Rough road ahead for shippers

David Hannon -- Purchasing, 1/13/2005

Managing freight and logistics costs will be more difficult in 2005 than ever. Not only will the strong demand that surfaced in 2004 continue to drive rates higher in nearly all transportation sectors, but unpredictable fuel prices and surcharges will make budgeting and managing logistics expenditures a greater challenge.

"We are out of capacity as a country on virtually every segment in the transportation industry at the same time," says Lee Clair, transportation expert and a senior partner with Norbridge Associates in Deerfield, Ill. "We are out of highway capacity, [road] congestion is getting worse, and the rail system is out of capacity in the major corridors and lanes. And intermodal is on a growth rate of 'all that the system can accommodate.'"

Add in West Coast port congestion and no wonder shippers and freight buyers are in a frenzied mode. How large the impact will be on shippers and freight buyers depends on the organization's supply chain priorities and carrier relationships—but it's not promising. After all, Economics 101 tells you that when demand booms, rates go up and capacity shrinks.

Not surprisingly, buyers aren't optimistic. In a late 2004 PURCHASING Magazine survey, two-thirds of buyers said that they expect freight rates to continue to rise in the first quarter of 2005 fueled by increased across-the-board demand. Freight demand has been growing steadily since the third quarter of 2003 and reached unprecedented levels in 2004, says Eric Starks, president of freight industry consultancy FTR Associates in Nashville, Ind., which tracks the equipment side of the logistics industry. It estimates that the tractor-trailer loadings growth in 2004 was 4.9% after a basically flat year in 2003, creating the capacity issues shippers have seen in the market in the past year.

Shippers expect to feel the pinch of increased rates in all modes in 2005.

The freight market is experiencing the "classic effects of supply and demand" on many levels from truckload shortages to port congestion to increasing fuel surcharges, says Jeff Johnson, vice president of North American logistics and transportation at high-tech supplier Ingram Micro of Santa Ana, Calif. While contracts helped insulate Ingram Micro from most rate hikes in 2004, logistics costs remain a concern because the small percentage of freight bought on the spot market came at a much higher price in 2004 and he expects that to continue at least through 2005.

"Carriers continue to implement surcharges, which could result in increased costs and push more freight from truckload to less-than-truckload (LTL)," and increase rates in that sector as well, says Johnson.

Capacity has been tight across all modes, but most noticeably in truckload, where the industry, suggests Chris Osen, vice president of logistics at MeadWestvaco in Richmond, Va., has leveraged the tight capacity into increased rates across the board.

How tight is the capacity? Carrier capacity—which increased 18% between 1990 and 1999—increased only 3% between 2000 to 2003, and 11,500 carriers reported bankruptcy in those three years, says Robert Brescia, vice president of North American logistics for Michelin. In a presentation at the Freight Transportation Capacity Crisis Productivity Summit sponsored by the Logistics Institute of Georgia Tech in late 2004, Brescia said that he expects capacity shortages to continue to impact the shipping market well into 2005, along with other issues such as driver salaries, carrier insurance costs and fuel rates. "Fuel is always a wild card," Brescia says. "We saw tremendous fluctuations in 2004, which were most challenging to the small carriers. Hopefully prices will stabilize more in 2005."

Compounding the situation is that the freight market defied the normal rules of demand vs. fuel prices in 2004. "We never would have guessed [that demand] would be so strong with prices for oil going up as high as they did so quickly," Starks says. Indeed, he says that when fuel rates skyrocket as quickly as they did in 2004, the trucking industry typically sees an increase in bankruptcies. But that didn't happen in 2004, he says, perhaps because the industry had been right-sized in the downturn leading up to the current boom.

Where the fuel-price market is headed in 2005 is unclear.

Norbridge's Clair believes that indexed fuel surcharges will shoot up in step with price increases of oil and gas. "Carriers are on thin margins and have indexed the fuel costs to protect their margins and stay in business," he says, speculating that since neither the shipper nor the carrier has control over the price of fuel, neither can manage the cost effectively going forward.

On the other hand, Sparks says that he doesn't expect surcharges to go up much higher because it looks to him as though prices have peaked. But he admits he's seen past peaks prove to be false, driven by increased demand where shippers are willing to pay more. "If you are a manufacturer and have moved to a low-inventory model, you need that level of transportation service to be there no matter what the cost," he says.

The tightest squeeze for shippers, suggests buyers, carriers and market experts, may be in trucking because of the volumes of freight the trucking industry carries and its impact on the U.S. freight market.

FTR puts tractor capacity utilization at 95% in November 2004, the highest level since FTR began tracking those rates in 1992. One reason: the number of semi-trailer tractors in use has remained stagnant since 2001 at 2.3 million. FTR predicts a demand increase of 2.6% for logistics in 2005, down from the 4.9% expected at year-end 2004, which means tractor capacity could open up slightly. But it adds that even the smallest increase in demand could drain the remaining capacity and cause a freight crisis of sorts. "Going forward we expect capacity will be extremely tight and we may start seeing shippers do bizarre things to ensure capacity as they have in other demand peaks," says Starks.

That tight capacity means rates may rise even more on top of the 9% increase in truckload rate—a shock to the industry after annual price increases of about 1% during much of the 1990s, says Jon Langenfeld, an analyst with Milwaukee's Robert W. Baird & Co.

Trucking firm Swift Transportation, for example, says that it will try to raise its rates in 2005 to help improve margins. "We haven't fully taken advantage of an opportunity that was there," said Steve Attwood, vice corporate controller at a recent conference, adding that many of the company's contracts are coming due in the next couple of quarters.

In addition, carriers that have trimmed equipment investment during times of low demand are having difficulty in getting new equipment because manufacturers were blindsided by the quick ramp-up in demand. Trucking and rail networks, says FTR's Starks, "are constrained" by the slow rate at which the [transportation equipment] manufacturers are getting things out the door.

"On the trucking side, only a handful [will add] new equipment into 2005, really only replacing units," he says. "We are not forecasting sales above replacement until late 2005, assuming equipment manufacturers can meet production" demands by then.

Trucking capacity will also continue to be impacted by the shortage of drivers which has prompted some larger trucking companies to increase driver wages in an attempt to alleviate the problem. (Demand for drivers is increasing by 3.4% a year compared to a 1% annual increase in drivers.)

"How successful trucking companies will be in solving their driver shortage problem remains to be seen, but as long as there are attractive options for drivers and potential drivers, the driver shortage will remain with us," says analyst Ken Kremer of Global Insights.

Fueled by the overall growth in freight and the search by shippers for more cost-efficient alternatives, intermodal shipping volume, which rose between 8% and 10% in 2004 is projected (by FTR) to increase 3.2% in 2005 and 5.2% in 2006.

And it might be growing faster, but rail service has been "less than stellar," says Kremer.

"We are seeing an easing of the component and steel shortage problem and look for deliveries of new freight cars to rise substantially in the future," he says. "The railroads are not unaware of their service shortfall and are trying to address the problem through expanded investments in infrastructure, equipment and people."

That lack of capacity in the rail and intermodal market may cause a ripple effect into other transportation modes if the supply/demand imbalance keeps rates higher than normal for much of the year. Clair cites Los Angeles as a prime example, where ports are having trouble getting containers off ships and onto trucks or rail lines because of rail capacity issues.

"We have finally used up all the excess capacity that was created following deregulation," Clair says. "As long as the economy remains strong and volume and demand stays up, it will be very difficult to get capacity, service and on-time delivery. And costs will be hard to control."

Still, expect rail rates to continue to increase. "For the foreseeable future, something in the 2% to 3% range is very achievable," said Thomas Hund, CFO of Burlington Northern Santa Fe at a recent industry conference: And Union Pacific CFO Rob Knight said UP will employ "aggressive pricing", adding that UP intends to "ramp-up fuel surcharge mechanisms on every piece of business we touch." (About 80% of its revenue base pays a fuel surcharge.) "We will walk away from business" if the margins aren't right.

Internationally, the most important freight market to watch is China, as continued building projects in that country fuel freight demand, says Global Insights. And it calls India a "China waiting to happen." And with demand from Japan, South Korea and Taiwan still strong, shippers buying and managing freight across the Pacific are hungry for capacity, triggering rising prices. Freight rates for iron ore, coal and other dry-bulk commodities have doubled since June as China buys more raw materials, creating a shortage of vessels as more than 90% of world trade is carried by ship.

The Baltic Capesize index, which tracks the cost of hiring larger bulk freighters across different routes, has continued to rise. And the demand for shipping space already registering into 2005 means that vessel capacity will be fully committed, and practically guarantees that ocean freight rates will increase further in 2005.

The Baltic Dry Index, which measures the cost of shipping iron ore and other dry-bulk commodities, jumped 20 points in November to an eight-month high. The price of leasing a ship for loading 4,000 containers rose 36% to $45,000 a day in late 2004, according to Oslo-based shipbroker R.S. Platou Shipbrokers.