Wednesday 21st Nov 2018 - Logistics & Supply Chain

Fuelling change

The $100-plus barrel of oil has driven fuel costs for freight into sharp focus. Diminishing supplies and the voracious appetite for carbon fuels from China and India suggest that even a global slowdown will not restore oil prices to their previous levels. Green initiatives will also tend to raise or maintain fuel costs.

While there is no formal index, all the data points to the fact that freight costs have fallen in real terms by up to 75 per cent. Scale, efficiencies and competition have been underlying drivers of this. The UK and other European countries have seen an increase in the tonne-kilometres carried that has maintained a close correlation with growth in GDP until recently when that trend has been broken.

Since tonnes carried have not increased significantly in the past 40 years, there has been a structural increase in freight transport intensity in the economy.

The barriers to entry in road freight are low. Growth with market scale has motivated new entrants and created heightened competition. Even the container shipping market which is highly capital-intensive is remarkably fragmented and prone to commodity pricing practices. This has driven prices and margins down in most areas of freight, lowering costs to industrial companies.

This combination of improved efficiency, low margins and plenty of competition has made freight seem like an infinite resource with continuing low costs.

This has reinforced the creation of logistics network structures that are centralised and trade off higher transport costs against reduced warehousing and inventory holding costs.

Is this organisation of logistics sustainable in the face of increased fuel costs and the potential for carbon pricing? The answer is probably no.

This conclusion is based on three facts. First, the margins on freight and logistics are now dangerously low based on market place capacity. Second, operators are seeing increases on every front including fuel which is only part of the equation and third, providers have begun to see rate increases stick.

Certainly this is the case with the big logistics brands which have asserted their power and encountered little resistance. But the smaller providers have been put under greater pressure in business threatening negotiations. Their increases have been less and failures are rising.

These three factors combine to create a rather pessimistic picture. Some small providers will be driven out of business, capacity will exit the market and remaining providers will increase prices beyond cost increases to restore margins and exercise improved market power. Government actions that impose increased taxes to reinforce green policies will accentuate this position. As a result, freight costs may rise at a much faster rate than inflation, at least in the short term. The supply side will likely concentrate and there will be psychological barriers to new entrants in the face of the turmoil.

So what will be the structural impacts on logistics operations if this scenario plays out? We can expect to see a trend back towards logistics network solutions based on local configurations, with port-based logistics increasing in importance. There will be an increasing emphasis on creating economic transport schedules with shared user networks. Faster adoption of technologies will improve fuel use and operating effectiveness, there will be an increased focus on intermodal freight to transport costs and satisfy environmental initiatives and government intervention on fuel costs will come about. Meanwhile, environmental incentives will reinforce all the points above.

Whichever way you look at it, freight is back in focus and facing some high pressure challenges.

Prof Alan Braithwaite is visiting professor, Cranfield School of Management and chairman of LCP Consulting

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