RATES CHASNG COSTS

Talk to almost any trucking executive about freight rates and you'll find most are very pleased with what they're getting. However, many also say the higher rates are going right back out the door to cover a variety of rising costs, from driver wages and fuel to skyrocketing insurance premiums and pricier equipment. Clarence Werner, chairman, president and CEO of truckload carrier Werner Enterprises,

Talk to almost any trucking executive about freight rates and you'll find most are very pleased with what they're getting. However, many also say the higher rates are going right back out the door to cover a variety of rising costs, from driver wages and fuel to skyrocketing insurance premiums and pricier equipment.

Clarence Werner, chairman, president and CEO of truckload carrier Werner Enterprises, says: “Base rate increases continue to be necessary to recoup several inflationary cost increases, including driver pay and benefits, truck engine emissions costs and tolls, and to improve our return on assets.” He reports that Werner was able to meet its goals for base rate increases last year because “a solid freight shipping market for our services, combined with an extremely tight truck capacity market, created a strong freight market.”

J.B. Hunt Transportation Services is facing a similar scenario. “Due to higher driver pay, increasing equipment prices, and other cost increases, one of our focus items for 2006 will be obtaining the necessary higher freight rates to offset them,” says Kirk Thompson, president & CEO of the TL carrier. “Rate increases are currently being proposed to customers as their contracts come up for renewal.”

“Assuming moderate to strong economic growth, a continuation of tight truckload capacity, and an ability to keep our trucks seated similar to last year, we expect rates to increase in the range of 3% to 5% over 2005,” adds David Parker, chairman, president, and CEO of Covenant Transport.

LTL carriers are also charging more for their services. In April, FedEx Freight implemented a 5.95% general rate increase for interstate and intrastate traffic, as well as selected shipments between the U.S. and Mexico and Canada. The factors behind the FedEx rate increase are no different than what's facing TL carriers: increasing highway tolls and access fees and more expensive equipment, according to Dennie Carey, senior vp-marketing.

Steve O'Kane, the new president of A. Duie Pyle, characterizes the regional LTL carrier's first quarter as “very successful,” adding that he expects rates to remain pretty firm for the year. “In terms of rates, it's been a pretty firm market,” he adds. “No firmer than the last two years, but it hasn't softened.”

CAPACITY CRUNCH

Lack of capacity is destined to keep rates up for the foreseeable future, driven in large measure by a growing shortage of drivers. “We are all enjoying more freight; the struggle is finding drivers willing to haul it,” says Clifton Parker, president and general manager of G&P Trucking.

“In the 1990s, capacity used to fluctuate wildly and the driver shortage wasn't nearly as difficult a problem,” adds Jim O'Neal, president of O&S Trucking and first vice chairman of the Truckload Carriers Assn. “Now capacity is always tight; we haven't really added much capacity as an industry since 2001. We have a lot of catching up to do.”

Again, O'Neal says, it all relates back to the driver shortage. “You can buy as much equipment as you want today, but without drivers, you can't expand,” he explains. “I've got enough freight that we could easily operate 450 to 500 trucks [versus the 400 O&S currently operates] but we simply don't have the drivers.”

Bob Costello, chief economist for the American Trucking Assns. (ATA) notes that very few of the trucks being purchased during the past few years are for expansion purposes; rather, they're replacing older equipment.

“We surveyed our membership and found truckload carriers as a group only expanded capacity by an average of 1.7% in 2005, while smaller carriers added just 0.5%,” he says. “Only marginal capacity is being added to this industry and few if any new carriers are being formed.”

One important thing to realize about capacity, Costello stresses, is that it's not constant. “Freight is very volatile on a month-to-month basis, which is why available capacity fluctuates,” he says.

He points to the 2.5% decline in ATA's truck tonnage index in February, the first monthly decline since August, 2005, as an example of the unexpected swings that can occur in freight volume. “That string of consecutive monthly increases was bound to come to an end at some point,” Costello says. “We continue to believe that motor carriers should expect modest growth in volumes going forward and that the latest decrease should not alarm the industry. The state of relative tight capacity we are in isn't going away any time soon.”

BUMPS IN DEMAND

Larger economic factors, however, are clouding some of the rate forecasts for truckers. Lackluster performance overall for the retail sector in February and March coupled with a big inventory reorganization plan by Wal-Mart has put some downward pressure on rates.

“Despite benign weather [this winter], truckers are all struggling to make earnings,” says Edward Wolfe, research analyst Bear Stearns. “Wal-Mart remains in the midst of a major planned inventory change which is negatively impacting some truckers. We also see costs and productivity issues continuing to climb for both TL and LTL providers, while pricing continues to modestly decelerate.”

Wolfe believes upward earnings revisions for 2006 and 2007 were artificially augmented by the impact of Hurricanes Katrina and Rita. He cites the improved utilization and pricing related to hurricane recovery efforts, which soaked up small-fleet capacity in the Gulf, combined with a rapid falloff in fuel prices at that time.

“We now expect flattish operating margins for TL providers during 2006 — despite a continued strong economy — along with rising costs and strong but gradually decelerating pricing dynamics,” he says. “For LTL providers we see more consistent tonnage and utilization, but weaker pricing dynamics as fuel surcharge comparisons flatten out and overflow TL freight goes back to TL providers.”

“We measure everything by freight demand — and demand is a little bit off right now, especially in the retail sector,” adds O&S Trucking's O'Neal; that has the greatest impact on the dry van segment.

Capacity in the refrigerated and flatbed markets, however, is still tight, due primarily to an increase in shipments of perishable foodstuffs and a boom in new-home construction.

Changes within the structure of the trucking itself could compensate for fluctuations in demand in the near future. These changes fall into two categories: actions carriers will take to minimize rising costs; and external factors beyond their control that may restrict capacity even more.

THE NEW BOTTOM LINE

For example, LTL consolidation is changing how that segment addresses market needs, explains Tom Escott, president of Schneider Logistics. “The consolidation predicted at the beginning of deregulation [in 1985] has nearly been completed,” he says. “The list of the top 50 carriers in the early 1980s bears no resemblance to the same list today. All of the top 10 carriers listed today either … were not part of the original list or did not exist. This has driven a change in LTL business philosophy.”

In the past, LTL carriers maintained operations based on market share considerations, says Escott. Today, they close or restructure operations to meet desired financial results. Examples include shuttering USF Dugan and USF RedStar, and restructuring the USF Reddaway-Bestway-Holland network to eliminate duplication.

“These actions were intended to maximize returns with an indifference to market share,” he says. “This type of action has been mirrored by other LTL carriers. We are also seeing further consolidation with the YRC Worldwide, formally known as Yellow Roadway Corporation, and United Parcel Service's acquisition of Overnite Transportation and Motor Cargo.”

On the TL side, G&P's Parker notes that a much more restrictive business environment is making it harder for even veteran and savvy carriers to stay in the game. “The real wild card is insurance. We're all carrying huge deductibles and that leaves us just one or two accidents away from a major hit on the bottom line,” he says.

J.B. Hunt is one carrier trying to cut that Gordian knot by establishing a multi-year $500,000 deductible as its primary insurance coverage for 2006 and 2007, down from its previous $2 million deductible.

“While increasing our fixed costs, lowering the deductible should create less volatility in our earnings,” said Hunt's Thompson. “We will, of course, continue relentless efforts to reduce the claims under this lower deductible to realize potential cost reductions.”

Another issue is the changing driver environment. According to Stephen Russell, chairman and CEO of Celadon Group, while drivers as a group are aging — with little fresh blood being added — new HOS rules are complicating their routines.

“The average age of one of our drivers is 47; for Wal-Mart, it's 53; for the Teamsters, it's 55,” Russell says. “On top of that, the trucking lifestyle is a lot tougher. Take HOS changes: team drivers used to be able to drive five hours in sequence till they got where they needed to go. Now one has to drive 10 or 11 hours and then stay in the bunk, whether tired or not. Then there's the 34-hour restart. It sounds great, but there are very few places you can-or want to — park for 34 hours straight. So a tough lifestyle just got tougher.”

In spite of those changes, the current trucking environment is strong enough for fleets to make positive changes, including those that will help their bottom line, as well as their drivers.

PLAYING IT STRAIGHT

“This is an industry where capacity is short, so we can make the decisions necessary to strengthen the financial performance of our company,” says Russell. “It's created an environment where a well-regarded fleet can be more direct with customers.”

“In August last year, we withdrew our trucks from an auto manufacturer that wouldn't pay a fair fuel surcharge and would not pay detention for delays in loading. We were doing about $6 million in revenue with this customer, and now we are doing zero.”

The ability to be customer-selective isn't going to change soon, adds Russell, since the driver shortage will continue to put the brakes on capacity. “In fact, it is difficult to see what might change [tight freight capacity], short of a collapse of the U.S. economy.”

Private view

The forces strengthening rates for TL and LTL operators are benefiting private carriers, too — perhaps even to a greater degree. “Market dynamics right now are definitely playing in favor of private fleets, especially in terms of backhauls,” says Gary Petty, president and CEO of the National Private Truck Council (NPTC).

“The average backhaul capacity for private fleets runs around 15% to 16%, and with for-hire capacity so tight they are able to sell more of it,” he explains. “Instead of selling maybe 3% to 4% like in the past, they are able to sell 6% or more. That means the private fleet, which tends to operate as a cost center for a corporation, is now selling more capacity at a profit, and that translates into a better bottom line.”

Petty adds that private carriers are also able to expand their operations more easily than for-hire operators as they can offer better pay and far more home time than either TL or LTL fleets.

“Many private fleets are finding they have to expand, too,” he says. “About 40% of private carriers use dedicated carriage from the for-hire market and many are finding costs for that dedicated capacity is significantly increasing in key markets; in some cases rates are going up 50%. In some situations, they can't get service at any price, so they are trying to take over more lanes over with their own equipment.”

Adding extra capacity isn't cheap, says Petty. Driver pay and benefits are going up as private carriers need to attract what he terms “quality drivers” to expand their operations.

“Private fleets tend to have extremely low turnover — many in the single digits — because the pay and benefits package plus home time are there,” he says. “However, there's a customer service component to the private-fleet-driver job that needs to be addressed. So expanding operations is going to require more pay incentive to attract those kinds of drivers.” As a result, current salaries, which hover around $55,000, are expected to increase to an average of $65,000 over the next 36 to 40 months.

Even with those costs in mind, Petty feels private fleets are well-situated to grow their operations to fulfill their own internal capacity needs, as well as sell what they don't use for better rates than before. “Even corporations that outsourced their private fleet operations are re-visiting that decision and find there are models they can use to form fleets without huge capital outlays for drivers or equipment,” Petty says. “Many can use 100% leased drivers and 100% leased equipment, for example. So the current trucking capacity environment is putting a lot more options on the table.”

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