The Threat of Global Gridlock

As our worldwide transportation network becomes less and less able to support the demands of a global economy, we’re heading straight into a crisis.

A crisis? How can we be facing a critical shortage in transportation capacity when plummeting demand and rising protectionism have reduced the flow of goods around the world to a trickle? When container ships are being laid up and the rail and trucking industries are laying off workers? When the United States is spending billions of economic stimulus dollars on improving its transportation infrastructure?

Today’s economic meltdown masks the threat. But if prerecession trends reappear when the economy recovers, lack of infrastructure capacity, in combination with rising oil prices, will constrain global trade and drive up costs. The U.S. stimulus package, with its focus on “shovel-ready” projects that quickly create jobs, will produce newly painted bridges and newly paved roads but is unlikely to address the capacity problem.

Few executives realize the magnitude of the challenges that are about to hit them. Even fewer are investing to reduce transportation costs, improve logistics, and gain an advantage. But before companies can outsmart competitors with creative responses to the crisis, they need to understand it.

By Truck

Increases in traffic have outpaced road construction in Europe and the U.S. Consider that the capacity of the U.S. highway system increased only slightly in the years after 1990, while traffic grew by nearly half. Truck traffic grew even faster, particularly in metropolitan areas. Over the next few years, that trend is likely to return.

By Train

Some look to railroads to reduce pressure on an overburdened road system. In Europe, however, differences in national gauges, electrical systems, and management practices place constraints on rail transport. And in the U.S., the number of track miles fell before the downturn, while the volume of freight traffic steadily rose, making delays in shipments inland from West Coast ports more frequent.

By Ship

Before the recession, the increasing volume of cargo passing through key container and bulk ports in the U.S. and Europe was pushing at capacity limits. The three largest European ports (Antwerp, Hamburg, and Rotterdam) experienced significant congestion in recent years, as did U.S. West Coast ports—most of which are located in densely developed urban areas, making expansion of capacity politically difficult.

By Air

Airways may become as jammed as roads, rail lines, and ports. No new airports are planned for North America or Europe, and new runways can take a decade to gain approval. Major upgrades to air traffic control (ATC) systems are needed but have been repeatedly delayed. Without those improvements, traffic could exceed capacity at nearly 20 major U.S. airports by 2015.

How Companies Are Affected

Most of today’s retail and durable-goods companies put down their business footprints—their sourcing, manufacturing, distribution, and retail networks—decades ago, at a time when logistics costs were steadily declining. Improved roads and rail service, along with the advent of container shipping and intermodal transport, made moving goods more efficient, while fuel costs remained stable or even fell in real terms.

A company serving U.S. markets, for example, would build big, efficient manufacturing plants in a low-cost location like Iowa, far from metropolitan customers, and ship goods from there. More recently, business footprints expanded as companies shifted sourcing to lower-cost countries like China.

But as supply and distribution chains have become longer and more complex, companies have begun to realize that increased logistics costs can reduce or even eliminate the benefits of manufacturing where labor is cheap. The congestion and bottlenecks of a transportation system strained beyond capacity compound the problem, making supply chains seem even longer and more unpredictable.

Some of the logistics costs are obvious. In recent years rapidly rising fuel prices have made it less attractive to source goods oceans away from their end consumers. Less obvious is how an overtaxed transportation infrastructure can amplify the impact of higher fuel costs. If stop-and-go traffic means that it takes a truck three hours rather than one to pass through the New York metropolitan area, for instance, fuel costs will increase even though the distance doesn’t.

Another cost results from the time goods are tied up in transit. When goods take, say, 10 rather than five weeks to reach their destination, that means they’re in a company’s inventory, tying up working capital, for five extra weeks. Companies are increasingly taking that into account when calculating the implications of offshoring versus sourcing closer to markets.

Few businesses, however, appreciate the effects of variability in supply chain performance. For example, if the volume and mix of components arriving at a factory are predictable—even if they’re a long time in transit—the factory can consistently run at optimal levels. But if deliveries are erratic, the factory will be underutilized when parts are delayed (raising unit production costs) and suddenly overutilized when they arrive (resulting in additional labor costs to get back on schedule).

The same whipsaw effect can occur when consumer demand for a particular product changes rapidly, as in fashion retailing. A supply and distribution chain that is slow and erratic will lead to overstocks (having too much of products that people aren’t buying) and stock-outs (not having products that people want to buy). The first usually result in sales at marked-down prices, typically reducing gross margins by half or more. The second result in the loss of immediate sales—which may never be recouped, even when the items arrive at the store—and the entire gross margin from those sales, which can range from 30% to 90% of retail prices.

Many companies aren’t aware of the magnitude of these indirect costs. But once the combined expense of carrying a lot of inventory in the supply chain, suboptimal factory utilization, and overstocks and stock-outs is added into the equation, what appeared to be a healthy profit may actually turn out to be a loss. The infrastructure crisis, by exacerbating the problems of transport time and variability, will contribute significantly to those indirect costs, which will increasingly counteract the gains companies seek from cost-cutting efforts such as layoffs.

Avoiding the Hidden Costs of Delay

What Companies Can Do

A company can’t avoid the looming infrastructure crisis. But it can ensure that it’s affected less than its rivals are and even use the crisis against them.

The first step is to understand the cost and time trade-offs built into your logistics system. Measures that slightly increase costs—such as “hot hatching,” in which the shipping container holding your goods is loaded onto a vessel last and unloaded first—often can save huge amounts of time, preventing overstocks and stock-outs. Other premium services to consider: direct-to-store shipments from a manufacturer, and dedicated “unit trains” that go directly to a specified destination (reducing the risk of goods’ sitting on a siding while the railway tries to figure out where a missing car is). You also could reserve manufacturing capacity from your supplier to get preferred treatment as demand for your products fluctuates.

Or you could ship more by air. Granted, the airways have their own congestion problems, which aren’t likely to go away soon. And airfreight typically costs four to six times as much as ocean shipments. But the extra expense—still less than 10% of the shelf price for many items—may be justified for products with high margins or highly variable demand.

You should also reassess your company’s business footprint. You might source closer to your end markets: Mexico for North America, and Central and Eastern Europe for Western Europe. Although production costs in those locations may be higher than in Asia, lower logistics costs may decrease the delivered costs at the point of sale. Massive plants that make a few products for worldwide distribution may no longer make economic sense, and you may choose to replace them with smaller plants that make many products for regional or local distribution. The unit production costs will be higher, but lower logistics costs and faster replenishment cycles may more than offset the increase.

Finally, implementing best practices in logistics—for example, improving the flow of information among all parties in a supply network—can enhance the speed and predictability of your system.

If your company can master the techniques of squeezing time and variability out of its logistics system, you can avoid some of the degenerating effects of transportation congestion and bottlenecks—and use your position as a weapon against less savvy rivals. You can quickly lower or raise prices to reflect changes in input costs—or simply to throw competitors off balance. You can allow customers to change the volume or mix of their orders closer to the time of sale. You can give them better terms, including consignment pricing—requiring them to pay only when they sell the product. That concession will be feasible only because you, unlike your competitors, won’t be burdened with the high costs of carrying inventory that is slowly working its way through a long and uncertain supply chain. If rivals without your advantage copy this tactic, they’ll drive up their costs. If they don’t, they’ll most likely lose business to you.

The transportation infrastructure challenge presents a major strategic opportunity, one that many companies will ignore because they fail to understand the importance—and the impact on profitability—of a rapid-response supply chain. Even if they do appreciate the hidden costs associated with time and variability in a supply chain, few see supply chain investments as an outright source of competitive advantage.

A handful of forward-looking companies are already using one or more of the techniques I have described. That early adoption has given them an important edge. After all, if you simply keep pace with competitors, you’ll all arrive at the same point pretty much together. While your customers will benefit, you won’t.