Without higher freight rates, economy stands to be disrupted
Inflation spells danger for trucking, whether we're talking about private or for-hire fleets. And right now the industry is faced with price increases in a number of areas: fuel, wages, and insurance.
Let's look at private carriers first. Because they act as cost centers for their parent firms, private fleets need to remain within budget for transportation expenses. While some make use of backhaul opportunities as revenue generators to offset costs, most are dedicated to their own transportation requirements. The impact of increases in the cost of fuel, wages, and insurance directly affects the bottom line. As a result, the cost of goods sold for the parent firm will have to reflect the entire cost burden.
There are only a limited number of opportunities for private fleets to offset cost increases. First, the carrier can arrange for forward contracts for fuel - an opportunity that becomes more limited in availability as prices rise. If it hasn't been exercised already, this option will offer only minimal benefit.
Second, the carrier can seek to reduce employee benefits. In a tight labor market, however, this alternative is not likely to succeed. And even if private carriers have competitive wage packages for drivers, they'll still be affected by wage increases in the for-hire segment since alternative employment opportunities will keep pressure on to increase the overall wage package.
Finally, the carrier can try to raise self-insurance levels to offset rate increases. This not only increases exposure to the parent firm - usually a no-no since it sets transportation exposure apart from overall corporate operating exposure - but it also doesn't eliminate the rate increase, since it will be applied to each level of exposure.
Assuming that fuel, driver wages, and insurance represents 60% of operating costs for the transportation portion of the private carrier, the result of cost increases in these areas will be to add 8-10% to transportation costs.
Assuming that transportation costs average 3% of total costs for goods sold, then the price of goods will rise 0.24% to 0.3%. In industries where that cost cannot be passed along, corporate profits - the primary source for investment capital - will suffer.
The same costs appear on the for-hire side, but with a more dramatic impact since transportation is the primary business of the carrier. Operating margins for carriers averaged 3.3% for general freight carriers, according to the latest American Trucking Assns. Financial & Operating Statistics report.
General-freight TL carriers reported that fuel, driver wages, and insurance were one-third of total operating costs. Fuel cost increases through January would indicate a cost-per-mile increase of 6 cents-8 cents, depending on the average length of haul. The greater the length of haul, the greater the average increase.
With margins in the 3% range, it's clear this cost must be captured in rate increases or the industry will face significant disruptions. These disruptions will lead to lack of service, ballooning inventories to create buffer stocks, and continuing increases for the prices of final goods. Inflation will lead to interest rate increases and then we'd have the prospect of a traditional recession.
At this time, the economy has a head of steam that will not be easily deflated. However, since fuel increases are not expected to abate in the near term, wages are not going down, and insurance costs will continue to rise, the only relief for for-hire carriers is on the rate side.
Private carriers can choose to outsource, if it's cost-effective and service can be provided reliably, or raise the price of their goods to the market. However, if rate relief is not in place by the end of the second quarter, we could see serious disruptions to the economy.