Logistics productivity goes flat
In his annual look at logistics, Bob Delaney finds that productivity has stagnated. The reason, he says: We've forgotten the lessons of the past.
By Thomas A. Foster -- Logistics Management, 7/1/1999
The state of business logistics in the United States is disappointing, says Robert Delaney, executive vice president of Cass Information Systems. Delaney, who has been reporting on the cost of U.S. business logistics since 1990 and tracking logistics costs since 1973, believes there has been very little improvement in logistics productivity for most of the 1990s.During 1998, the cost of U.S. business logistics systems increased by $36 billion to $898 billion or the equivalent of 10.6 percent of gross domestic product (GDP). When Delaney first calculated the 10.6-percent figure, it appeared to be a slight improvement over the 10.7-percent figure reported in 1997. Using a revised formula for interest rates, however, Delaney recalculated 1997 U.S. business logistics at 10.6 percent of GDP--a level that has not changed in three years.
"When you remove the contribution of favorable interest rates, the 10.6-percent-of-GDP plateau applies for most of the 1990s," says Delaney, whose annual State of Logistics Report is co-sponsored by Cass Information Systems and ProLogis, a global provider of integrated distribution services and facilities.
In the simplest terms, logistics costs are rising in lockstep with the GDP. The 1998 nominal GDP of $8.51 trillion was 4.9 percent above the GDP for 1997. Logistics costs, in which Delaney includes inventory carrying costs, transportation, shipper-related costs, and administration, rose by 4.2 percent.
Most of the increase in the nation's 1998 freight bill is attributable to the $25 billion jump in trucking expenditures, which account for more than 80 percent of the nation's freight transportation spending. Inter-city trucking costs increased by 7 percent. Local trucking increased by almost 4 percent. Overall expenditures for water transport were flat, although revenue for Great Lakes and international movements were up 5 percent and 2-plus percent, respectively. Domestic airfreight increased by 4 percent, and international airfreight increased by almost 5 percent. Shipper-related costs, which include traffic department operations and vehicle loading and unloading, were unchanged. Delaney calculated logistics administration at 4 percent of total logistics costs.
The investment in all business inventories--from raw materials to finished goods--was $1.368 trillion. The cost of carrying inventory includes interest at the annualized commercial paper rate of 5.4 percent. Delaney applied a total inventory carrying rate of 24.5 percent to business inventories to reach total inventory carrying costs of $334 billion.
Improvements in inventory efficiency since 1982 have been significant as companies replaced inventory with more versatile and responsive transportation service. In 1980, total business inventory was equal to 2.6 percent of GDP. By 1993, it equaled 1.7 percent. But in recent years, the gains have slowed: Total business inventory in 1998 was 1.6 percent of GDP.
Lessons Not Learned
Delaney sees a number of reasons for the slowdown in efficiency gains, including federal regulations that hurt productivity, laws that allow transportation rates that aren't competitive, and misplaced faith in certain technologies. However, he believes the biggest culprit is the typical U.S. company that has failed to learn the lessons of the past two decades. Although he applauds companies like General Electric, Wal-Mart, and Rohm & Haas for vigorously removing wasteful inventories from their supply chains, he says most companies have abandoned the strategies that so successfully reduced logistics costs in the 1980s--using market forces to reduce transportation costs and focusing on reducing inventory levels.
When Delaney issued his first annual report in 1990, he set a goal for the nation's logistics managers of reducing logistics' portion of GDP to 10 percent by the end of the decade. He now acknowledges that the productivity goal of 10 percent of GDP is unlikely to ever be achieved. Yet he insists that further gains are imperative. "We have to try to reduce our logistics costs for the sake of maintaining our global competitiveness, which is clearly threatened by our lack of improvement," he says.
As part of his analysis, Delaney suggests the following 12 propositions for reducing logistics costs:
1. Resolve to follow the paths that have led to success.
Delaney points out that the logistics industry made huge strides in the 1980s after deregulation. Just prior to deregulation in 1980 and 1981, logistics costs had grown at a compound annual growth rate of 16.8 percent for five years. Just after deregulation, logistics managers cut the compound annual growth rate to 4.3 percent between 1982 and 1989. The introduction of supply chain management, third-party logistics, and other innovations reduced the compound annual growth rate to 3.7 percent during the 1990s.
"We need to preserve that performance and improve on it, if we can," says Delaney. "It represents our profession's contribution to low inflation in this country."
2. Improve the efficiency of inventory investment.
The efficiency of inventory investment declined during 1998 based on ratios that compare manufacturing inventories with sales, shipments, and unfilled orders. The shipment-to-unfilled-order ratio improved from 1.61 months of supply at the close of 1997 to 1.58 at the close of 1998. But the ratio of shipments to inventory increased from 1.35 in 1997 to 1.38 at the close of 1998. Delaney expected to see a trend developing in which the ratio of manufacturing, wholesale, and retail trade inventory to final sales would decline to 1.30. Instead, it increased to 1.39 at the close of 1998. "We appear to be stuck in a band between 1.35 and 1.40 months of inventory since 1996," he says.
This is disappointing because e-commerce, Internet initiatives, and various logistics planning techniques such as Collaborative Planning Forecasting and Replenishment Programs could cut excess inventories, Delaney says. He points to a Mercer Management Consulting study of the top 60 publicly traded North American chemical companies, which says these companies could liberate $25 billion in cash if inventories and accounts receivable were reduced to best-practice levels.
3. Reconcile logistics needs with enterprise resource planning (ERP) systems.
U.S. companies have embraced ERP to satisfy management's desire to manage back-office operations better. But in doing so, they have hurt the ability of logistics managers to manage inventories effectively. Delaney says that under the direction of top management, many legacy planning systems that fueled past logistics productivity gains were set aside in the move to ERP systems, which do not appear to be providing strong alternative planning support.
4. Exploit the cost and service opportunities provided by third-party logistics services.
One of the great successes in the logistics industry in the 1990s has been the emergence of third-party logistics providers, or 3PLs, which generally have reduced customers' logistics costs by at least 10 percent.
U.S.-based 3PLs are expected to grow 15 percent to 20 percent for the next three to five years. Armstrong & Associates, a Stoughton, Wis., firm that tracks the 3PL industry, suggests that major opportunities exist in companies of all sizes. Only half of all Fortune 500 firms are using 3PLs. The potential market in mid-sized and smaller companies is even greater.
5. Exploit opportunities in integrated package design.
Protective packaging used to be a key logistics responsibility. It no longer is and Delaney says businesses are paying the price in poor productivity. By using sophisticated software, logistics practitioners could optimize the cost of transportation and warehousing in concert with package design, he says. He points to hospital supply company Becton Dickinson, which has launched a major initiative aimed at reducing logistics costs by 30 percent, including reductions in packaging costs of 33 percent. Delaney contends that every company should apply a packaging optimization process for problem items within its "A" level of inventory--those items that account for less than 20 percent of its products but more than 80 percent of its sales.
6. Support programs that will reduce the driver shortage.
The already acute driver shortage will get even worse within five years, when 3 million class 8 trucks will be traveling on America's highways. To meet business's needs, the trucking industry will have to attract 80,000 new drivers each year between now and 2005 because of growth and attrition, Delaney says. The driver-turnover problem is greatest in the truckload dry-van market, which also is experiencing the highest rate of growth. According to Delaney, 80 percent of carriers have increased pay scales by an average of 10 percent to attract and retain drivers. Even so, the problem is far from being solved.
Shippers can help by looking more favorably on rate increases that are directly tied to drivers' wages, Delaney suggests. They also can help minimize excessive driver waiting, loading, and unloading times. Drivers are spending an average of 30 hours per week on those activities, curtailing more productive driving time, he says.
7. Reform public policy to improve productivity.
Delaney says that public environmental policies fail to take into account their detrimental impact on transportation. For example, a U.S. District Court judge soon may decide to fine the six primary U.S. diesel-engine manufacturers more than $1 billion under a contentious consent agreement with the Environmental Protection Agency. The truck manufacturing industry has agreed to spend another $110 million in order to reduce nitrogen oxide levels over the next 10 years. Emissions limits that were supposed to take effect in 2004 have been pushed up by 15 months and will become effective Oct. 1, 2002. Fuel economy will decrease as the 2002 emission rules take effect. The related increase in the cost of fuel will be passed through directly to the prices paid for trucking services.
8. Focus transportation policy on competition instead of protection.
Current political infighting between the rail and trucking industries reminds Delaney of the protectionist days of the 1970s, when logistics productivity was at its worst. Railroads are funding what Delaney calls phony "grass-roots" safety organizations such as the Coalition Against Bigger Trucks and Citizens for Reliable and Safe Highways to oppose larger trucks and restrict drivers' hours of service. The railroads, he says, want to use government regulation to protect them from more truck competition. In response, the trucking industry is considering playing a role in the debate over railroad competitive access.
9. Reduce trucking costs with safe, longer, and heavier highway vehicles.
The United States should be able to achieve cost reductions by operating longer, heavier highway vehicles, as called for in a recent legislative proposal that would allow states to increase maximum truck weights to 97,000 pounds loaded on six axles.
Delaney says safety would not be compromised with larger vehicles such as the "Argosy Safety Concept Vehicle" introduced last year by Freightliner and Wabash National. It has a 90,000-pound payload that is achievable by adding a fifth axle to the trailer.
10. Ensure that maritime reform delivers the economic benefits that are available.
Delaney says the Ocean Shipping Reform Act (OSRA), which was implemented on May 1, provides a $2 billion improvement opportunity in logistics productivity. He admits there are concerns on both sides. Some shippers believe that "discussion agreements" will simply replace the conferences and that collective ratemaking will continue. Some carriers are concerned about the formation of shippers associations by non-vessel operating common carriers. Delaney sees OSRA as an opportunity to encourage productivity-enhancing competition in the maritime industry, just as earlier deregulatory legislation allowed competition to revitalize the airfreight, motor carrier, and railroad industries.
11. Avoid railroad reregulation, which would hurt capital investment.
Delaney opposes current legislative proposals to reregulate the railroads, which he says would undermine efforts to encourage more investment in infrastructure. The Staggers Act has resulted in an inflation-adjusted drop in rail rates of more than 46 percent since 1980, according to calculations made by the Association of American Railroads (AAR), while ton-miles have increased 56 percent. However, Delaney says, no one fully recognized the implication of the resulting increase in capacity utilization--that railroad capacity can reach a maximum. Over the last 10 years, Class I rail-freight density has increased by more than 50 percent. At the same time, the major railroads have abandoned or sold unproductive routes. In other words, more freight is moving over less track. As a result, average freight-train speeds have decreased by 19 percent since 1992.
To reverse the capacity and service problems, Delaney says, the rail industry must increase capital spending to upgrade and enhance track, signaling, and communications, and add to freight-car and locomotive fleets. AAR President Edward Hamburger has estimated that the industry will need to increase its level of spending to more than $362 billion between now and the year 2020.
"With a rate of return already below their cost of capital, the transfer of revenue [that] could result from reregulation would make it impossible for railroads to invest at the levels needed," says Delaney.
12. Reform the Jones Act to improve global competitiveness.
For nearly 80 years, the Jones Act has reserved shipping between U.S. coastlines and territories to ships that are registered and built in the United States and are crewed by U.S. citizens. The purpose of the act is to ensure availability of U.S. cargo ships for defense purposes. The effect, Delaney says, is to raise the cost of shipping to Alaska, Hawaii, and U.S. territories. He says the Jones Act results in increased economic costs of $14 billion, since qualifying vessels are in short supply and carriers can exact high rates. The situation is aggravated by other government regulations that prohibit the use of foreign-built ships to transport U.S. "preference" cargo, such as grain shipments under federal loan programs. Delaney suggests removing the prohibition on foreign-built ships. Ultimately, he says, the answer is to repeal the Jones Act and other preferences. "We need to stop hiding behind the flag and see the Jones Act as a costly form of protection," he insists.
The Rest of the Story
In the pages that follow, Logistics examines each segment of the transportation industry to see how carriers performed in 1998 and to consider the challenges that carriers and their customers now face.
Throughout the report, a number of common themes emerge: Customer demands are forcing carriers to provide faster deliveries with more precision. Shippers increasingly don't care what type of carrier handles their freight, as long as the service and price are right. As a result, carriers are facing competition from beyond the boundaries of their own modes of transportation.
At the same time, all carriers are facing cost pressures and the need for more investment in infrastructure and technology while dealing with increasingly serious labor shortages. Carriers in every mode need better levels of profitability if they are to afford the sophisticated services their shipper customers demand.
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