Top Source of Supply Chain Stress? Volatile Freight Costs

Date: Wednesday, March 8, 2023
Source: Sourcing Journal

The global supply chain over the past three years has been plagued by drastic swings in demand, resulting in rising and falling container prices, congested ports, and cargo backlogs that have devolved into empty containers and blank sailings.

But despite the stressors that triggered this instability, logistics has been the main catalyst of supply chain turmoil, KPMG and the Association for Supply Chain Management (ASCM) found in a new report.

In fact, logistics accounts for 71 percent of the variability within the supply chain, with freight costs and labor being the primary drivers, according to the KPMG Supply Chain Stability Index.

The Stability Index cites logistics, capacity and supply as the three factors most responsible for supply chain performance. Each factor is characterized as a sub-index containing variables that influence behavior. For example, logistics includes drivers such as ocean freight rate, intermodal rate and logistics and manufacturing job openings.

In one example of ocean freight’s impact, 44 percent of North American ports struggled at the bottom third in container port performance, according to the Container Port Performance Index from S&P Global Market Intelligence. This drove companies to use fast but expensive air freight, which carries the highest carbon footprint amongst all logistics modes. The price and number of U.S. inbound flights from Asia had an outsize impact on stability—more so than air freight from any other region, the report said.

A similar trend emerged in trucking, where rates and volumes have the biggest effect on domestic shipping.

“Since 2008, the trucking industry has experienced a 2 percent year-over-year increase in price. In the past two years those prices increased by more than 45 percent, much of it being escalated by the Russia-Ukraine conflict and its impact on fuel commodity prices,” the report said. “During the same period, transportation job openings grew in response to ongoing shortages of truck drivers, which further compounded the stress on logistics operations.”

But as it pertains to intermodal freight, the analytics attributes stress to higher rail prices, not volumes. Rail freight is known for efficiency and scale, but the tradeoff is speed and flexibility as it requires more days in transit and lacks options with origin-destination (OD) pairs and schedules. Hence, shippers chose the customer responsiveness of truckloads over the cost efficiency and lower carbon footprint of rail, even in the face of inflationary pressure.

Capacity stabilizes due to tight labor market

Beyond logistics, capacity underutilization, meaning the lack of labor efficiency, contributes 19 percent of the variance present in the index. The unemployment rate in manufacturing and logistics, which has been falling since it peaked in 2020, is largely responsible.

Stabilizing capacity stems from continued attrition in a tight labor market in the U.S. where just 3.4 percent of the applicable population is jobless.

In the new norm, the Great Resignation is seeing workers tap out. What’s more, involuntary attrition is a side effect of organizational “right sizing” measures to cut costs. The report cited Amazon’s 18,000 job cuts as one example of big companies including FedEx, Flexport, Convoy and C.H. Robinson that dropped workers after staffing up during peak pandemic demand.

KPMG said as of July 2022 there was a 1.9 ratio of job openings to workers seeking employment.

“Two job openings for every unemployed person means that workers who resign or lose their jobs are landing new ones almost immediately,” the report said. “Hence, workforce utilization remains strong with capacity continuing to regress back towards a more stable state of pre-pandemic behavior.”

Supply volatility escalates amid globalization

Supply dictates the last 10 percent of Index variability and is following a trend line opposite to capacity. While capacity is mostly back to where it was before the pandemic, supply variability has almost more than doubled in magnitude on an annual basis for the past two years.

Supply is largely driven by the commodity and material costs required to produce inventory. While supply chain globalization and continued efforts to diversify have helped U.S. companies reduce expenses through low-cost sourcing, now businesses are dependent on their offshore supply investments, the report said.

As such, this volatility has turned that dependency into vulnerability, disrupting supply lines for commodities and raw materials. It doesn’t help that U.S. economic activity in the manufacturing sector contracted in February for the fourth consecutive month, following a 29-month period of growth, according to the Manufacturing Institute of Supply Management (ISM) “Report on Business.”

Truckload prices linked to unfilled orders

The KMPG/ASCM report touched on areas beyond the three main catalysts for supply chain variability, particularly how transportation service levels have evolved amid volatility.

For example, domestic trucking rates are the new leading indicator for order fill rate performance, which calculates the percentage of customer orders that are immediately fulfilled by available stock.

This means that as truckload prices rise, unfilled orders follow suit.

Carrier rates for truckloads and unfilled orders from customers were somewhat independent of each other, with a low coefficient of correlation of 0.45. But in the three years since, the correlation has doubled to 0.92. This represents a 104 percent increase in how freight price now drives service level performance.

Additionally, rates for ocean freight are now moving in lock step with fluctuations in raw material price. Since 2020, the correlation between the two has risen by 151 percent. As prices for processed goods increase, rates for container ships follow the same trajectory.

“As the economy expands and demand for goods exceeds commodity and raw material supply, shipping prices increase to help manage demand for cargo space, and to cover costs from unprofitable periods when prices fall,” the report said. “The relationship between raw material and ocean freight has become much more pronounced due to the effects of market volatility.”

Prepare for material sourcing, supplier risk

So what’s the key to getting the supply chain under control? It’s all about the people, according to KPMG.

Prior to 2020, manufacturing and logistics job openings were linked to peaks and falls in ground and ocean freight. And while this continues to be the case, new drivers of job growth contribute to the 10.5 percent increase in transportation and warehousing jobs since February 2020.

Commodity and raw material price volatility were strong influences on the number of jobs openings over the past two years.

This means that optimizing organizational capacity and talent in areas such as material sourcing, commodity management, and supplier risk has become key for companies to stabilize supply performance.

Plus, the increase in unfilled orders for manufacturers also generated more job openings, as a response to production capacity shortages throughout the pandemic. And a downward trend for inventory-to-shipment ratios in retail and wholesale industries has created more demand for logistics workers, while companies continue addressing the shortage of drivers and personnel to move inventory.


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