17th Annual State of Logistics Report finds that rising prices and interest rates will soon push logistics costs above 10 percent of GDP.
From the pages of Logistics Management
Costs under pressure
17th Annual State of Logistics Report finds that rising prices and interest rates will soon push logistics costs above 10 percent of GDP.
By James A. Cooke, Contributing Editor -- 7/1/2006
___________________________________________________
Pressure on logistics costs has been building for awhile, and the results are evident: After declining for most of the last seven years, logistics costs as a percentage of the nation's gross domestic product (GDP) are pushing upward.
For the past 17 years, the State of Logistics Report has given logistics and supply chain professionals insight into the economic forces that affect logistics costs. This year's report, written by economist Rosalyn A. Wilson under the auspices of the Council of Supply Chain Management Professionals (CSCMP), places logistics expenditures at 9.5 percent of GDP. That's a sharp departure from the three previous years, when those costs ranged between 8.6 and 8.8 percent of GDP (see Figure 1). And it's perilously close to the 10 percent mark, a long-accepted demarcation separating reasonable and exorbitant cost levels.
In fact, estimated logistics costs in 2005 totaled a whopping $1.183 trillion, an increase of $156 billion over 2004 and the largest year-on-year change in the 17-year history of the report. Shippers are feeling pressure from two directions.
One factor is the steady climb in interest rates, which has pushed up inventory-carrying costs. But the biggest cost driver has been rising transportation expenses, which reached $744 billion in 2005, up from $636 billion in 2004. Soaring fuel prices, a driver shortage, and diminished competition have all come together to raise rates across all modes, and for trucking in particular.
Things could have been worse. "We've had a robust economy with rising transportation costs. I was surprised that it didn't go over 10 percent this year," Wilson says.
Figure 1. After steadily declining for several years, logistics costs are heading back up toward the 10 percent mark. Rising fuel prices and inventory-carrying costs are partly to blame.
The 10 Percent Benchmark
When the late Robert V. Delaney began the State of Logistics Report in 1984, he set a 10 percent threshold as the ideal level of logistics costs as a percentage of the U.S. economy. Back then, when transportation deregulation was still in its early stages, logistics expenditures accounted for 13.4 percent of GDP, and transportation alone accounted for 6.8 percent.
As regulatory barriers lifted and competition for shippers' business increased, transportation costs quickly fell. By 1989, transportation represented just 6.0 percent of GDP.
By 1992, logistics costs, which include the costs of transportation, inventory, and logistics administration, finally reached Delaney's goal of 10 percent. Throughout the 1990s, they hovered around the 10 percent mark.
In 2001, logistics costs fell to 9.5 percent and reached a low of 8.6 percent in 2003. That decline was due in part to historically low interest rates that resulted from the Federal Reserve Board's attempts to stimulate the economy out of a recession.
A weak economy signals less demand for transportation services. Now that the U.S. economy is booming, demand is exploding. The days of cheap money appear to be behind us: The Federal Reserve Board has begun ratcheting up interest rates in an effort to hold back inflation caused by higher energy costs. These higher borrowing costs have been especially troublesome because they coincide with a recent trend toward building up inventory.
Inventory Inflation
In conducting and analyzing her research, Wilson continues to follow Delaney's methodology, which uses the so-called Alford-Bangs formula to determine the value of logistics relative to overall economic activity. That formula adds together three components: inventory-carrying costs, transportation costs, and administrative costs. This year Wilson calculated total logistics costs for 2005 at $1.183 trillion, a 15.2 percent hike over the previous year's total. (For a breakdown of those cost components, see Figure 2.)
Figure 2. Most cost categories have risen in the past year. Transportation costs made the biggest leap, up 14.1 percent to $744 billion in 2005.
The rise in inventory-carrying costs over the last two years is clearly evident. According to Wilson's analysis, those costs rose from $332 billion in 2004 to $393 billion last year. That figure is a composite number that includes $58 billion for interest, $90 billion for warehousing, and $245 billion for taxes, obsolescence, depreciation, and insurance.
To determine interest costs, she multiplied the value of the nation's inventory—$1.76 trillion—by the average "commercial paper" rate of 3.3 percent. That refers to the rate financial institutions charge to most businesses for borrowing money. As the Federal Reserve Board raised its lending rates to banks, they hiked the price of commercial paper by 1.4 percent from 2004 to 2005.
Wilson expects the trend toward higher interest rates to continue throughout this year. One ominous sign: The commercial paper rate for the first four months of 2006 has already reached 4.6 percent.
Adding to shippers' pain is the fact that companies are now holding more inventory, apparently reversing the '90s trend toward leaner stocks. According to Wilson, the value of inventory in 2005 was $116 billion higher than it was in 2004.
In her view, companies are storing more goods in response to longer, often unpredictable transit times. Also contributing to the buildup is a shift from central, mega-warehouses to smaller distribution centers across the country. That strategy improves delivery times and reliability but requires shippers to hold complete product lines in more locations.
The cost of warehousing those inventories, of course, is also on the upswing. According to ProLogis, a leading provider of distribution facilities and services, warehouse vacancy rates dropped to 7.3 percent at the end of 2005, from a high of 9.7 percent in 2004. With demand for storage space growing, it's no surprise that average prices for public warehouse space rose 5 percent, to $90 billion in 2005. Wilson bases that figure on data released by the U.S. Commerce Department's Bureau of the Census.
Rising inventory-carrying costs are indeed a concern, but a bigger worry for many shippers is the cost of transportation. That tab rose 14.1 percent, to $744 billion in 2005, and it now accounts for 6 percent of GDP. During the past decade, transportation costs have risen 77.1 percent.
The trucking industry represented the lion's share of transportation costs, with expenses rising from $509 billion in 2004 to $583 billion in 2005. The worsening driver shortage contributed to diminishing trucking capacity and concomitant higher freight rates as motor carriers engaged in fierce competition for labor, Wilson notes in her report.
Because so few workers are taking up trucking as an occupation, most carriers have been forced to recruit drivers from their competitors. That was evident in a recent report from the American Trucking Associations, which pegs the average driver turnover rate for large truckload carriers at 130 percent last year, the highest such rate ever recorded.
Jacked-up diesel prices also hit motor carriers hard this past year. The trucking industry spent $87.7 billion on diesel fuel in 2005, compared to $65.9 billion in 2004. The U.S. trucking industry consumes some 650 million gallons of diesel each week, making fuel its second-largest expense, after labor.
Other transportation modes confronted the same pressures brought on by spiraling energy costs coupled with greater demand. Costs for all other types of transportation services amounted to $153 billion in 2005. Heavy demand for railroad services pushed those costs from $42 billion in 2004 to $48 billion in 2005, a 14 percent increase. In order to increase capacity, Wilson notes, U.S.-based railroads are expected to hire some 80,000 new workers by 2012.
Shippers' expenditures on water transportation was almost flat in comparison, rising just $2 billion, from $32 billion to $34 billion. Air cargo costs soared from $34 billion to $40 billion in 2005, primarily due to rising fuel costs. As Wilson points out, fuel represented about 14 percent of air carriers' operating expenses in 2003, but jumped to 22 percent last year.
Like all of the other sectors in this category, domestic freight forwarding services were not immune from rising costs. Expenditures in that category moved up from $18 billion in 2004 to $22 billion last year. Oil pipeline transportation, at $9 billion, was the only transportation segment that did not change year to year.
Finally, shipper-related costs (which include such expenses as loading and unloading activities, transportation equipment, and traffic department operations) and logistics administration costs also experienced substantial hikes in 2005. Those costs combined leaped from $47 billion in 2004 to $54 billion last year.
Long-term Challenges
In her report, Wilson outlines two long-term challenges for logistics managers: aging, inadequate infrastructure, and safeguarding the supply chain. Both must be addressed if logistics costs are to remain under control.
The woeful state of the nation's transportation infrastructure hinders freight movements, leading to greater delays and higher costs. "The dramatic growth in the volume of freight in our logistics system has severely strained the transportation network in some locations," Wilson writes.
Burgeoning international trade has placed mounting pressure on the points of entry, including ports, airports, and border crossings, to create freight bottlenecks. The nation's harbors in particular are in dire straits. Wilson points out that an estimated 800 oceangoing ships make more than 22,000 calls at the nation's 145 ports each year. Even if those ports could manage to handle the growth in container loadings and discharges, they still would suffer from congested truck and rail access to their docks. The situation will only get worse, she predicts, as ocean carriers deploy larger vessels carrying many thousands of containers. The new ships' size, moreover, will force ports to widen their navigation channels and deepen shallow harbors.
Congestion also plagues the nation's highways, and that situation, too, is expected to worsen in the years ahead. The Federal Highway Administration predicts that the volume of freight traffic on U.S. roads will increase 70 percent by 2020. Just to maintain the current highway infrastructure, the agency has said, the United States will have to spend nearly $76 billion annually through 2020.
To avoid potentially disastrous bottlenecks and solve the congestion problem, Wilson contends, the country must adopt a "total system" approach that looks at the connections between all modes. "Investment decisions should be made to maximize the benefits of improvements that will reduce the bottlenecks and the freight exchange points throughout the system in the next three years," she argues.
The issue of cargo security poses another problem that could drive up logistics costs. In 2005, more than 11 million containers were imported into the United States. By 2007, an estimated 13 million containers will be entering the country annually. Any disruption to this container flow would have immediate and wide-ranging economic implications, Wilson notes.
Like many other industry observers, Wilson argues for a holistic approach to security. She advocates end-to-end monitoring of cargo and at the same time establishing and preserving a proven chain of custody. Although companies would have to bear the costs associated with those practices, she believes that improved security would justify the expense. "Investment in state-of-the-art cargo- security technology and monitoring solutions can provide a significant return on investment, often at bargain prices considering the value of the capital that could be lost by a disruption in global container shipping," she writes. Embracing security as a core business function will mitigate the need for invasive government practices, she adds.
Problems caused by the nation's aging infrastructure and the need to improve cargo security will only add to the growing pressure on logistics costs. Add to that inevitably higher interest rates, rising fuel prices, and escalating wages, and there's no question that logistics costs as a percentage of GDP are headed up—and over—the 10 percent mark. "It's not a matter of if anymore," Wilson says about crossing that threshold, "but a matter of when."
Author Information
Contributing Editor James A. Cooke has covered transportation and logistics for more than 20 years.
© 2006, Reed Business Information, a division of Reed Elsevier Inc. All Rights Reserved.
Costs under pressure
17th Annual State of Logistics Report finds that rising prices and interest rates will soon push logistics costs above 10 percent of GDP.
By James A. Cooke, Contributing Editor -- 7/1/2006
___________________________________________________
Pressure on logistics costs has been building for awhile, and the results are evident: After declining for most of the last seven years, logistics costs as a percentage of the nation's gross domestic product (GDP) are pushing upward.
For the past 17 years, the State of Logistics Report has given logistics and supply chain professionals insight into the economic forces that affect logistics costs. This year's report, written by economist Rosalyn A. Wilson under the auspices of the Council of Supply Chain Management Professionals (CSCMP), places logistics expenditures at 9.5 percent of GDP. That's a sharp departure from the three previous years, when those costs ranged between 8.6 and 8.8 percent of GDP (see Figure 1). And it's perilously close to the 10 percent mark, a long-accepted demarcation separating reasonable and exorbitant cost levels.
In fact, estimated logistics costs in 2005 totaled a whopping $1.183 trillion, an increase of $156 billion over 2004 and the largest year-on-year change in the 17-year history of the report. Shippers are feeling pressure from two directions.
One factor is the steady climb in interest rates, which has pushed up inventory-carrying costs. But the biggest cost driver has been rising transportation expenses, which reached $744 billion in 2005, up from $636 billion in 2004. Soaring fuel prices, a driver shortage, and diminished competition have all come together to raise rates across all modes, and for trucking in particular.
Things could have been worse. "We've had a robust economy with rising transportation costs. I was surprised that it didn't go over 10 percent this year," Wilson says.
Figure 1. After steadily declining for several years, logistics costs are heading back up toward the 10 percent mark. Rising fuel prices and inventory-carrying costs are partly to blame.
The 10 Percent Benchmark
When the late Robert V. Delaney began the State of Logistics Report in 1984, he set a 10 percent threshold as the ideal level of logistics costs as a percentage of the U.S. economy. Back then, when transportation deregulation was still in its early stages, logistics expenditures accounted for 13.4 percent of GDP, and transportation alone accounted for 6.8 percent.
As regulatory barriers lifted and competition for shippers' business increased, transportation costs quickly fell. By 1989, transportation represented just 6.0 percent of GDP.
By 1992, logistics costs, which include the costs of transportation, inventory, and logistics administration, finally reached Delaney's goal of 10 percent. Throughout the 1990s, they hovered around the 10 percent mark.
In 2001, logistics costs fell to 9.5 percent and reached a low of 8.6 percent in 2003. That decline was due in part to historically low interest rates that resulted from the Federal Reserve Board's attempts to stimulate the economy out of a recession.
A weak economy signals less demand for transportation services. Now that the U.S. economy is booming, demand is exploding. The days of cheap money appear to be behind us: The Federal Reserve Board has begun ratcheting up interest rates in an effort to hold back inflation caused by higher energy costs. These higher borrowing costs have been especially troublesome because they coincide with a recent trend toward building up inventory.
Inventory Inflation
In conducting and analyzing her research, Wilson continues to follow Delaney's methodology, which uses the so-called Alford-Bangs formula to determine the value of logistics relative to overall economic activity. That formula adds together three components: inventory-carrying costs, transportation costs, and administrative costs. This year Wilson calculated total logistics costs for 2005 at $1.183 trillion, a 15.2 percent hike over the previous year's total. (For a breakdown of those cost components, see Figure 2.)
Figure 2. Most cost categories have risen in the past year. Transportation costs made the biggest leap, up 14.1 percent to $744 billion in 2005.
The rise in inventory-carrying costs over the last two years is clearly evident. According to Wilson's analysis, those costs rose from $332 billion in 2004 to $393 billion last year. That figure is a composite number that includes $58 billion for interest, $90 billion for warehousing, and $245 billion for taxes, obsolescence, depreciation, and insurance.
To determine interest costs, she multiplied the value of the nation's inventory—$1.76 trillion—by the average "commercial paper" rate of 3.3 percent. That refers to the rate financial institutions charge to most businesses for borrowing money. As the Federal Reserve Board raised its lending rates to banks, they hiked the price of commercial paper by 1.4 percent from 2004 to 2005.
Wilson expects the trend toward higher interest rates to continue throughout this year. One ominous sign: The commercial paper rate for the first four months of 2006 has already reached 4.6 percent.
Adding to shippers' pain is the fact that companies are now holding more inventory, apparently reversing the '90s trend toward leaner stocks. According to Wilson, the value of inventory in 2005 was $116 billion higher than it was in 2004.
In her view, companies are storing more goods in response to longer, often unpredictable transit times. Also contributing to the buildup is a shift from central, mega-warehouses to smaller distribution centers across the country. That strategy improves delivery times and reliability but requires shippers to hold complete product lines in more locations.
The cost of warehousing those inventories, of course, is also on the upswing. According to ProLogis, a leading provider of distribution facilities and services, warehouse vacancy rates dropped to 7.3 percent at the end of 2005, from a high of 9.7 percent in 2004. With demand for storage space growing, it's no surprise that average prices for public warehouse space rose 5 percent, to $90 billion in 2005. Wilson bases that figure on data released by the U.S. Commerce Department's Bureau of the Census.
Rising inventory-carrying costs are indeed a concern, but a bigger worry for many shippers is the cost of transportation. That tab rose 14.1 percent, to $744 billion in 2005, and it now accounts for 6 percent of GDP. During the past decade, transportation costs have risen 77.1 percent.
The trucking industry represented the lion's share of transportation costs, with expenses rising from $509 billion in 2004 to $583 billion in 2005. The worsening driver shortage contributed to diminishing trucking capacity and concomitant higher freight rates as motor carriers engaged in fierce competition for labor, Wilson notes in her report.
Because so few workers are taking up trucking as an occupation, most carriers have been forced to recruit drivers from their competitors. That was evident in a recent report from the American Trucking Associations, which pegs the average driver turnover rate for large truckload carriers at 130 percent last year, the highest such rate ever recorded.
Jacked-up diesel prices also hit motor carriers hard this past year. The trucking industry spent $87.7 billion on diesel fuel in 2005, compared to $65.9 billion in 2004. The U.S. trucking industry consumes some 650 million gallons of diesel each week, making fuel its second-largest expense, after labor.
Other transportation modes confronted the same pressures brought on by spiraling energy costs coupled with greater demand. Costs for all other types of transportation services amounted to $153 billion in 2005. Heavy demand for railroad services pushed those costs from $42 billion in 2004 to $48 billion in 2005, a 14 percent increase. In order to increase capacity, Wilson notes, U.S.-based railroads are expected to hire some 80,000 new workers by 2012.
Shippers' expenditures on water transportation was almost flat in comparison, rising just $2 billion, from $32 billion to $34 billion. Air cargo costs soared from $34 billion to $40 billion in 2005, primarily due to rising fuel costs. As Wilson points out, fuel represented about 14 percent of air carriers' operating expenses in 2003, but jumped to 22 percent last year.
Like all of the other sectors in this category, domestic freight forwarding services were not immune from rising costs. Expenditures in that category moved up from $18 billion in 2004 to $22 billion last year. Oil pipeline transportation, at $9 billion, was the only transportation segment that did not change year to year.
Finally, shipper-related costs (which include such expenses as loading and unloading activities, transportation equipment, and traffic department operations) and logistics administration costs also experienced substantial hikes in 2005. Those costs combined leaped from $47 billion in 2004 to $54 billion last year.
Long-term Challenges
In her report, Wilson outlines two long-term challenges for logistics managers: aging, inadequate infrastructure, and safeguarding the supply chain. Both must be addressed if logistics costs are to remain under control.
The woeful state of the nation's transportation infrastructure hinders freight movements, leading to greater delays and higher costs. "The dramatic growth in the volume of freight in our logistics system has severely strained the transportation network in some locations," Wilson writes.
Burgeoning international trade has placed mounting pressure on the points of entry, including ports, airports, and border crossings, to create freight bottlenecks. The nation's harbors in particular are in dire straits. Wilson points out that an estimated 800 oceangoing ships make more than 22,000 calls at the nation's 145 ports each year. Even if those ports could manage to handle the growth in container loadings and discharges, they still would suffer from congested truck and rail access to their docks. The situation will only get worse, she predicts, as ocean carriers deploy larger vessels carrying many thousands of containers. The new ships' size, moreover, will force ports to widen their navigation channels and deepen shallow harbors.
Congestion also plagues the nation's highways, and that situation, too, is expected to worsen in the years ahead. The Federal Highway Administration predicts that the volume of freight traffic on U.S. roads will increase 70 percent by 2020. Just to maintain the current highway infrastructure, the agency has said, the United States will have to spend nearly $76 billion annually through 2020.
To avoid potentially disastrous bottlenecks and solve the congestion problem, Wilson contends, the country must adopt a "total system" approach that looks at the connections between all modes. "Investment decisions should be made to maximize the benefits of improvements that will reduce the bottlenecks and the freight exchange points throughout the system in the next three years," she argues.
The issue of cargo security poses another problem that could drive up logistics costs. In 2005, more than 11 million containers were imported into the United States. By 2007, an estimated 13 million containers will be entering the country annually. Any disruption to this container flow would have immediate and wide-ranging economic implications, Wilson notes.
Like many other industry observers, Wilson argues for a holistic approach to security. She advocates end-to-end monitoring of cargo and at the same time establishing and preserving a proven chain of custody. Although companies would have to bear the costs associated with those practices, she believes that improved security would justify the expense. "Investment in state-of-the-art cargo- security technology and monitoring solutions can provide a significant return on investment, often at bargain prices considering the value of the capital that could be lost by a disruption in global container shipping," she writes. Embracing security as a core business function will mitigate the need for invasive government practices, she adds.
Problems caused by the nation's aging infrastructure and the need to improve cargo security will only add to the growing pressure on logistics costs. Add to that inevitably higher interest rates, rising fuel prices, and escalating wages, and there's no question that logistics costs as a percentage of GDP are headed up—and over—the 10 percent mark. "It's not a matter of if anymore," Wilson says about crossing that threshold, "but a matter of when."
Author Information
Contributing Editor James A. Cooke has covered transportation and logistics for more than 20 years.
© 2006, Reed Business Information, a division of Reed Elsevier Inc. All Rights Reserved.