Recent rise in logistics costs could spark inflation
By Tim Minahan -- Purchasing, 9/1/1998 6:00:00 AM
Despite all the talk about reducing inventories and improving distribution networks, manufacturers are paying more to move and handle goods. According to a new report from Cass Information Systems and Security Capital Trust, the cost of the nation's business logistics system swelled to $862 billion last year, or the equivalent of 10.7% of the Gross Domestic Product.
That's a jump from 1993, when tight inventory controls, record-low interest rates, and low transportation rates held logistics costs to just 10.2% of GDP. According to the ninth annual "State of Logistics" report, the recent increase has cost the nation $40 billion of logistics productivity potential in the past four years. Even worse, such a rise could soon lead to inflation.
"The productivity of the U.S. business logistics system is directly linked to the declining inflation since 1982," says Robert V. Delaney, executive vice president of Cass Information Systems, the freight payment industry leader based in St. Louis.
He notes that, between 1977 and 1981, when the nation's logistics costs were increasing due to excessive inventories and high transportation costs, inflation soon followed. (See chart.) Using the Commerce Department's national income and product accounts data, Cass has determined that the nation is facing a similar pattern today.
"Our logistics productivity peaked in 1993," says Delaney. "We are less productive now. If we fail to get our logistics productivity back on track, the pressure of higher cost may lead to increasing inflation."
One reason for the increase in logistics costs: Rising truck rates. According to estimates from R. Wilson Inc., intercity trucking costs increased by nearly 10% last year. Local trucking costs climbed 8% during the same period.
"The engine that drives the logistics system is our trucking industry," says Delaney, adding that the $32-billion increase that the trucking industry achieved in 1997 exceeds the total expenditures for the entire intermodal transportation industry. Other increases in transportation costs include domestic air freight costs, which rose by 8%, and international air freight costs, which increased by 14%.
The good news: Delaney says the nation can drive business logistics costs below 10% of GDP by the year 2000. However, it won't be easy.
Attaining this goal will require a $56-billion reduction in logistics costs over the next few years. A task which, according to Delaney, can only be achieved through a mix of continuous improvement within individual companies, shared productivity, and public policy reform.
The report makes the following recommendations for improvements in the nation's logistics productivity:
Reduce the inventory to sales ratio: According to the report, the nation's businesses "lost control" of inventory in 1995, when GDP growth declined to 1% and the ratio of inventory to sales increased to 1.46 months. Since then, businesses have been able to reduce this ratio, ending 1997 with a ratio of 1.37. However, the report says the nation's businesses will need to cut the inventory-to-sales ratio to 1.3 months of supply to shave $25 billion off logistics costs.
Leverage integrated package design: Alternative packaging designs may be the last bit of low-hanging fruit available to companies who have exhausted most other distribution cost-reduction opportunities. While results vary by company, changing the weight, size, shape, material, and/or handling of a package can yield significant savings in packaging, transportation, and storage costs.
Ensure information systems remain flexible and open: If your company is implementing an Enterprise Resource Planning (ERP) system, such as SAP, Baan, or Oracle, be certain the plan also includes installation of an Advanced Planning System, such as i2, Logility, or Manugistics, and the necessary software and support to allow the two systems to interact as seamlessly as possible. The report provides no savings estimate for this recommendation. Instead, because of the rigid architecture of and complexity of installing ERP systems, the report says the suggestion is necessary "to avoid increasing costs and productivity losses."
Tap third-party logistics providers: The contract logistics industry is much more mature than it was at the beginning of the decade. The top players have built significant information technology and transportation infrastructures. Manufacturers would be wise to leverage such attributes to improve the efficiency of their own logistics operations. According to the report, third-party logistics services will save users $5 billion by the year 2000.
Help reduce the driver shortage: Finding and keeping good drivers is a big problem both for for-hire and private carriers. In recent years, the annual driver turnover rate in the for-hire trucking market has topped 100%. To alleviate this problem, many carriers, such as J.B. Hunt, have adopted aggressive driver retention programs, which include pay increases and other benefits. The report suggests that shippers should help absorb some of these costs. In addition, shippers should develop driver-friendly distribution operations that include such plans as relieving drivers from the time-consuming (and unpleasant) task of loading and unloading of freight. Such efforts will keep drivers on the road and hold down driver recruitment and training costs. Potential savings: $2 billion.
Promote open competition in the transportation industry: The report says deregulation of the air and trucking markets has promoted competition and helped reduce overall logistics costs. The authors urge shippers to endorse efforts to deregulate other transport ion industries, such as the ocean shipping reform bill that is currently moving through Congress.
Consolidate and rationalize the nation's railroads: Contrary to recent arguments that the troubles along the Union Pacific Railroad demonstrate that the nation has gone too far in rail consolidation, the report suggests that the industry needs to be consolidated further. The report estimates that the average inflation adjusted railroad rate has declined by 46.4% (a 15.6% dip without any inflation adjustment) during the past 15 years. New investments in technology and infrastructure should improve efficiencies further, according to the report.
Allow use of heavier vehicles: A report from the National Research Council says tractor-trailer productivity can be improved by 21% with six axles on the ground, and by 48% with seven axles on the ground--all with no adverse impact on roads and bridges. The Cass report says the safe operation of such vehicles, which are already in use in Europe, Canada, and the state of Michigan, could shave $10 billion off U.S. logistics costs.
Pass maritime reform: After four years of discussion, the nation's lawmakers appear ready to approve the Shipping Reform Act. Cass estimates that the legislation, which would allow confidential service contracts and eliminate tariff filing, will reduce logistics costs by $2 billion.
Reform the Jones Act: The Jones Act, which reserves shipping between U.S. coastlines and territories to ships that are registered and built in the U.S. and crewed by U.S. citizens, costs the U.S. economy between $4 and $10 billion, according to the International Trade Commission. Reforming the Jones Act to allow foreign flag ocean carriers to provide intercostal service could shave an estimated $7 billion off the nation's logistics costs, according to Cass.
How it all adds up
(Logistics costs in $ billions)
Carrying costs: $325
Motor carrier costs: $400
Other carrier costs: $99
Shipper related costs: $5
Logistics administration costs: $33
Total logistics costs: $862
SOURCE: CASS INFORMATION SYSTEMS
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