The Supply Chain Outlook, Innovation and Challenges, and Implications for Military Transportation
By Benjamin Gordon, Managing Partner, Cambridge CapitalThe supply chain sector is in the news today. Rising tariffs, the trade war with China, Amazon’s quest for same-day delivery, autonomous vehicles, and drones are all in the news. What does it mean, and how does it impact the overall supply chain, as well as military transportation?
We see three major challenges facing the supply chain market today.
Trade: War and Peace
The first challenge is the choppy political climate. On the one hand, we averted a trade war with Canada and Mexico when the Trump Administration canceled the North American Free Trade Agreement (NAFTA), but then replaced it with a similar deal in September.
On the other hand, we may be entering a bigger battle with China. President Trump and Chinese Core Leader Xin Jinping agreed to postpone retaliatory tariffs on December 1. But if they fail to reach agreement, the US will impose 25 percent tariffs on $200 billion of Chinese goods, and China will reimpose 40 percent tariffs on US cars.
The US supply chain is already feeling the consequences. West Coast shipping data shows a drop in exports to China. In November, over 186,000 containers in Long Beach were shipped empty back to Asia, reflecting an 11 percent increase. It appears that China is finding non-US sources for products wherever possible.
In the short term, the data is mixed. In fact, the US imported record levels of products in the first quarter of this year. In addition, at the port of Long Beach volumes are at all-time highs, and exceeded 7.5 million containers handled. Many analysts believe US retailers pursued a surge in Chinese purchases in late 2018, to beat the 2019 tariffs. If true, this pre-buy could lead to a 2019 slowdown.
An unintended consequence of the Trump trade policy is the trend toward reshoring. Tariffs are intended to encourage American consumers to buy American. In turn, Trump has sought to bring manufacturing jobs to the US. Some companies, like Carrier, announced plans to expand manufacturing in the US. However, others have announced plans to increase manufacturing in China, in order to avoid US-China tariffs for products aimed for non-US consumers. BMW, for instance, began building their X3 Sport Utility Vehicles in China, and announced plans to make China an export hub for the electrified X3.
For supply chain companies, one silver lining is volatility. More uncertainty typically means more margin opportunities for freight forwarding and other asset-light companies.
Labor: The $100,000 Truck Driver
The second challenge is the tight labor market. Consider the truck driver—At Walmart, entry-level drivers are now earning record salaries of $86,000. Fully-loaded to reflect the cost of benefits, this costs Walmart over $100,000 per year. Meanwhile, at YRC, the Teamsters are beginning steps toward a new collective bargaining agreement, replacing a five year extension that expires on March 31. The contracts cover 20,000 Teamsters. In the words of the Teamsters’ Ernie Soehl, “we are not interested in concessions in these negotiations!”
Is it a coincidence that trucking stocks have plummeted, and companies like Knight, Werner, ArcBest and YRC are trading at 6x, 5x, 4x, and 3x EBITDA [earnings before interest, tax, depreciation and amortization], respectively?
Yet these cost spikes also carry unintended consequences. As labor becomes more expensive, technology becomes more competitive. Will 2019 be the year when autonomous trucks gain traction?
McKinsey estimates that full automation of trucks could slash operating costs by as much as 45 percent in the next decade, saving the industry over $100 billion. Benefits include:
- Two-truck platooning – yielding one percent savings due to fuel improvement
- Driverless platooning – enabling “follower trucks” to drive unmanned, producing an additional 10 percent savings
- Constrained autonomy – allowing unmanned trucks to operate in geofenced areas, garnering 20 percent savings
- Fully-autonomous trucks – eliminating drivers for all functions including loading, driving, and delivery, and achieving a full 45 percent saving
Are these Panglossian projections, or are they realistic? In Australian mines, Komatsu has been operating driverless construction vehicles for years. And on the passenger side, Intel is launching a fleet of 100 self-driving cars.
Technology: The Many Arms of the Octopus
This brings us to the third challenge: technology disruption. 2018 was a year of rapid change and investment in technology. The chart below illustrates 16 new technologies that are powered by six major trends. Each of these factors represents a threat to the established order of supply chain companies today.
For example, the intersection of ecommerce, cloud technology, and “supply chain 4.0” has led to a surge in digital freight brokers. Convoy became a unicorn. Transfix is rumored to be not far behind. Uber invested aggressively into its Uber Freight initiative. In total, more than 20 companies in this sector raised capital in 2018. Meanwhile, hundreds of enterprises are investing in “Digital Transformation,” as they seek to keep up.
The Biggest Disruptor: Amazon
Many companies are using technology to pursue disruption. None is doing so in a more powerful manner than Amazon. With $740 billion of enterprise value as a war chest, Amazon is deploying its resources to pursue logistics.
Amazon views its logistics business as a differentiator. Last quarter, Amazon delivered over 1 billion holiday packages “for free,” to members of Amazon Prime. It spent over $9 billion on shipping charges last quarter, representing close to a 30 percent increase over the prior year. And Amazon already delivers about 10 percent of its own packages.
In 2018, Amazon bought transportation and logistics assets. On the warehousing front, Amazon began to deploy its Whole Foods acquisition in order to turn its stores into distribution centers. On the transportation front, Amazon has doubled down on its aviation assets, announcing that it would add 33 percent more planes to its lease agreement with Air Transport Services Group (ATSG), while extending the duration of the prior leases by two to ten years. ATSG and Atlas air now operate 40 767 planes. In addition, Amazon negotiated warrants that could boost Amazon’s ownership to 39.9 percent of ATSG and 20 percent of Atlas. Could a purchase of transportation companies be next?
Meanwhile, Amazon has continued to invest in innovation. For a good leading indicator into Amazon’s plans, we can look at its patents. Amazon’s 2018 patents included a “robotic pitcher.” The Amazon arm intends to identify, grab, and throw objects into bins. Another patent provides ultrasonic pulses on wristbands to guide employees’ hands. Crazy or scary? We will have to see.
Against these challenges of political volatility, labor shortages, and technology disruption, where are the opportunities?
Technology: The Empire Strikes Back
One major opportunity is for incumbents to use technology to fight back.
For example, in retail logistics, Amazon’s strategic initiatives are driving competitors to act. Target is seeking to replicate Amazon Prime capabilities with its own supply chain investments. After buying Shipt and Grand Junction, Target is now seeking to expand its capabilities. Shipt will soon reach 50 million households. And Target will offer free 2-day delivery for “Redcard” holders and purchases of over $35, including drive-up service.
Walgreens saw Amazon’s purchase of Pillpack and decided to respond too. They forged a partnership with Fedex to pursue next-day prescription delivery nationwide.
On the intellectual property front, Walmart is investing in patents too. A recent patent seeks to provide a “Fresh Online Experience.” Consumers will be able to see individual fresh items remotely before making a purchase.
Lastly, other transportation and retail companies are forging partnerships to innovate together. For instance, Pizza Hut and Toyota joined forces to create a “pie-making truck.” In the truck bed, robots are going to produce pizza pies on demand.
Incumbents Create Corporate Venture Groups
A second major opportunity is for incumbents to create corporate venture groups.
Ford Motor Company is a case in point.
The automotive industry has been beset by technological disruption. In 2017, we saw the advent of ACES, the acronym for key trends including Autonomous, Connected, Electrification, and Sharing.
Ford and GM enjoyed nearly a century as established US market leaders. Despite their entrenched leadership positions and 100-year head start, today, the combined market value of these two incumbents is now less than the combined market value of Uber and Tesla—two startups that didn’t exist only 15 years prior.
In many ways, what is happening to carmakers is a prelude to what is happening in trucking. As Tesla rolls out its electric trucks, and as driverless technology begins to take root, the entire transportation industry is likely to go through the same transformation. For instance, in the logistics sector, stocks like XPO, CH Robinson, Echo and Hub Group dropped as much as 50 percent from peak to trough in 2018, based in part on fears of technology disruption.
So how did Ford respond? Ford characterized these changes as “the fastest transformation in 100 years.” As Ford watched these trends, they decided to respond with key investments and acquisitions. Ford formed a strategic venture arm in Silicon Valley, called the Ford Research and Innovation Center. Ford then invested in several autonomous vehicle pioneers, including Velodyne LiDAR, Civil Maps, SAIPS, ARGO AI, and Nirenberg Neuroscience.
Today, Ford sees its future as not just a carmaker, but also a “mobility manager.” These kinds of changes would have been unthinkable as little as 2 years ago. Will other transportation sectors and companies follow suit?
We expect to see more transportation and logistics companies choose to make a portfolio of strategic investments throughout this year.
Consolidation: The Party Continues
This brings us to the third major opportunity: deal activity. Amidst all of these positive catalysts, we are continuing to witness record mergers and acquisitions (M&A) activity across all industry sectors.
Major deals in the past year included several themes:
- Niche consolidation: MNX acquired Network Global Logistics, creating a market leader in time-critical logistics. Penske bought Old Dominion Truck Leasing, expanding its core leasing business. RoadOne bought First Coast Logistics, bolstering its drayage network. Transportation Insight bought Nolan Transportation Group, doubling down in truck brokerage and freight management. And Lineage bought a string of cold storage companies including Service Cold Storage, bidding to challenge Americold.
- Geographic expansion: DSC Logistics sold to South Korea’s CJ Logistics. CFI (formerly Con-Way Freight and now a part of Transforce) acquired Optimal Freight, resulting in a truckload and asset-based 3PL expansion on a NAFTA-wide basis. FedEx teamed up with Wirecard, providing payment processing and retail outlets in India, Germany, and elsewhere. Meanwhile, AIT bought ConneXion World Cargo, bringing the UK-based forwarder into their fold. Panalpina added Skyservices in South Africa, with a focus on perishables. Kerry Logistics went to Italy to buy Saga Italia in oil/gas freight forwarding. And Kuehne + Nagel purchased Panatlantic Logistics in Ecuador.
- Service synergies: BNSF bought Unlimited Freight, adding flatbed capabilities. Pilot purchased Manna, gaining a last-mile foothold in furniture. Ryder bought MXD, becoming #2 in “big and bulky e-commerce.” And Hub bought CaseStack, combining intermodal logistics with asset-light warehousing.
- Global technology: Project44 bought GateHouse, adding a Denmark-based business with breadth of European visibility data. Meanwhile, Australia-based WiseTech bought a string of US-based customs brokerage technology companies.
- Logistics plus technology: Yusen Logistics added ILG, gaining an ecommerce warehousing platform with more than 700 clients worldwide. Ryder bought MXD, adding ecommerce fulfillment. FedEx bought UK-based P2P Mailing, providing ecommerce transportation solutions, and expanding FedEx’s cross-border capabilities.
- China: In a busy year, China deserves its own category. Alibaba and its logistics subsidiary, Cainiao Network, invested $1.4 billion in last-mile logistics company ZTO Express. As large as this deal was, it was Alibaba’s third such deal, after YTO Express and Best. Meanwhile, JD.com made a $115 million investment in China’s second largest logistics real estate supplier, China Logistics Property Holdings.
For the military supply chain, several conclusions stand out.