When the economy slammed on the brakes last year, the nation's logistics system reacted quickly, thus averting a huge inventory pileup.

Not only did managers of the nation's business logistics systems prevent a stock pileup, but they actually reduced inventory significantly. In fact, they managed to hold down inventory investment in all four quarters of 2001, ultimately reducing the nationwide annual inventory investment figure by $36 billion over 2000 levels, according to the 13th State of Logistics Report, which was issued last month.

The annual State of Logistics Report, which was prepared by Robert V. Delaney, vice president of Cass Information Systems, and Rosalyn A. Wilson, a consultant with 23 years' experience in transportation, is the most closely followed study of logistics costs in the nation. It is sponsored by Cass, which has businesses in freight bill auditing and payment and commercial banking, and ProLogis, the nation's largest provider of distribution facilities and services. Delaney initiated the report more than two decades ago to measure trends in logistics efficiency following transportation deregulation. In the years since, he has expanded its scope to examine emerging trends in logistics and supply chain management and their effects on logistics efficiency.

A look at the national report card shows that, on balance, logistics efficiency improved in 2001. Logistics costs equaled 9.5 percent of gross domestic product (GDP) last year, the lowest level in the 21-year history of the study. Not that logistics and other inventory managers could stay entirely ahead of the slowdown: "[S]ales were so weak we struggled [with an inventory-sales ratio that ranged] between 1.42 and 1.45 ... for most of 2001," says the report. It wasn't until the fourth quarter that the months-of-supply figure showed a decline. Even so, the relative decline in logistics costs versus overall spending indicates that the logistics system has become quite nimble.

The current study shows that the nation's annual logistics bill—which includes inventory carrying costs, transportation costs and administrative costs—totaled $970 billion last year, down from just over $1 trillion the previous year. That number, which represents 9.5 percent of the $10.21 trillion nominal GDP, signals the first significant improvement in logistics efficiency after close to a decade of hovering around 10 percent. (See Figure 1.)

According to the report, the average investment in inventory for all businesses last year was $1.44 trillion. That's about 14 percent of the nominal GDP, compared to 24 percent in 1981, the first year tracked in the report.

To obtain that number, Delaney applied an inventory carrying rate of 22.8 percent to the $1.44 trillion inventory investment figure. That rate—which includes interest based on an annualized commercial paper rate of 3.8 percent, plus estimates for taxes, obsolescence, depreciation and insurance—was a full 2.5 percent lower than the one he used in 2000. This savings, combined with the lower total inventory investment, yielded inventory carrying costs of $328 billion, which was $49 billion lower than the previous year's figure.

To calculate the nation's overall 2001 logistics costs, Delaney added transportation costs of $605 billion to that $328 billion in inventory carrying costs. He then added shipper-related costs of $5 billion (which includes expenses for traffic departments and loading/unloading operations) and administrative costs of $37 billion, to get a total of $970 billion. (See Figure 2.)

Of all the line items in that freight bill, transportation accounts for the lion's share, representing more than 60 percent of all logistics costs (trucking alone makes up just over half of all logistics expenses). Happily for shippers, 2001 saw no serious escalation in these costs. For instance, trucking costs rose only 2.7 percent, which was less than the 3.4-percent growth in GDP. That's reflected in the difficult year many motor carriers reported, with tonnage down 5 to 10 percent in some segments of the industry.

Rail costs rose by a somewhat larger percentage—5.6 percent, or $2 billion—last year, according to the report. Railroads were somewhat successful in luring business away from motor carriers, thanks in large part to improvements in the reliability of intermodal service. In addition, write Delaney and Wilson, the railroads were able to raise rates on traffic where they faced no competition.

Overall, transportation costs have consistently stayed close to 6.0 percent of GDP since 1988. Last year, transportation dropped to 5.9 percent of GDP. "That's as low as it's ever been," says Delaney. "The market has been severe and no one has any pricing power."

Compared with transportation costs, the cost of inventory has dropped much faster over the years. "Inventory carrying costs have declined by more than 60 percent during the past 21 years as faster and more reliable transportation allowed U.S. businesses to invest less in inventory and consolidate it in fewer locations," says the report. "With the record low achieved in 2001, total logistics costs have declined by more than 40 percent in these 21 years. The focus of everyone managing in logistics has to be on inventory investment."

But in a departure from previous reports, Delaney and Wilson have added a crucial caveat to that pronouncement. "[W]e are learning," they write, "that the management of finished-goods inventory is a marketing activity with strategic implications."

Delaney and Wilson drew that conclusion in part from a study conducted by Ohio State University professors Bernard LaLonde and James L. Ginter. That research showed that although most industries had made substantial improvements in inventory efficiency, the ratio of investment in finished goods to cost of goods sold had increased or remained unchanged between 1979 and 1999 for nine of the 14 industries included in the study. In industries such as computers and peripherals, where product has high value and depreciates rapidly, the ratio of finished-goods inventory to cost of goods sold has declined markedly. In others, such as consumer goods, which is dominated by customers who hold low inventory but require rapid and reliable replenishment by suppliers, the ratio has not improved. (For more on the Ohio State study, see Logistics Management, April 2002, page 17 .)

A further surprise was the finding that companies that hold high levels of finished-goods inventories also report higher gross margins than competitive businesses that do not. "They apparently hold high levels of inventory because they can afford it," suggest Delaney and Wilson in their report.

Logistics managers' success in managing raw material and work-in-progress inventories suggests that businesses have done a good job of managing internal process change. By the same token, their failure to make as much of a dent in finished-goods stocks suggests that collaboration across the supply chain, through such initiatives as collaborative planning, forecasting and replenishment (CPFR), has yet to make major inroads.

Other factors leading to high finished-goods inventory, they speculate, could be product proliferation and logistics managers' efforts to cut transportation costs. As a possible explanation, the authors of the State of Logistics Report cite an analysis by consultant Roger Urban, who notes that shippers continue to pursue such tactics as switching to less reliable modes or consolidating shipments and shipping less often to cut costs. These practices increase inventory in the supply chain, he points out, which more than offsets the transportation savings.

Ever-increasing demands for managing inventory efficiently in the supply chain, write Delaney and Wilson, require fast adaptation to change. "Agility, accommodation and flexibility are the keys to survival for supply chain managers," they say. That helps explain the current emphasis on visibility. "Accurate inventory information is needed in order to continuously adjust supply chains."

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