Noel Perry, a Partner with FTR Associates, has written a very interesting and thought provoking paper entitled, “The Challenge of Deep Economic Cycles,” In his report, he argues that “the United States has resumed a pattern of high cyclicality. That means bad things for logistics.”
Mr. Perry suggests that most of us tend to operate in a “bipolar” way. As creatures of the present, we interpret a good stretch of economic activity as a constant that will last forever. Our confidence in a continuation of the good times leads us to “end up in an overbuy mode. At some point, usually after a significant overbuy, we realize our error and stop buying. The same focus on the present . . . now causes us to . . . underbuy, again by a significant amount. That is a recession. The economy is bipolar, cycling between euphoria and depression.”
As we become more euphoric, “our neurosis becomes psychosis and the overbuy becomes a ‘bubble.’ At some point the bubble bursts and we get a long-overdue big correction.” Most recently, “the . . . three overbuys of the cycle were consumer credit, home prices and financial risk taking. When those bubbles burst in 2008 the economy collapsed.”
This leads to Mr. Perry’s key thesis that the latest bubble has yet to burst. This bubble will result from the credit problems in Europe and in the United States. “Since I have yet to see the least evidence of the resolve to reduce U.S. governmental borrowing, from either party, I conclude that our creditors will prick our bubble sometime this decade, probably sooner than later. Moreover, the resulting shock to a governmental system . . . will create a wave of . . . taxes and spending policies that will add another level of volatility to the transportation environment.”
Using historical data on previous economic cycles, Mr. Perry demonstrates that recoveries following deep downturns tend to be much shorter (e.g. 10 quarters versus 25 to 28) than the more shallow cycles and the peak to trough is five times worse. “Short recoveries are bad for transportation for a simple reason. The benefits from an upturn take about a year to come in. It takes six months or more for the average manager to realize that there has been a turn; it takes another six months for that manager to take advantage.”
These rapid changes in a short time frame make it difficult to right-size the fleet. “Right-sizing usually falls short of the required amount because the fleets seldom choose to right-size fully and because they can’t right-size fast enough, even if they wanted to. They must complete the job after the rises and falls are complete.” This creates a significant capacity utilization issue. In addition, regulatory changes are expected to take more than 200,000 drivers out of the U.S. workforce. This will create stress for all industry participants. Mr. Perry also argues that “truck pricing has entered a new and radically more volatile phase.” A more volatile environment also creates large swings in trucking company earnings as we have seen the past year.
If we are headed into a more difficult freight environment, what should trucking company leaders be doing? Mr. Perry argues that there are two approaches to developing a cyclical strategy.
“Smoothing The Cycle. Mr. Perry suggests that there are five variants to this option for a carrier:
• Choose a customer segment that is growing, in the hope that the underlying trend will moderate a downturn.
• Choose a customer segment with inherently low cyclicality. The classic example is the reefer segment. Americans always overeat; there is no undereat. . .
• Assemble a diversified portfolio of customer segments that vary in different ways and at different times. Railroads, inherently do this with large portfolio of weather-related commodities (grain, coal) that offset autos and steel that cycle with the economy. . .
• Concentrate on the most stable portion of any customer’s business, usually the base load, dedicated portion. Customers attempt to protect their dedicated operations in a downturn to keep productivity high and cost low. . .
• Attempt to lock in volume during a downturn in exchange for guaranteeing capacity during the next upturn. The catch to this strategy is the tension between market conditions and the smoothed trucker’s earnings. During the downturn those earnings are above industry averages attracting competitive attention. During the upturn the smoothing results in earnings below industry averages, creating pressure for a move. This tension requires very committed manage¬ment and solid relationships with customers.”
The other option is:
“Chasing The Cycle. The alternative is to adopt flexible operations that move with the cycle. One cuts cost aggressively during the downturns . . . then adds capacity rapidly during the upturn—for a price. This approach puts a premium on forecasting and monitoring because the highest returns go to the first adapter. That firm cuts costs before prices collapse in a downturn and scarfs up capacity just before the real capacity crunch.
The deep-cycle economics of the current decade will require managers (and investors) to adopt four new paradigms, heretofore seldom seen in North American logistics. The first is a switch to flexible budgeting and planning, abandoning the comfortable notion that the next year is predictable. This will take a significant increase in market tracking and scenario planning.
The second switch is from short-run profit maximization to full-cycle profit maximization. All of the possible strategies for managing deep cyclicality make the practitioner suboptimal at some point in the cycle. Management (and investors) must fight the urge to abandon the strategy at that point.
The third switch is related; that is the development of full-cycle relationships between shippers and carriers, characterized by much tighter three- to five-year contracts rather than the loose one-year contracts in vogue. Jumping ship has a much higher cost in a deep-cycle economy.
The fourth switch is the change from simple cost minimization to cost minimization with capacity assurance. This will be a major challenge to a shipper base whose value system rejects price premiums and a carrier base shy about extracting capacity premiums.”
Dan Goodwill, President, Dan Goodwill & Associates Inc. has over 30 years of experience in the logistics and transportation industries in both Canada and the United States. Dan has held executive level positions in the industry including President of Yellow Transportation’s Canada division, President of Clarke Logistics (Canada’s largest Intermodal Marketing Company), General Manager of the Railfast division of TNT and Vice President, Sales & Marketing, TNT Overland Express.
Goodwill is currently a consultant to manufacturers and distributors, helping them improve their transportation processes and save millions of dollars in freight spend. Mr. Goodwill also provides consulting services to investors, vendors to the trucking industry, transportation and logistics organizations. All posts by Dan Goodwill