U.S. business cannot blame logistics managers for the runup in logistics costs this past year. That admonishment comes from Robert V. Delaney, who publishes an annual report on the state of the logistics industry in the United States.

Logistics costs represented 10.1 percent of the nation's gross domestic product (GDP) in 2000. That's a bit higher than the 9.9 percent of GDP reported in 1999. (See Figure 1 below.) But a slowing economy in the middle two quarters of 2000 led to an inventory buildup as sales slackened unexpectedly. On top of that, high commercial paper rates drove up inventory-carrying costs. By all accounts, logisticians rose to the challenge. "In the third and fourth quarters of 2000, logistics managers were controlling inventories more effectively than they did ... in 1995-1996," wrote Delaney in his 12th annual State of Logistics Report. "If we had experienced normal growth, we would have come out a lot better."

What's even more surprising, logistics managers switched gears and threw their inventory operations into reverse during the first quarter of 2001. Delaney noted that inventory accumulation of $55.7 billion in the last quarter of 2000 became a $7.1 billion liquidation in the first quarter of 2001. "It was so major that it was the largest downward adjustment in inventory investment since the end of World War II," observes Delaney, a vice president at Cass Information Systems Inc. in St. Louis. Cass and ProLogis, a third-party provider of warehousing services, sponsored Delaney's annual report.

Delaney's annual report on logistics expenses has taken on oracle status in the profession and the statistics in it are often cited in federal government reports. His annual study breaks down overall logistics expenditures into three key components—inventory-carrying costs, transportation, and administration.

Carrying costs are the expenses associated with holding goods in storage, or, as Delaney puts it, inventory at rest. In this year's report, the Cass executive computed carrying costs at $377 billion. (See Figure 2 below.) That figure represents the sum of three components: $95 billion for interest, $78 billion for warehousing expenses, and a lump-all category for taxes, obsolescence, depreciation, and insurance that totaled $204 billion in 2000.

To determine the interest expense of $95 billion, Delaney multiplied the value of the nation's business inventory—$1.485 trillion—by 6.4 percent for interest. He chose 6.4 percent because it represented the average commercial paper rate banks charged businesses last year.

His warehousing cost estimate of $78 billion encompassed both the public and private segment. Delaney obtained public warehousing data from the Commerce Department's Census Bureau but used his own estimate for the private segment.

Freight transportation expenses constituted the second major component of overall logistics costs in the year 2000. Delaney said that freight transportation expenses—or the cost of inventory in motion—totaled $590 billion. He took his numbers for transportation costs from the annual Transportation in America report published by the Eno Transportation Foundation.

Motor carriers, which had a rough year in 2000, accounted for the largest portion of that figure—$481 billion. After a favorable first half, demand for trucking services declined in the second half of 2000 due to the economic slump, Delaney says in his report. In fact, motor carriers experienced 3,600 bankruptcies last year, an increase of 35.5 percent over the previous high recorded in 1997. "The combination of higher rates and insurance costs, driver shortages, the dramatic increase in fuel prices, and the slowing economy led to a record number of trucking company failures in 2000," Delaney wrote. In particular, he added, truckload motor carriers last year confronted excess capacity in tractors, declining market value of used equipment due to the capacity glut, and an increase in rail intermodal competition.

Railroads, for their part, accounted for $36 billion of the overall $590 billion spent on transportation last year. Delaney noted that rail tonnage for basic commodity shipments declined during the second half of the year. However, those declines were offset to some extent by a modest upswing in intermodal traffic. Delaney said that improvements in the reliability of rail intermodal services enabled the rails to recapture some longhaul traffic from truckload carriers as the economy flagged.

Although domestic airfreight revenues were flat this past year, air carriers still accounted for $27 billion of the total national freight bill. Maritime and domestic water movements, which increased by $2 billion last year, contributed another $26 billion. Other expenditures cited in Delaney's report were $9 billion for oil pipelines, $6 billion for forwarders, and $5 billion for miscellaneous shipper-related expenses (including traffic department operations and loading/unloading costs).

Delaney calculated the third component of logistics costs—administrative costs—at $39 billion. To obtain this number, he multiplied the sum of the inventory-carrying costs ($377 billion) and transportation costs ($590 billion) by a constant of 4.0 (his estimate of administrative costs as a percentage of total logistics costs).

As the recessionary winds began to blow, says Delaney, logistics managers as a group did their part to steer through the storm in 2000. He pointed out that transportation spending accounted for 5.9 percent of nominal GDP this year as it did during the recession period of 1991 and 1992. Yet average inventory-carrying costs this year were 3.8 percent of GDP, compared with an average of 6.0 percent of GDP during the 1980s.

In his report, Delaney called particular attention to the monthly inventory-sales ratio. He noted that the ratio hit a record low of 1.31 months of supply in March of 2000. The ratio then increased to 1.32 months of supply at mid-year. As the economy lost steam in the third quarter, the inventory-sales ratio gradually climbed, reaching 1.36 months of supply in December when logistics managers held the increase in inventory to a mere 0.1 percent. "That was a solid performance but there was no improvement in the ratio because sales also increased by only 0.1 percent last December," Delaney wrote. "It is clear that logistics managers have done a better job controlling inventory investment during our current economic slowdown than they did during the so-called soft landing of 1995-1996 when the monthly inventory ranged between 1.40 and 1.44 months of supply."

As in the past, Delaney's report included his observations on logistics and transportation industry trends. This year he offered his take on the steady growth of warehousing. Many industry analysts had hypothesized that demand for warehousing services would decline if companies embraced supply chain management principles and optimized their inventories. Instead, Delaney noted, the supply of industrial warehouse space actually increased to nearly 6.5 billion square feet in 2000 from 6.l billion in 1999.

In Delaney's view, warehousing services are on the rise because the warehouses themselves no longer serve merely as storage sites; instead, they house a variety of value-added activities that third-party logistics companies are performing for a growing number of manufacturers and retailers. And they won't be going away anytime soon. "Warehouses will continue to be required as inventory investment comes into our $10 trillion economy quarter after quarter," Delaney opined. "The work that is performed within the warehouse has changed, and it will continue to change consistent with the long-term trends in fast cycle procurement."

As for electronic commerce, Delaney expressed skepticism about the hype surrounding logistics portals and Web connectivity in the supply chain. For one thing, he noted, collaboration is a difficult process to manage—Internet or no Internet—and he predicted that trading partners would be slow to move to online collaboration. "Web-enabled supply chains may be the future," he wrote, "but in the near term, a manufacturer lives or dies on the quality of its goods and its relationships with suppliers and customers."

Finally, Delaney predicted that this time around, contrary to typical practice in a flagging economy, shippers would not begin emphasizing price to the exclusion of everything else in selecting carriers. "Airfreight, motor, and rail carriers are reporting declines in shipping volume in the 10- to 12-percent range but pricing has been generally firm," he observed. "More volume is moving under contract as carriers try to avoid the spot pricing environment."

Indeed, Delaney expressed skepticism that freight exchanges would get shippers to rethink their use of contractual commitments and switch to these online auction sites. Instead, he expects that the survivors among freight exchanges will become virtual freight brokers.

"Cass has been approached by many freight exchanges and transportation dot-coms [that] were interested in having us provide payment services to support their spot-market programs," said Delaney. "We have not seen anyone having the transaction volume to warrant our serious review. We see no breakdown in core carrier programs despite the economic slowdown."

Although the dot-coms may pose no serious threat to long-standing shipper-carrier relationships, Delaney did predict that logistics software vendors would complicate life for third-party logistics (3PL) companies. He noted that software vendors were marketing online applications that could potentially eliminate the need for a 3PL's expertise. "[Software vendors] claim that the user does not need the experienced people, execution process, technology, and communication provided by the 3PLs," Delaney observed. "The competition between and among third-party logistics companies has always been intense. Now, the Internet-based application service providers have added the elements of a perfect storm."