“Pricing has become more competitive” as truckers compete in a dwindling market, said Wachovia Securities analyst Justin Yagerman in a recent report.
Stifel Nicolaus analyst John Larkin said in a recent note that next year, “Rising demand layered on top of declining industry capacity…should create a veritable bonanza for freight transportation companies that are able to provide capacity into the marketplace.”
How to approach the spend: Use current trucking market to negotiate improved service levels and access to capacity from carriers, but be very leery of cutting too hard on base rate. Also work to improve visibility into carriers’ financial status if at all possible.
Ocean
Ocean freight demand has dropped off significantly in 2008 and rates have followed. On the bulk side, the Baltic Dry Index, which tracks rates for vessels carrying raw materials, at press time is at its lowest level since July 2006. The average spot rate for a medium-sized drybulk vessel is around $18,900. A year ago the rate was about $90,000.
On the container shipping side, demand has dropped significantly this year and rates are coming down as well. A recent Wall Street Journal story points out that a year ago, the basic price of shipping a large container of goods from Asia to Europe, the world’s busiest route, was $2,800. In mid-October, with demand plunging amid a worsening economy, that price was $700.
According to a new report from London-based Drewry Shipping Consultants, the “strong growth in the container shipping sector is now going into reverse as the credit crunch impacts all the major economies.” According to Drewry, since summer container freight rates have plummeted and appear to still be in decline and the outlook for 2009 shows a continued decline in demand as more capacity hits the water in the form of newly ordered vessels. But Drewry says the plunging demand is not all in the shippers’ favor, as the strategy of slow steaming adopted by shipping firms to offset fuel costs is slowing shipments and soaking up overcapacity, as carriers also cut unprofitable routes.
The steep demand drop has resulted in more talk of mergers in the ocean shipping industry. In October German firm TUI announced it was selling container shipping giant Hapag-Lloyd to a group of investors for more than $6 billion after a bid by Neptune Orient Lines failed. Top Ships said it is still in talks with an affiliate of Greek ship owner George Economou regarding a possible sale of the company, but that the original proposed purchase price is still being negotiated
How to approach the spend: Take advantage of the rate decline this year, as capacity appears to be ample heading into 2009. Use the leverage in the current market to firm up your long-term capacity needs.
Small Parcel
“The timing has never been better to run a small parcel bid. The stars are aligned. Over the past month we are seeing the deepest discounts ever.”
The comments of Bill Knasinski, vice president of parcel and logistics solutions at Pittsburgh-based Genco, sum up the small parcel market well. “Carriers are being very aggressive. Most of our clients have seen over 20% cost reductions [from small parcel providers].”
The reason for the aggressive pricing by small parcel carriers is twofold. First, with volumes declining, carriers are working hard to gain new customers and fill lanes, even if it means taking on less profitable business. Secondly, the uncertainty in the market resulting from DHL’s plan to outsource its air freight to UPS has created some market turbulence that buyers can capitalize on. Some market watchers say despite those firms’ steadfast insistence they’ll remain competitive, both UPS and FedEx are working aggressively to win over some of the customers or shippers with service concerns about the deal. And the peak shipping season volumes are not materializing, leaving all carriers a bit more hungry for business than they usually are at this time of year.
How to approach the spend: Now is a very good time to negotiate small parcel rates. Carriers are hungry for market share and volume so consolidating volumes to gain better pricing will work in this market.
Rail/Intermodal
In some ways, rail and intermodal are the exceptions to the rule. When the economy slows down and costs become a bigger concern, then rail is often given a closer look as a low-cost shipping option. And even when its overall volumes decline, railroads can increase pricing as is happening now. For example, Michael Ward, CEO of CSX recently said CSX was well into the process of re-pricing its contracts for 2009 and expects to raise freight rates 6–7% on average. “While shipments are down somewhat, they’re being offset by…pricing increases,” he told CNBC.
Canadian National said in its most recent earnings statement its third-quarter revenues increased 12% “due to freight rate increases” and it expects to be able to increase its pricing 4–5% in 2009 despite the current economic uncertainty. Norfolk Southern said while its intermodal volumes were relatively flat, its revenue in that sector was up more than 16%, indicating the strength of intermodal pricing. And Dahlman Rose & Co. analyst Jason Seidl recently said most of the railroads have more than half of their business under contract at “attractive rate increases for 2009.”
Captive rail shippers are taking advantage of the Surface Transportation Board’s new system for filing complaints against rate hikes. In October, the Seminole Electric Cooperative, a group of utility companies in Florida and captive shipper to railroad CSX, challenged a proposed rate hike due to take effect January 1. Seminole’s coal shipments will move under published tariff rates which would double Seminole’s expiring rates. Earlier this year CSX was ordered by the STB to reduce the rates it charged another captive shipper.
How to approach the spend: With demand for rail and intermodal stronger than other modes, it may not be the best time to negotiate rates, but it is a good time to closely evaluate the total cost including rate and fuel of trucking vs. intermodal in certain lanes. And if you’re a captive shipper being saddled with unrealistic rate hikes, it may be time to look into the STB’s new process.
3PL
Negotiating with 3PLs is typically a bit less cut-and-dried than with carriers directly. But as with any spend area, understanding the current dynamics in the market can help buyers in their negotiating sessions with 3PLs. In the current market, demand for 3PL services continues to rise as more companies look to reduce overall costs.
An annual survey of from Cap Gemini, DHL and Georgia Tech found 89% of 3PL users consider their 3PLs a “strategic competitive advantage” at their companies but those benefits come only from “deliberate efforts to form strong relationships and through the use of detailed contracts that include clear expectations and metrics.”
But that certainly doesn’t mean 3PL contracts are not open for negotiation. In fact, another survey conducted by Penske Logistics and Northeastern University found that CEOs at major 3PLs say the increased role of purchasing professionals in negotiating 3PL contracts is resulting in increased pricing gains. And Schneider’s Escott recommended transportation buyers “take advantage of procurement techniques and tools” in sourcing all freight contracts.
How to approach the spend: Logistics buyers should become more involved in the 3PL contracting process with the goal of establishing a deeper, more cost-focused relationship with a 3PL but also ensuring the rates are fair. If the 3PL contract is designed well and adhered to, the overall cost reductions could supplement short-term rate gains.