(This is part one of a three-part series. Read parts two and three.)
It's 11 a.m. Monday and you're putting the final touches on a presentation you'll be making to your executive leadership team about your organization's preparation and readiness to handle the holiday season spike. You also expect to be asked how you're addressing increasing fuel costs, how well you're meeting customer service expectations, and what other plans you have for achieving this year's financial and strategic objectives.
You're prepared to address each of these areas, but you also see this presentation as an opportunity to raise what you've come to see as a major concern: the serious volume and infrastructure challenges facing U.S. supply chain operations. You recognize that U.S. networks are becoming seriously constrained. They are becoming slower; less flexible; less dependable, in some cases; and definitely more expensive.
You hope to use today's meeting to advise your executive leadership of the potential risks created by these constraints, how disruptive they could be to the business, and your recommendations for mitigating them. You want your leadership to know that pressures on the company's supply chain may increase—that, indeed, you're convinced things will get worse. And you want to warn them that the problem is bigger than just your company, that the nation's shippers collectively appear to be headed for a collision between what they need and what the system can provide.
What are some of those risks, and what can you do about them?
In part one of this special report, we will review current and future dynamics confronting U.S. companies, including the significant increase in volume and how this is stressing the U.S. transportation infrastructure. We will look at capacity pressures and offer observations about how they may change in the future. We will then suggest some actions to consider as you work to mitigate their effects on your company.
Supply chain activity gathers steam
In some ways, the strains on the system are a result of too much of a good thing, as the growth in demand for freight transportation has outstripped supply. For the last two years, manufacturing has seen a significant resurgence. From 2003 to 2004, manufacturing production increased 3.0 percent. Shipments of durable goods increased 10.4 percent through October 2004. Economic indicators, although mixed by sector, generally point to improvement. The U.S. Department of Transportation is predicting increased freight movements for the next five to 15 years.
Growth is good, but it has strained the transportation system. Additionally, growth plans often involve a wide array of factors, such as product proliferation, regional marketing, and sales strategies that can place additional demands on a supply chain. The growth of imports, in particular, has an enormous effect on distribution networks.
U.S. companies have moved quickly to capture the advantages of low off-shore labor costs as well as the market opportunities offered by developing countries. In 2003, the U.S. trade deficit was $500 billion, of which trade with China represented approximately $125 billion. Forecasts for 2005 show the trade deficit at $700 billion, including a $200 billion deficit with China.
That has major implications for U.S. supply chains and, by extension, the nation's transportation infrastructure. In remarks made this past May to the Senate Committee on Commerce, Science and Transportation, Christopher Koch, president and CEO of the World Shipping Council, painted a sobering logistics picture. He said, "Consider the requirements of one customer of our industry; Wal-Mart will import roughly 360,000 FEUs [40-foot containers] this year. If you were to place that volume on trucks bumper-to-bumper in a single line, it would stretch 3,750 miles. And those volumes have to be moved efficiently at the same time as L.L. Bean's, Target's, Home Depot's, Ford's, K-Mart's, Procter & Gamble's, McDonalds', Hewlett Packard's, General Motors', General Electric's, Whirlpool's, Nike's, Becks Beer's, Joe's Hardware Store's, and [those of] thousands of other shippers."
Skyrocketing global and domestic trading volumes are forcing a wholesale re-examination of how supply chains need to be designed and operated. This is especially true as it relates to planning and execution requirements for transportation lanes and finished-goods storage locations as the growth in import flows far exceeds the growth in traditional domestic distribution from U.S. plants.
This will require added capacity to specific lanes as well as a potential change to the ideal locations for storing finished goods. These shifts affect not only those companies that are importing manufactured product but also those companies that are growing their domestically sourced product volumes. Why? Because both are competing for the same supply chain infrastructure resources.
Can our existing infrastructure handle demand that is both growing and shifting? An examination of that infrastructure foretells some major difficulties. Let's start with ports.
The ports get stormed
Due to the surge in U.S. import volumes, four of the six largest U.S. ports—Los Angeles, New York/New Jersey, Savannah and Norfolk—have experienced double-digit growth over the last three years. Both Eastern and Western U.S. ports are affected.
Adding further pressure is the need to handle larger ships. Ocean carriers are rapidly reshaping their vessel portfolios. Vessels in the 2000-4000 TEU range make up about 45 percent of today's fleet. By 2006, vessels of 4000 TEU and greater are expected to represent 47 percent of the fleet. China Ocean Shipping Companies (COSCO) recently ordered four 10,000 TEU vessels. Handling even a single vessel of that size will put enormous strain on the system.
In addition to dock capacity issues, U.S. port authorities and their stakeholders must also address the downstream off-dock volume and congestion problems. Handling and staging this volume of containers and getting them into the transportation network won't be easy. Although ports are adding labor and equipment assets, the need for future planning, environmental studies, maintenance and time to "build-out" the future infrastructure makes it difficult, if not impossible, to respond quickly to growing volumes.
Recall, too, that major ports are located in or near major metropolitan areas. Domestic shippers in those locations compete for much of the same truck and rail capacity as importers, adding yet another layer of competition to an already stressed rail and truck network.
The "disappearing rail capacity" blues
It wasn't all that long ago that the railroad industry seemed to be on the wane, its ranks thinned by mergers and abandonments. But the story is very different today: The demand on the domestic rail network, particularly in intermodal utilization, has been steadily increasing since 1991 from slightly over 6 million shipping containers and trailers to somewhere in the range of 10 million.
To accommodate these historically high volumes, the railroads have added equipment, used routing alternatives and hired more people. Yet despite the estimated $35 billion railroads have spent on capital improvements in recent years, capacity constraints persist. And unless they can recoup their costs through higher rates, railroads will have a hard time funding new locomotives, technology and rail cars while maintaining their current infrastructure.As with the ports, time is a major factor; rail capacity upgrades can take years, even decades, to achieve.
Road worriers
As important as rail movements may be to U.S. supply chains, 85 percent of all U.S. freight, measured by revenue, moves by truck. Unfortunately, as demand for trucking services has grown, trucking capacity has not kept pace. Between 2000 and 2003, the industry recorded 11,500 carrier bankruptcies. Compounding this situation is a driver shortage. In recent years, the trucking industry's reputation for relatively low pay and work/life issues has driven many potential drivers to take jobs in construction and other industries. Making matters even worse, the current driver population, with an average age of 57, is heading for retirement. With relatively few drivers entering the industry, this is going to continue to be a significant problem until the industry can develop programs to attract and retain qualified drivers. Recent hours-of-service regulations add further strains.
As the pressure rises across the system, transportation planning and execution become much more difficult. As the recent DC VELOCITY/WERC survey showed, it's getting increasing difficult—and costly—to find a truck these days. (For more on the study, see part three of this report.)
Winging it
For those businesses enjoying advantages of size, weight, or high product value, air freight continues to be a viable means of transport. However, the air transport sector faces the same kinds of infrastructure challenges that the other modes confront. Air carriers are collectively facing spiraling fuel costs, which they will need to recover via surcharges or rate increases. In addition, the ability to increase fleet sizes is tied to the production rates of the aircraft manufacturers. New aircraft take years to come on line.
Fuel costs are hitting every mode hard, of course, and the prospects for a return to cheap oil seem slim at best. Even before the post-Hurricane Katrina price runup, oil was trading above $65 a barrel, and diesel costs had jumped 28 percent in a year.With freight capacity tight, many carriers were able to pass those higher costs on to their customers in the form of fuel surcharges. But in today's competitive consumer markets, shippers' companies rarely have the pricing power to recover higher logistics costs.
And then there's the unthinkable ...
All of these constraints make the logistics system vulnerable to disruptions. In the aftermath of Hurricane Katrina, that may seem more obvious than in the past. But what's more worrisome still is the continuing potential for a terrorist attack on or through the transportation system. Although no one can fully estimate the costs of a terrorist attack on a supply chain, it's safe to say the consequences would be severe. Worse still, another attack would almost certainly lead to severe regulatory restrictions on freight movements that could hamper the entire economy.
The federal government has a number of programs in place aimed at thwarting terrorist attacks through the transportation system. For shippers, the primary program is C-TPAT, a voluntary program through which U.S. importers work with their overseas partners to manage the security risk at the front end of the supply chain. To this point, the results are mixed. The growing interest among participants is good; however, it is not a regulatory program. It is also expensive for participating businesses, and requirements for participation have become more onerous.
While various technology solutions for container security are promising, we must address the risks inherent in global terror, and specifically global supply chains, and develop plans and alternatives to allow our business to provide excellent service to key customers without sacrificing profitability.
Oh, yes, get the numbers right, too
On top of all the capacity and security challenges, logistics and supply chain professionals find themselves very much affected by financial regulations that grew out of corporate scandals in the last few years. The Sarbanes-Oxley legislation has already had a tremendous financial impact on U.S. companies. Section 404 of Sarbanes-Oxley, now expected to be fully implemented by U.S. companies by July 2006, requires businesses to report on and certify the effectiveness of internal control structures and processes. Section 409 dictates the disclosure of material information "on a rapid and current basis." Together they define the need for financial transparency, identification of compliance and performance indicators, rapid reporting of changing financial conditions, and auditing of processes.
The attention to detail required to support Sarbanes-Oxley requirements will put additional stress on those accountable for managing a supply chain's processes and performance.
The result of all this is that global trade has introduced tremendous strains on our domestic freight transport system. At current rates of growth, our system will become less dependable, less responsive and considerably more expensive. Relying on former planning practices and outdated productivity metrics will likely make matters worse. Planning future actions based on historical activities will no longer suffice. We must take a new approach to solving a completely new set of supply chain paradigms. We must begin now.
The five things you should do
The best way to position your company to meet these challenges is to ensure that you have a solid plan that both addresses things that you can do today and includes well-defined contingency plans for responding to identified risks. This type of planning should be done by everyone—both those involved in importing and exporting and those with only domestic operations.
Having this plan established will position your organization to be responsive to a changing environment and thus protect both service performance to customers and company finances.
The following five steps are offered as a guide—every company's situation will, of course, be different. This guide is based on the premise that an organization can blend solid operational knowledge with accurate industry information into supply chain analytical efforts in the areas of forecasting, network design, and inventory and transportation decision-support evaluations.
- Assess Your Situation.
Understanding your current environment is paramount. We suggest doing the following to thoroughly understand your current operation:
- Detail your current supply chain product flows in sufficient detail to understand operating network constraints and behavior characteristics and their drivers. This should include sourcing and manufacturing considerations, port capacities (if applicable), mode selection decisions and capacities, finished-goods storage, and distribution operations.
- Understand your current network operating gaps and constraints that would limit your ability to be agile. This involves obtaining accurate industry information regarding supply chain asset capabilities (ports, rail, carriers, etc.) and the implications for their current and future operations.
- Understand your current ability to measure performance in as close to real time as possible.
- Assess your current ability to accurately forecast short-term and long-term capacity requirements and your effectiveness in communicating these requirements to your supply chain partners.
Often supply chain "surprises" have been handled by changing modes or other forms of "expediting" actions. In the future, this may not be as compelling a strategy. Therefore, it's essential to take a more practical position to review degrees of risk and the ways to mitigate that risk. What follows are some suggestions on how to sort through these complex issues:
- Ensure that you understand key industry information and intelligence regarding trends, cost structures or other relevant information that could affect your future supply chain performance. Perform appropriate, detailed supply chain diagnostics to analyze each alternative while also considering the amount of investment required, the time-frame for implementation and the potential impact that the alternative(s) would have in mitigating that element of risk.
- Using these findings, identify constraints and gaps, prioritize the supply chain areas that represent the highest areas of risk, and decide which ones should be acted upon and which ones addressed through contingency plans. Validate the analysis with internal stakeholders and collaborate with key customers and service providers. For those items that you decide should be implemented, immediately begin taking the required steps. For other potential identified risk areas, prioritize contingency plans, actionable steps and expected outcomes.
In all cases, it is critical for the management team to recognize the degree of risk, its correlation to each element of the supply chain, and the various strategies required to deal with it. Once each element of the supply chain is ranked relative to risk exposure, the top third can be handled through "redundancy," the next third by "contingency," and the last third by "policy" strategies within resource limitations. "Redundancy" suggests full supply chain fault tolerance that will operate at lower volumes until needed. "Contingency" suggests alternate elements that do not operate routinely but can be activated relatively quickly when needed. "Policy" is a triage method designed to create alternates when needed.
No plan can be effective unless it is well understood among all of the plan's stakeholders. The following steps are critical to the success of this effort:
- Ensure that all internal stakeholders have a clear understanding of the changes that are planned as well as the contingency options.
- Work with your supply chain partners to clearly define expected operating performance objectives and their use.
- Communicate with your customers to understand their requirements and the realistic performance objectives that can be expected under standard and exceptional operating circumstances.
- For each key area of the supply chain that was identified as critical to supply chain performance, ensure that you have accurate and timely ways to measure current and anticipated operating performance indicators.
- Ensure that you have the proper allocation of resources, processes and systems to monitor performance and ensure your people understand how to interpret variances and what associated actions they should take if problems occur.
- Establish practices that ensure that actions taken and their consequences are properly documented for use in Step 5.
Review and rank your operating plan drivers (assumptions, prioritized risks, etc.) as well as new industry or supply chain information to identify changes or additional considerations not factored into the current plan.
- Periodically ask your customers, service providers and other supply chain stakeholders to validate information.
- Incorporate those changes in the analytical work done earlier to determine the substantive impact.
- Update the operational, tactical and strategic plans to account for the changes …and ensure that your company maintains a sense of urgency to address these changes, as they will continue to occur in our global economy.
