Upping the ante

Costs continue to mount for hours-of-service proposalWe've looked at how proposed revisions to the hours-of-service (HOS) rules will affect fleets in terms of the cost of adding, maintaining and operating more equipment. In fact, we've estimated this to be somewhere near $20 billion.But these are not the only areas that will be affected. We also have to take into account the cost of increased inventories

Costs continue to mount for hours-of-service proposal

We've looked at how proposed revisions to the hours-of-service (HOS) rules will affect fleets in terms of the cost of adding, maintaining and operating more equipment. In fact, we've estimated this to be somewhere near $20 billion.

But these are not the only areas that will be affected. We also have to take into account the cost of increased inventories throughout the production and distribution pipeline, and the impact of more consolidation among linehaul carriers.

While drivers are "resting," the cargo they're carrying will be resting too. Thus, more money will have to be spent to maintain current inventory levels at distribution, retail and manufacturing facilities.

Here's what could happen. Assume that Company A is vertically integrated, with both a manufacturing plant and a retail facility at each of two locations. Before the change in HOS rules, the company maintained an inventory investment of $100,000 per year, with some inventory sitting on the road in trucks, some at the manufacturing plant and some at the retail facility.

Since under the revised rules more inventory will be sitting idle on the roads, Company A will have to increase inventory investment to maintain current levels of inventory at manufacturing and retail locations. If this means a 10% increase, for example, then the total inventory investment will go up by $10,000. And it doesn't stop there: Company A's suppliers will also be affected.

The carrying costs of inventory include the opportunity cost of having working capital tied up; warehousing costs, including labor; insurance; taxes; and obsolescence. Since additional inventory will be sitting in trucks, warehousing costs have been accounted for in the costs associated with more drivers and equipment. But the opportunity cost of capital has not been counted, and it could be substantial.

In addition, the Federal Reserve has produced convincing evidence that a stable economy is partially dependent on reduced inventory levels. So the impact of a less stable economy must also be factored in.

It's hard to determine exactly how big an increase we're talking about. Assuming we need to reach the kind of inventory-to-sales ratios we saw in the early '90s, we're looking at an increase in inventory to the tune of about $128 billion. Based on rates of 5%, interest costs alone could be over $6 billion.

And we can't ignore the consolidation that will result from the new rules. Carriers will do everything they can to minimize waiting time and contain costs. Efforts might include greater use of strategies like drop-and-hook operations; cellular and satellite technology to communicate with drivers; load-tracking systems; and logistics services.

The substantial financial and physical economies of scale attached to these strategies favor large carriers. With greater buying power, large carriers will be able to command lower per-unit prices for the tools they need to reduce costs. In addition, they'll be able to use these strategies more efficiently by achieving higher levels of specialization in the transportation services they provide. For example, larger carriers will be better able to position equipment and drivers around metropolitan areas to minimize waiting time. In the long run, these economies of scale will enable larger carriers to out-bid smaller ones for freight, leading to more consolidation.

The effects of the need for larger inventories and consolidation among carriers demonstrate the snowballing consequences of the revised HOS proposal. Many of these consequences have not been well thought out, and sufficient effort has not been made to understand their financial impact on the industry and, ultimately, its customers.

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