Logistics ropes in inventory

Better supply chain management has reduced inventory and helped drive logisticsrelated spending as a percentage of GDP to its lowest level in years.

By -- Logistics Management, 7/1/2000

What a difference a year makes. Last year, in his annual look at the industry, Robert Delaney called the state of business logistics in the United States "disappointing." Logistics costs, he reported, represented 10.6 percent of the Gross Domestic Product (GDP) in 1998-a figure he considered too high if U.S. companies were to compete on a global basis.

But this year, things have changed. U.S. business logistics costs amounted to only 9.9 percent of GDP in 1999, says Delaney, vice president at Cass Information Systems Inc. in St. Louis, which provides payment and information services for the logistics industry. In part, the improvement can be traced to the government's revision of its figures for GDP and the value of the nation's inventory. "[As a result of the revision,] we can now see that our business logistics systems [were] more productive than previously reported," says Delaney, whose 11th annual State of Logistics Report is co-sponsored by Cass and ProLogis, a global provider of integrated distribution services and facilities. "Our investment in inventory became much more efficient during 1999 than ever before in the history of the revised data."

As part of its recalculation effort, the U.S. Department of Commerce's Bureau of Economic Analysis revised its national income and product account numbers all the way back to 1959 to reflect the impact of software and information technology on the economy. The revision means that logistics costs for 1998 are now considered to have been $887 billion or 10.1 percent of GDP, which is the sum of money that the nation spends on goods and services. For 1999, Delaney pegs logistics costs at $921 billion in a $9.26 trillion U.S. economy or 9.9 percent of GDP (see Figure 1). The last time that logistics costs as a percentage of GDP fell below 10 percent was 1993.

Since his first report in 1990, Delaney has contended that distribution professionals should work toward a collective goal of driving logistics costs below 10 percent of GDP. "We are encouraged," he wrote in this year's annual report. "It appears that the inherent power of the Internet and the trends in business-to-business e-commerce are improving the visibility of inventory in motion. Add globalization of supply to fast cycle procurement, and you reach a conclusion that we can take the performance of our business logistics systems to a whole new level."

Solving the Economic Equation

Delaney's annual report on logistics has become almost gospel in the profession. His report is the only long-running study in the field that attempts to quantify the size of the transportation market and the impact of logistics on the U.S. economy. In the report, he breaks down overall logistics expenditures into three key components-inventory-carrying costs, transportation, and administration.

The first of these-carrying costs-are the expenses associated with holding goods in storage. They include interest charges, warehousing, obsolescence, deterioration, and labor costs as well as insurance and taxes. In his report, Delaney computed 1999 carrying costs at $332 billion (see Figure 2). Interest constituted $70 billion of the $332 billion. He calculated that amount by multiplying the value of the nation's business inventory-$1.376 trillion-by 5.1 percent for interest. The 5.1-percent figure was chosen because it represents the annualized commercial paper rate for 1999. Bear in mind that the Commerce Department revisions mentioned earlier changed the numbers for the value of business inventory and GDP that Delaney used in past calculations. The revision means that for the last half of the '90s, inventory values have gone down slightly. As a result, inventory-carrying costs dipped, and overall logistics costs dropped accordingly.

Delaney estimates that taxes, obsolescence, depreciation, and insurance totaled $187 billion last year. He pegged costs for warehousing at $75 billion. That figure covers both the public and private segments. (Delaney obtained public warehousing data from the Commerce Department's Census Bureau but was forced to rely on his own estimate for private warehousing.)

As for the second component of logistics expenses-transportation costs-Delaney used estimates from the Transportation in America series of annual reports published by the Eno Transportation Foundation. In 1999, Eno says, the nation's freight bill reached $554 billion. Of that $554 billion freight bill, expenditures for highway transportation-$450 billion-accounted for a full 81.2 percent. Intercity deliveries accounted for $300 billion or two-thirds of the dollars spent on trucking. Another $150 billion was spent on local trucking services.

U.S. businesses spent another $99 billion on the other modes of transportation. According to Delaney's figures, the railroads earned $36 billion, while water carriers, both domestic and international, earned $22 billion. Expenditures reached $26 billion for air freight, both domestic and international; $6 billion for freight-forwarding service; and $9 billion for oil pipelines. Delaney also calculated other shipper-related costs, which include traffic department operations and vehicle loading and unloading, at $5 billion. Overall, transportation costs remained at 6.0 percent of GDP, a ratio that has remained constant for the past few years. Delaney notes, however, that keeping these costs stable will become increasingly difficult in the future because of rising fuel costs and labor rates that have inched upward in a full-employment economy.

Delaney calculated the third component of logistics costs-administrative costs-at $35 billion. To obtain this number, he multiplied the sum of inventory-carrying costs ($332 billion) and transportation costs ($554 billion) by a constant of 4.0 percent.

Falling Stocks

Now that U.S. businesses have reduced logistics costs to under 10 percent of GDP, how can they keep it that way? Delaney believes that inventory management will be the key. Although the inventory-to-sales ratio hovered between 1.38 and 1.40 months' supply from 1996 to 1998, things changed abruptly last year: The inventory-to-sales ratio declined from 1.38 months of supply in January 1999 to 1.32 months at year's end. "That was a record low in the history of the revised data and it happened in the face of the so-called Y2K problem," Delaney observes, referring to earlier predictions that companies would stockpile inventory out of fear of Y2K disruptions.

In addition, the surge in sales meant inventory was consumed at a rapid clip. In 1999, inventories rose 4.6 percent, Delaney reports, while sales increased 9.2 percent or twice as fast as inventory. "Fourth-quarter 1999 sales were so strong, they powered quarterly GDP above 7.0 percent," he wrote in his report.

As noted earlier, the favorable change in inventory numbers stemmed partly from the revision of U.S. government numbers for business inventory. As a result of this revision, Delaney has recomputed carrying costs for all of the affected years, which has also changed the cost of business logistics overall as well as the figures for logistics costs as a percentage of GDP. (The current numbers are listed in Figure 1.)

Warehousing's New Role

In his annual reports, Delaney addresses overall trends in logistics and typically makes some observations on industry directions. This year, he focused upon warehousing services and both business-to-business and business-to-consumer electronic commerce.

Although many analysts had predicted that inventory reductions would cut demand for warehousing services over the past decade, Delaney reports that this was not the case. He notes that the total supply of warehouse space actually rose from 5.4 billion square feet to 6.1 billion between 1990 and 1999.

In Delaney's view, warehousing services will continue to grow "consistent with industrial production and consumer spending." He notes that warehousing has moved away from the mere storage of goods to offering value-added services, such as assembling kits, bar coding, labeling, and providing fulfillment services for e-commerce companies.

Warehousing services, says Delaney, will continue to change to meet corporate demands for high inventory turns and overnight delivery. "A large and growing number of shippers are moving toward warehouses and not away from them," he wrote in his annual report. "They want to optimize inventories, not eliminate them."

As for business-to-business electronic commerce, Delaney takes issue with analysts' predictions regarding the future of online industry marketplaces. In particular, he rejects a suggestion by Forrester Research analyst Stacie McCullough that companies like Dow Chemical will turn over much of their business to a public exchange set up for the chemical industry. "Dow's process for vendor qualification and selection is rigorous, long term, and enduring. Contracts are 10 years in duration. Confidential information is exchanged. Vendor performance is measured and monitored. We anticipate that Dow and [its] suppliers will make an effective use of e-procurement and share the benefits as [it has] historically," says Delaney. "We do not believe that significant volumes will be migrated to a chemical exchange as Forrester Research suggests."

Delaney also disputes the oft-repeated assertion that business-to-business commerce will result in smaller freight loads as corporations shift from pallet shipments to packages. "The cost of materials handling and product damage will outweigh the benefits of frequently shipping individual cartons and pieces," he insists.

Delaney adds that he believes that Web-enabled commerce will only deepen the relationships between suppliers, carriers, and logistics service providers. "Speed, information, and reliability will be emphasized," he wrote. "But we do not expect to see major changes in shipping patterns. Indeed, we believe that companies will continue to try to work with fewer suppliers and service providers, not more."

Unconventional Wisdom

Delaney also disputes the conventional wisdom regarding business-to-consumer electronic commerce. He contends that the future looks brighter for the established bricks-and-mortar retailers engaged in online selling than for the start-up Web merchants. "Traditional retailers," he points out, "have the benefits of experience with the customer, successful brand names, distribution operating skill, and reputations for quality."

Delaney cites the example of catalog retailer Lands' End, which recently made two-day delivery its standard level of service. "The retailer found that its return rate for delivery in four days was twice as high as [it was for two-day] delivery," he says. "That is why companies [that] combine Internet and traditional retailing will win. They [provide] a better experience for the customer than the pure-play e-tailers do."

As for the Web-based intermediaries that match shippers with carriers, Delaney contends that the only successful exchanges will be those that actually add value or improve carrier-customer relationships. He notes that Cass Information, which processes freight bills for 100,000 shipments per day, has found that 70 percent of those shipments move under contract. Furthermore, all of the carriers serving Cass clients have set up their own Web sites. "There is no room for the mischief and nonsense of so-called Internet channel captains who add no real value," he charges.

Delaney concedes that there are two schools of thought regarding the future of e-commerce. One holds that Web-based connectivity will enable the current transaction network to become more efficient, allowing trading partners to share the savings. The opposing view maintains that the new technology will affect business supply chains "beyond anything that has happened previously, including transport deregulation."

Delaney himself sides with those who believe that e-commerce will not change existing relationships among trading partners. "We don't see any radical change in shipping patterns," he says. "We hear a lot of noise about exchanges but don't see any volumes."

Despite his doubts about the value of Web-based intermediaries, Delaney does believe that the Internet itself will improve inventory visibility. As a result of the improved visibility, Delaney says, he's optimistic that logistics managers can keep business costs down. As he puts it, "We may even be able to maintain U.S. business costs at the goal we set in 1990-namely 10 percent of nominal GDP or lower."