Week One Discussion 1

Change of plans

Introduction 1

Executive summary 3 Reflecting on chaos 3 2020 transportation costs increase 4 Diverging by sector 5

Macroeconomics: a wild ride 9 State of the economy 9 Uncertainty is here to stay 10 Labor markets 12 Monetary and fiscal guessing games 13 International questions 14 Sustainability 15 The big picture for logistics 15

The logistics industry in 2020 16 Motor carriers: tight capacity, high rates 16 Parcel and last mile: tension at an all-time high 21 Rail: diverging lines 26 Water and ports: congestion and high prices 30 Air freight: tight capacity, more instability 34 Warehousing: surging growth 38 Freight forwarding: dealing with disruption 42 Third-party logistics: turbulent times 45 Pipeline: in the doldrums 49

Logistics trends and outlook: increasing resilience 52 Visibility and automation 52 Right-shoring 53 The next winners 54 Adapting to the no normal 55

Control tower: visibility and control, everywhere 56 Why it matters more now 56 The size of the prize 57 Setting the right ambitions 57 A transformational journey 57 A look ahead 59

Sustainability: from feel-good pledges to business necessity 60 What sustainability means 61 To help manage it, measure it 61 A framework for sustainability improvements 62 Examples from various logistics sectors 63 Next steps 64

Appendix 65 Estimating USBLC 65 Historical comparisons 67

There is much room for hope. Some shippers and carriers are profiting, and others are laying the groundwork for future success. E-commerce innova- tions have accelerated faster than anyone could have imagined. As shippers develop more resilient supply chains, their multi-shoring efforts will increase demand for more logistics optionality. These efforts will also increase demand for visibility across logistics segments, and for the technology that can provide such visibility. Finally, as consumers and investors demand more attention to sustainability, shippers and carriers will accelerate the creation and implementa- tion of new solutions.

Welcome to the 32nd Annual Council of Supply Chain Management Professionals (CSCMP) State of Logistics Report. After a wild ride in 2020, this year’s report identifies an industry buffeted by the COVID-19 pandemic. Costs for many transportation and warehousing services rose in 2020, while most volumes dropped. Consumer demands intensified even as the networks that would deliver their products were scrambled, while new threats loom. The result is that no logistician was able to simply stay the course in 2020, and conditions ahead will require even greater adaptability and nimbleness, a context we summarize as change of plans.

In 2020, United States business logistics costs (USBLC) fell 4.0 percent to $1.56 trillion, or 7.4 percent of 2020’s $20.94 trillion GDP.

The pandemic caused global supply chains to suddenly stop. Then to start again, haltingly. Then to be rerouted, sometimes stopping again, sometimes facing capacity shortages or price increases, often stymied by unexpected bottlenecks. Stay-at-home consumers increased demand for last-mile deliveries. Logistics proved essential to fighting the pandemic, even before the delivery of vaccines. Yet the pandemic made shippers’ and carriers’ assets less efficient and destroyed any idea of predictability. While service outcomes largely deteriorated, logistics was remarkably effective given the disruptions.

Logisticians worked valiantly to respond to crises and devise creative new solutions to unexpected challenges. Amid the chaos, this report seeks to provide a big picture. Who’s thriving, who’s strug- gling? What techniques are successful shippers and carriers using? What was the role of natural disasters such as hurricanes and forest fires—and what are the long-term implications? What other trends are on the horizon? And most importantly, given that costs for shippers went up and service went down, how can approaches to logistics be rethought to get better outcomes?

Introduction

1Change of plans

The crises of 2020 caused logisticians to constantly change their plans. The changes were rarely easy or welcome. But the experience sets logisticians up well for the future, as the ability to change plans will rise even more to the fore as a priority.

In this 32nd edition we provide a narrative on macro- economic factors affecting logistics, insights from industry leaders, discussion of important trends, detailed analysis of each major logistics sector, and a strategic assessment of the industry. This year, we add two new chapters that look at control towers and sustainability. We also have a sidebar that looks at logistics from the perspective of the healthcare industry. While not part of the physical report, it’s available here. As always, the report is rooted in calculations of USBLC, codeveloped by Kearney, CSCMP, and a diverse set of industry partners.

Once again, Kearney is honored to partner with CSCMP and Penske Logistics in authoring the State of Logistics Report. In compiling the report, we collabo- rated with a long list of contributors, including but not limited to: Marc Althen, Andy Moses, and Alen Beljin, Penske Logistics; Ravi Shanker, Morgan Stanley; Brent Hutto, Truckstop.com; Aleksandra Maguire, Mania Flaskou, IHS Markit; Raj Patel and Fab Brasca, Blue Yonder; Drew Cullen, Penske; Erik Neandross, GNA; Alan Shaw, Norfolk Southern; Terence Calloway, Energizer; James Hardenbergh, Herbalife; and Colin Yankee, Tractor Supply. We thank all of them, and others too numerous to name, for sharing their time and perspectives. We hope the data and analysis in this report helps you plan your business strategy for the remainder of 2021 and beyond. Please contact us with any questions or comments on the issues covered in the report or to suggest improvements that could make next year’s edition more useful.

The changes [of 2020] were rarely easy or welcome, but the experience sets logisticians up well for the future.

2Change of plans

Note: USBLC is United States business logistics costs. r is revised (see appendix for details).

Source: Kearney analysis

Figure 1 In 2020, USBLC represented 7.4% of GDP

USBLC as percent of nominal GDP

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Executive summary

Logistics costs represented 7.4 percent of GDP, which was actually a decline from previous years (see figure 1). The national economy shrank by 3.5 percent, to $20.94 trillion, while logistics shrank 4.0 percent, to $1.56 trillion. As discussed below, this was primarily due to advantaged financial metrics such as inventory carrying costs. Operationally, however, it was a painful and chaotic year. Some companies struggled with vanishing demand; others faced scarce supply. Most faced disruptions in the networks that connected them, and many paid dearly.

The K-shaped recovery of 2021 accentuates the helter-skelter character of global economic condi- tions. The pandemic changed consumer habits in ways that decimated hospitality, restaurants, and airlines while boosting grocery retail, home improve- ment, and e-commerce. The US economy is now expected to grow by 7.7 percent in 2021, and the global economy by 6.3 percent—far better than economists feared at the height of the pandemic. Yet the predictions feel tenuous, fueled by fiscal stimulus with uncertain longer-term effects, and potentially vulnerable to new viral outbreaks.

Reflecting on chaos The COVID-19 pandemic caused a stoppage, rerouting, and stuttering, inconsistent restart of global supply chains. This scrambling of flows and capacity brought profound inefficiencies to a once-optimized but ultimately fragile system. The resulting disruptions varied by sector, but frequently led to record-high prices and drops in service. Consumers shifted spending from entertainment and other service-oriented options to at-home consump- tion. As a result, many shippers faced huge demand to restock inventory—and sometimes struggled to find capacity at any price.

3Change of plans

Note: YoY is year-over-year. WACC is weighted average cost of capital.

Sources: CSCMP’s 31st Annual State of Logistics Report (see report appendix); Kearney analysis

Figure 2 Although transportation costs rose slightly in 2020, results varied by sector

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Total US business logistics costs

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307.5 684.8 118.6 47.7 26.6 74.3 96.5 26.1

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2020US business logistics costs ($ billion)

2020 transportation costs increase In 2020, United States business logistics costs (USBLC) fell by 4.0 percent (see figure 2). This drop was driven by a 15 percent decrease in inventory carrying costs. With the drop in manufacturing activity and commerce early in the pandemic, many companies reduced inventories—even if involuntary, the result was lower costs. Interest rates also fell slightly.

Thus, in our view, logisticians’ need to change plans will continue. The beatings of 2020 forced the abandonment of old plans. (As boxer Mike Tyson once said, “Everyone has a plan until they get punched in the mouth.”) At this point, beyond saying “new plans are needed,” logisticians must simply expect continual change. The pandemic’s aftereffects and new surprises will force continuous plan redevel- opment and adaptation.

Consider that the pandemic was far from the only major disruption facing logistics—even if you include the radical changes in consumer behavior it engen- dered. The need for resilience has combined with trade tensions to reverse the decades-old move toward offshoring, resulting now in a trend for multi-shoring. Technological advances offer more promise than ever before in achieving visibility and automation across logistics sectors, with great potential benefits yet many changes to old ways of doing business. Most substantially, events that threatened logistics in 2020 included a record-set- ting number of climate-related disasters, including hurricanes, floods, and wildfires. Such disruptions are sure to continue and they will thus require continuous plan changes.

4Change of plans

Diverging by sector Home isolation has led to explosive growth of e-commerce and last-mile delivery volumes. In 2020, e-commerce (some of which was picked up in-store) grew by 33 percent to $792 billion, representing 14 percent of all retail sales. Consumers expanded their baskets, adding more groceries and meals. They also expanded expectations, in both delivery time and in-transit visibility. Demand for home improvement and home furnishings exploded as house-bound consumers decided to upgrade their immediate surroundings and sellers expanded the range of delivery options. Terms such as DTC (direct to consumer) and BOPIS (buy online, pick up in store) became common retail language. These were accelerations of existing trends and are likely permanent. Thus shippers must adjust their delivery offerings and solutions, managing both capabilities and consumer expectations to create a better match while developing new ways to pay for these services and control their costs.

Road freight, the biggest segment of US logistics spend, fell slightly for the year 2020. But a fourth- quarter recovery suggests that continued economic growth will keep rates high through 2021, until new trucks and drivers can increase available capacity. The need to avoid “touch” processes during the pandemic may have overcome the industry’s long- standing resistance to digitization. If so, technology will improve service levels, with advances including online freight booking, which improves efficiency, and electronic logging devices (ELDs), which provide data that is used to curb time-wasting behaviors.

Railroad volumes and revenues were down, driven by reduced volumes of industrial products and coal. The intermodal subsegment saw smaller declines, thanks in part to high prices in competing trucking markets. But complex intermodal operations have traditionally hampered the profitability of this subsegment; future cost reductions and service improvements will depend on wise development of technology. The bidding war for Kansas City Southern demonstrates the potential value of railroads. But the path to realizing that value involves not only creative vision— such as new north-south configurations to meet multi-shoring demands—but also well-executed operational investments.

By contrast, transportation costs rose by 0.8 percent. This was far less than the 4.7 percent growth in 2019, or 10.4 percent in 2018, but certainly a contrast to an economy that shrank overall. The increase was driven by a 24.3 percent increase in the parcel and last-mile segment, as e-commerce and home delivery exploded. In other notable sectors:

— Air freight costs increased by 9.0 percent, as capacity was decimated by the cancellation of passenger flights, which carry about 50 percent of all cargo in the hold.

— Motor was down 0.6 percent, due to reduced capacity in the pandemic.

— Water was down 28.6 percent, due to a combination of one-time reclassifications in underlying calculations methodology, a likely drop in exports and domestic water traffic, and lower container prices in H1.

— Rail was down 11.0 percent overall, driven by a 15.0 percent reduction in traditional carloads, while intermodal fared slightly better.

— Pipeline was up 1.7 percent, despite reduced oil prices and volumes, reflecting high tariffs on contracts signed in busier times.

— Carrier support activities became more efficient and then were cut back with the drop in volumes.

As with the economy as a whole, and the pandemic as a whole, effects were capricious. Bottlenecks became highlighted. For example, no matter how much work ocean carriers put in, congestion at ports slowed their shipments. No matter how many planes were converted to cargo carriers, disruptions of passenger networks wreaked havoc on traditional air routings. And no matter how much attention was paid to last-mile solutions, consumer demand for ever- faster deliveries for a wider range of goods proved insatiable. In general, logistics cost increases resulted from trying to meet these difficult challenges with assets that could not be deployed as efficiently, along with an expanding scope of logistics activities (see sidebar: Scope of logistics on page 6).

5Change of plans

Scope of logistics Logisticians often cheer for USBLC to fall in relation to GDP, the ratio charted in figure 1. They want to see logistics activities operating efficiently, taking up a smaller portion of overall economic activity. By this standard, the tribulations of 2020 paid off. Nevertheless, given high prices in early 2021, the future direction of this ratio seems uncertain.

However, there’s another way to look at the logistics- GDP comparison. Logistics involves the movement of goods—traditionally, from the sources of raw materials to factories, and from factories through warehouses to retail stores. Yet the rise of e-commerce is expanding the scope of logistics activities, all the way to the home of the end consumer, creating more value.

In the stereotypical 1950s version of a value chain, a shopper’s trip to the grocery store (or the department store, stationery store, and so on) was not measured as part of GDP. Today, with home delivery of those same groceries (or clothing, furniture, office supplies, and so on), this last mile enters the realm of measurable economic activity. It’s an important sector, a locus of keen competition because consumers highly desire it. (Maybe home delivery is currently underpriced, and once shippers properly allocate costs, demand will fade. But we haven’t yet seen that.) As with the rise of day-care centers or dishwashers—or the rise in the sale of new socks as opposed to darning supplies to use to fix old ones— the change represents a commercialization of formerly domestic activities. Even if the ratio were to fall, it would not be a shameful inefficiency of logistics, but instead a commendable expansion.

Once you see it through this lens, you start seeing other shifts in the “proper” relation of logistics activities to the economy as a whole. As shippers search for resilience, they may broaden their sources of inputs, seeking to avoid political or climate risks, but increasing logistics costs in the process. They may hold more safety stock in warehouses or pay higher rents for warehouses closer to customers seeking same-day delivery, both of which would increase inventory carrying costs. Carriers and shippers alike may invest in technology, not to replace labor but to increase the scope of services they can offer to customers. (Indeed, those services might even include trying to reduce carbon impacts, an activity once borne in part by inefficient domestic trips to the recycling center.)

Some of these expansions in the scope of logistics may increase the costs of logistics. It’s a recognition of the importance of logistics to both economic activity and Americans’ general quality of life. These developments are often either spurs to or evidence of the change of plans that we discuss in this report. It’s truly remarkable that the USBLC/GDP ratio fell in 2020 despite these expansions in logistics activities. Going forward, a key challenge for logisticians will be to bring vaunted skills at creating efficiencies to this broader scope of activities.

6Change of plans

In freight forwarding, volumes declined but higher rates led to higher 2020 revenues. Mergers and integration were big news, most notably with carriers seeking to become end-to-end providers. Traditional freight forwarders face threats on many fronts, including well-funded digital start-ups and the increasing ambitions of established players such as Maersk and Amazon. The value of freight forwarding in ever-more-complex value chains remains unques- tionable. But competition among ever-widening players remains fierce.

Third-party logistics providers (3PLs) found them- selves squeezed between shippers’ desperate desires for better solutions and the crazy conditions of logistics markets—a perfect opportunity to demon- strate the value of their expertise. Although many 3PLs experienced higher 2020 revenues, many endured cost increases that harmed profitability. Performance improved by the fourth quarter, and the sector seems poised for growth. Many 3PLs have long specialized in factors that seem likely to drive future success, such as information, visibility, and integra- tion (especially among smart warehouses and last-mile delivery capabilities).

In the pipeline sector, after years of capacity expansion, oil volumes have plummeted. Although gas is more stable, the industry is expected to be sluggish. Tariffs (the fees that pipeline companies charge) remained flat in 2020, thanks to long-term contracts, but are likely to decline in 2021.

COVID-19 highlighted the value of resilience in supply chains—the ability to pivot assets and flows to new sources or routes in the event of pandemics, natural disasters, or trade wars. But resilience, in turn, highlights the value of visibility. Shippers need knowledge to make the smart decisions that engender resilience. Thus, many companies are redoubling their efforts to gain greater visibility across the entire value chain with some version of a control tower. In a world of increasingly abundant informa- tion, the control tower serves as an information hub to enable better decisions. A new chapter in this year’s report looks at the promise, the challenges, and what some companies are doing.

Ocean shipping rates and volumes soared in late 2020 as retailers restocked. Congested ports slowed already-scrambled routes. Dockworkers fell sick, crews got stranded, shipping containers became scarce. By March 2021, when the Ever Given got stuck in the Suez Canal, it was just one more element of the new normal chaos. History tells us that supply and demand will eventually regain equilibrium, but the remainder of an expensive 2021 appears to promise small price declines at best, as supply chains and the modes and nodes that serve them continue to adjust to disruptions.

Even in mid-2021, air cargo rates remain shockingly high. The industry has not yet recovered from the gutting of belly freight capacity resulting from the cancellation of passenger flights. In 2020, volumes were down compared to 2019, but capacity was down more. Some passenger airlines pivoted to cargo, but operational and business-model issues meant that merely converting equipment wasn’t enough. Shippers increasingly turned to forwarders, digital marketplaces, and other creative approaches, including chartering planes. But new demands— including those from global vaccines, newly resilient and more richly optioned supply chains, and a bias in favor of inventory vs. lost sales—suggest a continued situation of demand exceeding supply in 2021.

E-commerce spurred high demand for warehousing space, especially high-end facilities in urban locations. Vacant suburban malls are being converted to distribution centers, but a shortage looms of sites to facilitate urban last-mile delivery. Warehouse flows are becoming more complicated, especially with e-commerce returns. Thus, as labor conditions remain tight, many warehouses are increasingly looking at automation. Indeed, the emergence of robotics as a service (RaaS) provides financial flexibility that should boost adoption of automation across a wider variety of companies. With shifting demand and inventory mix, and increasing need for visibility, the future of warehousing presents fasci- nating strategic challenges.

7Change of plans

Shippers, carriers, investors, and consumers are increasingly acting in ways that demonstrate the value they put on sustainability. They see the economic consequences of the global climate crisis, and demand that their business partners participate in shared journeys to lower carbon emissions. Companies can join these journeys using three pillars: sustainable operations, sustainable service, and sustainable supply. The operations goal, which includes cost-saving efficiency measures as well as investments in alternative fuels, may even lead to receiving deserved credit for previous cost-reduction efforts. Another new chapter in this year’s report surveys efforts across various logistics segments.

Beyond these trends, continued development of technology, especially in visibility and automation, will affect the future of logistics. So will multi-shoring or right-shoring, as offshoring evolves into more diverse and resilient supply networks. Such networks require greater optionality—multi-shoring means that logistics becomes more multi-mode and multi-node. The outcome is greater complexity to be managed, and a higher-profile role for logistics in helping shippers achieve resilience. The upside is greater flexibility and resilience. Finally, we expect increased merger and acquisition (M&A) activity in logistics, as these new trends and challenges lead to new visions of how to combine capabilities into business models that create the most value.

The report is again linked to a deep dive for a logis- tics-dependent industry; this year, for the first time, we look at the healthcare sector, where patient expectations are increasingly shaped by their experiences in consumer e-commerce, where specialty drugs (with special handling requirements) are on the rise, and where complex medical equipment increasingly follows treatments away from hospitals. Although it’s not compiled as part of the physical report, you should not miss this sidebar.

For logisticians used to taking volatility and change in stride, the conditions in 2020 represented a massive escalation. In 2021, even if conditions prove less volatile, the changes may be more profound. The pandemic stretched and broke supply chains, as factories stopped, and shelves were empty. Now supply chain managers are building them back, in ways that we hope will be better and more resilient. These changes will pose new levels of challenges. And like the supply chains they serve, logistics networks must fundamentally rethink and redesign their solutions. If 2020 meant a change in plans, the coming years will be only more so.

Like the supply chains they serve, logistics networks must fundamentally rethink and redesign their solutions.

8Change of plans

Sources: Oxford Economics; Kearney analysis

Figure 3 The US economy outperformed expectations last year and is poised for strong recovery

US real GDP growth (annual percent change)

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Macroeconomics: a wild ride

State of the economy In 2020, the US economy shrank by 3.5 percent. The COVID-19 pandemic upended both supply and demand. Its disruptions varied considerably by sector. But the biggest factor impacting logistics was the stoppage, rerouting, and stuttering restarts of supply chains. Supply chains—and the logistics networks that supported them—had been “optimized” to become ultra-efficient. That also made them ultra-fragile. Once disrupted, these flows and markets became inefficient. Prices skyrocketed as shippers snapped up capacity to sustain production or restock inventory.

In logistics, total costs shrank by 4.0 percent compared to 2019. Much of this decline occurred in tandem with the broader US economy. For example, financial costs were down by almost a third compared to 2019, due primarily to lower interest rates. With many businesses slowing production, demand for logistics fell. But for shippers that did operate, turbulent conditions and bottlenecks raised costs.

On the plus side, the global and US economies are recovering, with the global recovery as strong or stronger than the US recovery. Kearney predicts 6.3 percent global growth in 2021, tapering to 4.6 percent and 3.1 percent in 2022 and 2023, respec- tively. The United States is expected to grow by more than 7.7 percent in 2021 before slowing to 4.5 percent in 2022 (see figure 3). Recoveries always play off abysmal GDP numbers of a recession, but these forecasts suggest a recovery coming more quickly than was expected in early 2020.

9Change of plans

The US recovery continues to be helter-skelter, however. The story of 2021 so far is an accelerating K-shaped recovery. Some sectors (such as grocery retail, e-commerce, and home furnishings) have rallied, while others (such as hospitality, restaurants, and airlines) are still reeling from reductions in travel and tourism.

Growth has been aided by fiscal stimulus, dovish Federal Reserve monetary policy, and rising consumer spending. But while strong growth thanks to stimulative policies spurs the economy, it also stokes risk. The economy may overheat, and inflation may overshoot. In a worst-case scenario, rapid monetary tightening could bring about a recession, though this remains a tail risk at the time of this writing.

COVID-19 also remains a major source of risk to economic recovery. Vaccinations are still under way at the time of this writing; newer and more easily transmissible strains may continue prompting new lockdowns domestically and abroad, sustaining disruption and global supply chain vulnerability. In mid-April, large areas in key European countries, including Italy and France, were under strict lockdowns and in early May, India was grappling with nearly a million cases per day.

In a normal year, the macroeconomic situation has a simple relationship with logistics. Faster growth increases demand for logistics services, leading to higher prices as capacity catches up. But the 2020 upheaval of supply chains created chaos that placed gigantic demands on logistics. The result was higher prices for logistics services despite a shrinking economy. Some logistics providers cut back on capacity, others waited to add it, and many found their existing capacity ill-matched to demand, with empty trucks and ships, for example, idled far from where they were needed without return loads.

In 2021, demand stays varied by supplier sector, transportation mode, and geography. Sudden jumps and dips will result from unpredictable, uncontrol- lable events. Shippers and carriers alike should plan for optionality in the face of instability. Logistics, like the economy as a whole, is in the midst of another wild ride in 2021.

Uncertainty is here to stay Over the past year, consumer confidence has risen and fallen with the severity of the pandemic, the effectiveness of the public-health response, and stimulus packages (see figure 4 on page 11). In 2020, the index saw its greatest-ever quarterly drops and gains. These numbers, too, are K-shaped. People with white collar and professional jobs have largely sheltered in place and transitioned to remote work. But at least 40 percent of Americans, mostly in lower-paying and lower-skilled occupations that do not allow remote work, have taken a financial hit.

Other indices echo the uncertainty. Order and capital spending indices fell in 2020. Business confidence is generally strong in 2021, although it again varies by sector. Meanwhile, two “fear” indices monitored by the Association of Chartered Certified Accountants (ACCA), which measure concern about customers and suppliers going out of business, have been trending downward since a mid-2020 peak, but remain elevated compared to historical levels.

The world will never be “over” COVID-19—the virus will keep mutating and may evolve into new virus strains that evade vaccines, leading to additional lockdowns and shutdowns. Other COVID-like diseases are likely in store and will be amplified by global warming, because research may show a link between infectious disease growth and warmer climates. If deforestation, wildland destruction, and biodiversity loss continue, more disease outbreaks could be on the horizon.1 The uncertainty aligns with gloomy scenarios about the ability of global economies to bounce back from disease, especially amid a changing climate. One report forecasts that the global economy will not reach pre-crisis output until mid-2022; another suggests that it will lose $22 trillion by 2025.2

1 Abrahm Lustgarten, “How Climate Change Is Contributing to Skyrocketing Rates of Infectious Disease,” ProPublica, May 7, 2020, https://www. propublica.org/article/climate-infectious-diseases

2 “New ACCA and IMA Survey on Global Economy Finds Fragile Confidence in Early 2021,” CPA Practice Advisor, Feb 16, 2021, https://www. cpapracticeadvisor.com/accounting-audit/news/21210425/new-acca-and-ima-survey-on-global-economy-finds-fragile-confidence-in-ear- ly-2021. Agence France Presse, “IMF warns of ‘diverging recoveries’ post-pandemic,” March 25, 2021, https://www.barrons.com/news/ imf-warns-of-diverging-recoveries-post-pandemic-01616687107

10Change of plans

Sources: University of Michigan, US Bureau of Economic Analysis; Kearney analysis

Figure 4 Consumer confidence is recovering

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Consumer confidence index (left axis) Personal consumption expenditures growth (right axis)

3 “Swiss Re Institute estimates USD 83 billion global insured catastrophe losses in 2020, the fifth-costliest on record,” Dec 15 2020, https://www. swissre.com/media/news-releases/nr-20201215-sigma-full-year-2020-preliminary-natcat-loss-estimates.html

Disruptions lurk everywhere. More than four million households in Texas spent days without electricity in February 2021, when the power grid was over- whelmed by winter storms. As extreme weather events grow in frequency and severity, crises of similar magnitude will pose ever-greater risks to US infrastructure and logistics networks. Hurricane Laura in August 2020—amid a record year of thunder- storms, tornadoes, and floods—stopped the production of 84 percent of oil in the US Gulf of Mexico, while nearly a million customers in four US states lost electricity.3

Similarly, recent events have demonstrated that supply chain vulnerabilities are not limited to COVID- induced disruptions. In March 2021, the Ever Given, one of the largest container ships in the world, became stuck in the Suez Canal and stopped 12 percent of global trade for almost a week. More than ever, logisticians need strategies and options in place for how to mitigate such risks. After years of talk about diversifying supply chains, the pandemic showed shippers the necessity of being able to quickly switch. That means they need logistics optionality.

11Change of plans

Note: Wage growth rate includes year-over-year increases in wages for production and non-supervisory employees.

Sources: Oxford Economics; Kearney analysis

Figure 5 The pandemic caused the unemployment rate to spike

US labor market Unemployment rate (%) and wage growth (%, year-over-year) The US labor market continues to tighten

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Unemployment rate (left axis) Wage growth rate (right axis)

4 Tyson Fisher, “Employment in trucking ends eight-month growth streak in January,” Land Line, Feb 5, 2021, https://landline.media/employment-in-trucking-ends-eight-month-growth-streak-in-january/

5 Bob Costello and Alan Karickhoff, “Truck Driver Shortage Analysis 2019,” American Trucking Associations, July 2019, https://www.trucking.org/sites/default/files/2020-01/ATAs%20Driver%20Shortage%20Report%202019%20with%20cover.pdf

6 Coyote Logistics and Emsi, “Drivers Wanted: Using data to understand the commercial truck driver shortage,” https://resources.coyote.com/coyote-curve/driver-shortage-research-study

Labor markets Like other economic statistics, the unemployment rate fluctuated wildly in 2020, and varied by industry, with high job losses for in-person jobs such as in hospitality, entertainment, and dining (see figure 5). At the time of this writing, food sector and hospitality employment is rebounding post-lockdown while healthcare-related occupations are expected to account for many new jobs through the coming decade.

As for logistics, labor markets in transportation have been tight for years but were nevertheless impacted by COVID-19. In 2020, the transportation sector shed about 74,000 jobs.4 This is compared to a gain of just under 120,000 jobs the prior year. The American Trucking Association has sounded the alarm on trucking shortages for the past 15 years.5 A COVID- induced slowdown in job growth in other sectors could therefore bring additional labor supply, espe- cially as trucking shortages will be exacerbated by an aging labor force in the medium and long term. The warehousing market, on the other hand, is a bright spot—with a younger labor force and a higher number of recruits over the past few years than job openings.6

12Change of plans

After years of talk about diversifying supply chains, the pandemic showed shippers the necessity of being able to quickly switch.

More broadly, other wildcards have emerged in the logistics sector, including unionization efforts. The threat of unionization is but one source of the upward pressures on cost and better working conditions in the logistics industry. It may drive logistics firms to relocate some of their operations or supply chains to locales with lower employment costs, or to increase automation and technology throughout their opera- tions. The trend toward automation was additionally accelerated by COVID-19 distancing imperatives and cost spikes.

On balance, however, labor markets in the logistics industry will remain tight because these relatively low-paying jobs compete with others that promise better conditions.

Monetary and fiscal guessing games In 2020, monetary and fiscal policies successfully limited the scope of a pandemic-induced economic shock. The Federal Reserve slashed interest rates, and the $2.2 trillion March 2020 CARES Act aided companies, local governments, and individuals. In 2021, Congress passed another $1.9 trillion of fiscal stimulus which focused on unemployment assis- tance, funds for COVID-19 measures, and support for state and local governments.

The extraordinary fiscal looseness is accompanied by accommodative monetary policy and historically low interest rates. To support the economy, the Federal Reserve embarked on an unprecedented bond- buying spree, increasing its balance sheet to $7.7 trillion in April 2021—up from approximately $4.7 trillion a year previously. To support spending and borrowing, the Fed has further pledged to keep rates at or near zero through 2023. Cheap credit gives businesses and households a lifeline and encourages business spending and investment. In addition, the Fed abandoned its 2 percent target inflation rate in 2020 and adopted average inflation targeting, meaning price levels can exceed 2 percent.

Some economists, including former Treasury Secretary Lawrence Summers, warn that fiscal stimulus prompts inflation, which may result in monetary tightening, potentially triggering another recession. Further amplifying inflation concerns is the fact that unemployment rates have decreased, reaching 6 percent in March 2021. Moreover, US households amassed $1.6 trillion in pent-up savings in 2020, which may cause excess demand and higher prices if and when unleashed by consumers.

At the time of this writing, an infrastructure package is in the works. It would include $1 trillion in needed improvements to physical infrastructure, as well as funds for digital, electric, and social infrastructures. The infrastructure package could prove to be a double-edged sword for logistics companies, however, especially as the Biden administration seeks to secure funding through corporate tax increases. To prepare, logistics companies should seek to offset tax increases through bolstering efficiency and adopting smarter solutions, while also cutting costs where possible.

13Change of plans

Navigating multi- shoring has clearly surged on the priority list of the logistician.

International questions In the next few years, US–China tensions will continue to impact the economy. Trade relations as well as geopolitical and broader economic tensions between the United States and China are unlikely to improve in 2021, due to bipartisan Congressional support for a tougher approach to China. Assuming tariffs do become permanent, companies will face pressure to restructure their supply chains to avoid geopolitical and tariff fallout.

US–China trade tensions come with a heavy price tag. They have cost the United States upwards of $315 billion, according to Bloomberg. Oxford Economics projects that an increase in tensions may add up to a $1.6 trillion economic loss for the US over the next five years. These losses would result from higher prices for inputs, higher consumer prices, and reduced consumer spending due to the resulting weaker economy. In other words, tensions are more likely to depress demand for logistics overall than they are to intensify domestic logistics networks due to reshoring.

In the near and immediate term, the Biden administra- tion has announced intentions to strengthen supply chains in four strategic sectors of the US economy so as to reduce reliance on other countries. These sectors include pharmaceuticals, rare earth minerals, semiconductor chips, and large-capacity batteries. Increasing US self-sufficiency in these areas mirrors similar efforts under way in other countries, such as France. These ongoing shifts will affect global supply chains in these areas and adjacent industries going forward. Shippers will be asking their logistics providers for help as they seek alternative suppliers with less efficient or lower frequency routings.

Navigating multi-shoring has clearly surged on the priority list of the logistician. Before the pandemic, US firms were planning more reshoring and nearshoring, moving some manufacturing operations to Mexico to be closer to the US market, and away from other countries, especially China. This trend is amplified both by US–China trade disputes and the recently concluded United States–Mexico–Canada Agreement (USMCA). Vietnam has also become a hotspot for companies seeking to avoid tariffs, although evidence of transshipment may result in measures to prevent such practices. Indeed, Kearney’s 2020 Reshoring Index shows that as the pandemic roiled import/ export dynamics, a once-binary choice about reshoring (“China or US?”) has evolved into multifac- eted strategies about right-shoring. The resulting complex logistics networks will require providers to become much more creative to meet or beat the speed and efficiency of routing from China.

14Change of plans

Forthcoming climate change regulations would put additional pressure on logistics companies to adopt greener technologies.

7 US Environmental Protection Agency, “Sources of Greenhouse Gas Emissions,” https://www.epa.gov/ghgemissions/sources-green- house-gas-emissions

Sustainability Even without a pandemic, the fragility of optimized supply chains would have been challenged by 2020’s natural disasters. The US had 22 separate billion- dollar weather and climate disasters, including Western wildfires, Gulf Coast hurricanes, and Midwestern derechos.

It’s not just that climate change is increasing the frequency of extreme weather events (although that’s certainly true). It’s also that the complex, increasingly interconnected and interdependent economy increases exposure and vulnerability.

In short, climate change has economic costs, especially for logistics companies: climate events create disruptions and bottlenecks. As Kearney’s Global Business Policy Council highlights in its climate perspective, extreme weather cost about $150 billion a year on average from 2016 to 2018 in the United States.

The transportation sector is currently one of the largest producers of greenhouse gas emissions in the United States.7 As a logistician, you thus have both a responsibility and two great opportunities to help reduce greenhouse gas emissions. First, you can apply smarter solutions in your distribution strategies, because every mile you save accrues to not only your balance sheet but also the climate’s. Second, you can increase reuse and recyclability in a circular-economy approach that de-emphasizes the manufacturing of new products. Because such reuse and recycling would increase demand for reverse logistics—taking a product back to the shipper instead of a landfill—it represents a growth opportunity for the logistics industry.

Forthcoming climate change regulations proposed by the Biden administration would put additional pressure on logistics companies to adopt greener technologies, particularly as the cost of noncompli- ance is likely to rise in tandem with such regulations. Among the proposed measures are tightening energy-efficiency standards and increasing efficiency requirements for manufacturers.

Global experience with COVID-19 does show that people can adapt to exogenous shocks—especially when they can rely on and mitigate some of the fallout through technological advances and bold leadership.

The big picture for logistics In 2021, shippers and logisticians must continue dealing with reduced capacity, volatile rates, and disruptions to operations. Some of these disruptions will be temporary aftereffects of COVID-19, such as vaccine distribution priorities. Others will be permanent consequences of new economic patterns, such as new sources, new routes, increased e-com- merce, and accelerated automation. As a result—like the supply chains they serve—logistics networks must fundamentally rethink and redesign their solutions and demonstrate that they are leaning into the challenges with better capabilities, options, and outcomes.

15Change of plans

Source: Kearney analysis

Figure 6 After a steep drop, freight volumes recovered steadily through the summer

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Motor carriers: tight capacity, high rates Motor carrier volumes and rates fell early in the COVID-19 pandemic. But inventory replenishment and supply chain restarts drove growth through the second half of 2020. Continued economic recovery, inventory replenishment, and e-commerce growth will clash with capacity constraints to keep rates high through 2021.

Volumes and rates are high

After a steep drop in March and April 2020, freight volumes made a steady recovery through the summer. By early 2021 the Cass Freight Index showed year-over-year (YoY) growth (see figure 6). The recovery drove increased demand for full truckload (FTL), less-than-truckload (LTL), and intermodal alike. However, there were imbalances across sectors, and challenging weather conditions further scrambled the winter picture.

Rates in 2020 were more volatile than ever. Tender acceptance was at record lows, and more freight was pushed to the spot market.

16Change of plans

Source: Kearney analysis

Figure 7 The spread between spot and contract rates appears to be stabilizing

Spot and contract rates, $—dry van

Mar-19

Spot

May-19 Jul-19 Sep-19 Nov-19 Jan-20 Mar-20 May-20 Jul-20 Sep-20 Nov-20 Mar-21Jan-21 May-21

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The spread between spot rates and contracted rates experienced wild swings in 2020, but it appears to be stabilizing in 2021 (see figure 7). In April 2020, dry van spot rates were $0.35 below contract rates, as so many economic sectors ground to a halt. But by late summer, with replenishment in full force, spot rates rose above contract rates.

In early 2021, the spread began to thin, and new contracts were signed. Higher contract rates have led to greater primary tender acceptance. This has lowered overall spot market activity, creating more favorable conditions for shippers. It’s an interesting tradeoff: shippers have to pay higher rates, but they gain better service, plus less wasted time and less uncertainty on the spot market. It could be that the spot-market swings of the past year have worked well to establish a new equilibrium. Or it could be that shippers will head back to the spot market as soon as it improves.

Nevertheless, for now these remain the highest rates the market has ever seen. Many shippers are now thus devising strategies to combat the continued high costs of trucking, such as evaluating LTL vs. FTL, adjusting the timing of any new tender requests for proposals (RFPs), and assessing the current state and future state of their transportation networks.

Why capacity is constrained

As we noted in last year’s report, poor carrier finances in 2019 and early 2020 reduced carrier investments in new equipment. Thus few new trucks were available to meet the rising demand in late 2020 and early 2021. Carriers are now increasing their orders for Class 8 trucks, with 2021’s first-quarter orders already at 45 percent of all 2020 orders (see figure 8 on page 18). However, additional structural and cyclical headwinds may continue to constrain capacity.

One factor is the availability of those new trucks. Pandemic shutdowns slowed production by truck manufacturers. Even aftermarket parts have been hard to come by, lengthening repair times for existing fleets, and thus depressing available capacity.

The Biden administration is expected to revisit hours of service (HoS) and other driver policies. Potential considerations include mandating that drivers be paid for detention, likely at the cost of the shippers. Reducing detention could merely drive up prices for end consumers. But ideally, it will increase overall capacity, as shippers will be forced to adjust their behaviors rather than incur costs. Drivers can then spend their time in more direct trucking functions rather than waiting at a facility.

17Change of plans

1 Extrapolated from January–April 2021 using 2019 seasonality (2020 being an outlier year)

Sources: Bloomberg; Kearney analysis

Figure 8 2021 first-quarter orders for Class 8 trucks reached 45% of 2020’s total

Class 8 net orders (thousands)

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For example, one large consumer packaged goods (CPG) company used trailer tracking technology to proactively adjust its staffing levels for people unloading trucks. If loads were running late, the company could move team members to other tasks before their shift started.

Driver shortages persist. Early in the pandemic, carriers downsized to stay afloat. Subsequently, some struggled to rehire enough drivers. Furthermore, the 2020 launch of a federal drug and alcohol clearing- house closed a loophole that allowed drivers who were fired for failing a drug test to get hired elsewhere by lying about that failure. And initial studies show that a large majority of the nearly 30,000 drivers in the clearinghouse do not quickly complete the steps required to allow them to get back behind the wheel.

Shorter haul lengths; fewer dedicated fleets; more reefer

In 2021, we can expect changes in demand patterns. One factor is multi-shoring. As companies move supply chains away from China, in search of resilience or relief from trade wars, they may bring more of their supply bases to North America. Indeed, President Biden’s Executive Order on America’s Supply Chains encourages domestic manufacturing in semiconduc- tors, batteries, critical minerals, and pharmaceuticals. As sources of products shift from ports to inland origins, FTL carriers may see their average length of haul diversify and decrease.

With retail sales shifting from brick-and-mortar to e-commerce, retailers may shrink dedicated fleets. Seeking to increase flexibility, they’ll be shifting their balance sheets from transportation infrastructure toward more distributed inventory. Given that dedicated fleets have historically been a source of consistent margins for carriers, these margins could be at risk.

18Change of plans

Source: Kearney analysis

Figure 9 Reefer load-to-truck ratios have moderated, but remain far above historical averages

2018 2019 2020 2021

Reefer load-to-truck ratio

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One of the biggest pandemic-caused shifts in consumer behavior—and perhaps a permanent one—was the rise in online grocery sales and home delivery of food, beverages, and medicines. It dovetails with growing consumer interest in fresh produce and organic foods, which generally have shorter shelf lives. The result is an increase in demand for refrigerated transport.

This increased retailer and restaurant demand, especially for multi-zone reefer trucks, will cause this specialized sub-sector to grow faster than the industry average. The growth creates opportunities for investments that could benefit refrigerated trucking companies and perishable food manufacturers. Finally, some shippers may look at containing costs through demand management.

The delivery requirements of Pfizer and Moderna vaccines focused attention last winter on pharmaceu- tical cold chains. However, those hauls were restricted to CRST, FedEx, and UPS, so they likely had limited displacement of general reefer capacity.

Nevertheless, COVID-19 spurred distribution of many perishable consumer foods. Thus the national average reefer load-to-truck ratio in February 2021 was up more than 300 percent from the previous year (see figure 9). February 2021 was an especially difficult month, as shippers needed temperature-controlled trailers to keep loads from freezing amid poor weather conditions. Since then the ratios have moderated, although they remain far above historical averages.

19Change of plans

Digitization and efficiency

During the pandemic, shippers and carriers both wanted to move away from “touch” processes— including paper documentation. The result broke through some of the longstanding resistance to digitization. Bills of lading are now being transmitted electronically. Evidence of delivery is accomplished with a photograph rather than a signature. Electronic communication has gone from desirable to necessary.

The most promising aspect of digitization comes in greater efficiency of LTL loads. The market continues to move to online brokers and online freight booking. Online platforms allow shippers and carriers to do their transactions in a shared access space. New digital matching functions give carriers the ability to place offers on loads, as well as increasing their flexibility. The brokerage market size is expected to more than double by 2024, largely due to the increased digitization.

New platforms also allow software packages (trans- portation management systems, warehouse management systems, and enterprise resource planning systems) to seamlessly connect and integrate. This helps shippers connect more directly to their carrier network. Going forward, it should help the entire ecosystem focus on pain points and inefficiencies such as empty miles, underutilized assets, and driver behaviors.

Improving service with technology

Electronic logging devices (ELDs) have been contro- versial among drivers during their several-year phase-in. But now that they are almost fully mandated, carriers are learning innovative ways to use them to improve service.

Big data has transformed many industries. And ELDs provide plentiful data on where trucks go and how long they wait. Carriers can use this data to stan- dardize trip planning and scheduling. The data can also help carriers understand and manage drivers who are losing or wasting time, not driving, and so on. Finally, the data can help carriers develop baselines for on-time deliveries (OTDs) and delivery windows. Because shippers know that this data exists, they can press for more visibility into their freight and carriers can make fact-based cases for improvements at the locations that most waste their time.

Online truck brokerages use ELD data provided to them for predictive analyses to identify the safest carriers or best/worst shippers. With fewer claims and incidents on the road, safer carriers will increase OTDs and decrease costs while prices are calibrated to shipper attractiveness. In other words, technology-based improvements are factors in driving logistics services buyers to become shippers of choice.

Older drivers famously fought ELDs. They were frustrated with the way that load delays and wait times ate into their 14-hour clock, and thus their earning power. They were used to being able to rig the system and compensate themselves for their time. But the ELD provides visibility into every minute of a driver’s day, and thus eliminated their workarounds for wasted time.

However, younger drivers may be attracted by the ELD mandate. It has pressured some carriers to confront these issues and address the root causes of wasted time, rather than foisting those costs off on drivers. These changes are also leading to more predictable schedules, which could better meet Millennials’ work/life balance needs. Given driver shortages, this could be a valuable tool to attract and retain new drivers, as ELD data provides facts that force shipper behavior to improve.

20Change of plans

Sources: US Census Bureau of the Department of Commerce; Kearney analysis

Figure 10 In 2020, the US e-commerce market grew 33% YoY to $792 billion

E-commerce sales ($bn) (left axis) E-commerce sales (% of retail) (right axis)

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Azuga, one of the top global positioning system (GPS) and dashcam providers, recently launched a new software called SafetyIQ. This software uses artificial intelligence and machine learning (AI/ML) to analyze commercial vehicle performance and driver behavior, as well as traditional hard braking and speeding events. It is sold as a monitoring service system that can help fleets mitigate risk and is a great example of how valuable telematics will continue to be for the industry. Improving driver safety scores will result in fewer accidents overall.

These safety tools and software are essential early steps toward autonomous trucking. They make highways simple to navigate. However, long-distance highway-style hauling is already well served by the rail/intermodal market; the real advantage of autono- mous trucking comes when autonomous trucks are capable of managing risks in more complicated situations. That risk management will be achieved in many small advances.

Telematics will thus attract much energy in coming years, as it shapes safety/incidents tracking, fleet productivity, shipper attractiveness, ELD compliance, overall reporting, and other improvements in road trucking.

Parcel and last mile: tension at an all-time high As the COVID-19 pandemic caused hundreds of millions of people to practice social distancing and home isolation, e-commerce and last-mile delivery became vital lifelines to secure goods. The result exacerbates shippers’ tensions: how do they simulta- neously deliver on customer expectations, manage costs, and execute consistent delivery quality?

Parcel and last-mile delivery volumes have grown explosively. In 2020, the US e-commerce market expanded by 33 percent, to $792 billion. That represents 14.0 percent of total US retail sales (see figure 10). Some of it was picked up in stores rather than delivered. Nevertheless, this change in consumer behavior categorically disrupted parcel and last-mile delivery networks (see sidebar: A fragmenting sector on page 22).

21Change of plans

A fragmenting sector Traditionally, USBLC data measured the parcel sector, in which companies such as UPS and FedEx delivered packages. In the past several years, rising e-commerce has not only boosted the volume of packages, but also shifted the dynamics of their delivery. Where once many parcels were business-to-business (B2B) documents or industrial parts, today nearly two-thirds of parcel volumes are business-to- consumer (B2C) goods. Home delivery means fewer packages per stop, and a lower density of stops per mile.

Where once a parcel made a single journey from source to destination, efficiency measures have broken it into stages. And where early stages (shipping to a hub) have been easily optimized, the last mile can now account for more than half of delivery costs and is the focus of much competitive energy.

New firms have entered that last-mile space, sometimes with new business models or technologies. And they deliver far more than parcels. Groceries, take-out meals, and heavy bulk items such as furniture are fast-growing components of the last-mile market. Meanwhile, traditional delivery companies such as FedEx and UPS have broadened their customer offerings to sometimes act more like third-party logistics providers than mere parcel delivery services.

As both shippers and carriers work to figure out the last mile, shippers will pursue an ideal of low cost and high service. Carriers—both new entrants and existing, dominant players—will develop capabilities to serve those needs. The uncertainty will lead to continued fragmentation and change, as new players emerge and existing ones seek new forms of collaboration.

22Change of plans

Now more than ever, rising consumer demands and rapidly shifting consumer needs have drastically increased pressure on shippers.

Rapid growth

The parcel delivery sector of USBLC grew 24 percent in 2020, to a $118.6 billion market. This compares to a five-year compound annual growth rate (CAGR) of 8.4 percent. FedEx has predicted that the parcel market will reach 100 million packages per day in 2023, with 96 percent of US growth coming from e-commerce.

The US same-day delivery market is poised to grow by $7.1 billion to $15.6 billion by 2024, a CAGR of about 22 percent. The heavy/bulky delivery market grew at a YoY rate of 12 percent to $13 billion in 2020, and could reach $16 to $18 billion by the end of 2023.

Due to this rapid growth, delivery networks are operating at full capacity. As a result, carriers in 2020 deployed strategies such as limiting less favorable freight during peak seasons or increasing their peak-season surcharges. Shippers mitigated those surcharges, primarily by thinking long term about carrier management and demand management. For example, to proactively manage demand while subsidizing last-mile delivery cost, many Amazon prime delivery options come with a $35 free-shipping threshold. Target/Shipt and Walmart have deployed similar strategies. Additionally, to expand delivery capacity, shippers have increased their use of regional delivery and parcel providers such as LaserShip and OnTrac. Despite their smaller coverage areas, regional providers are increasingly used to service key markets and regions.

However, constrained delivery capacity is not the only challenge that shippers are facing. Now more than ever, rising consumer demands and rapidly shifting consumer needs have drastically increased pressure on shippers. Today’s consumers demand continuous real-time consumer interaction complete with visibility into fulfillment options, unlimited product availability, faster delivery speeds, increased amenities (for example, in-home installation, add-on services), reduced carbon footprints, and frictionless returns.

Last-mile delivery models are rapidly evolving. Crowdsourced delivery solutions, such as Instacart or Amazon Flex, are expanding. Fully autonomous delivery options, such as Nuro and General Motor’s BrightDrop, are on the rise. And the expanding number of last-mile delivery solutions continues to attract increasing investment and acquisition interest.

“Reinventing the last mile through autonomous delivery is paramount for addressing the cost of the entire delivery chain,” says Cosimo Leipold, Head of Partnerships at Nuro. He predicts second- and third-order impacts: “As costs come down, delivery volume increases, basket sizes shrink, and traditional margins are pressured. The winners of the next technical revolution will be those best positioned to take advantage of that coming shift.”

With the rapid evolution of the last-mile delivery landscape and the increased pressure to deliver on rising customer expectations while minimizing costs, how should shippers craft their last-mile delivery strategy?

23Change of plans

Source: Kearney analysis

Figure 11 Deploying an interconnected delivery strategy unlocks a “fit-for-purpose” solution and enables profitable growth

Delivery offering

Delivery solution To ensure sustainable profitability, the interconnected strategy should evolve as

both delivery offering expectations and delivery execution capabilities grow.

Customer and product

segmentation 1 4

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The pandemic gave us a warp-speed acceleration into a future that would have otherwise taken about five years to arrive.

What shippers should do

Some COVID-19 effects were short-term blips. But e-commerce will continue to grow from this new higher baseline. The pandemic gave us a warp-speed acceleration into a future that would have otherwise taken about five years to arrive.

Thus, where direct-to-consumer (DTC) shipping enabled by last-mile delivery was once a desirable capability, and then a necessary capability, now it’s even more. As the last touchpoint in the consumer’s journey, it’s a key differentiating factor in the consumer’s experience. The quality of your last-mile delivery now has an even larger impact on your customers’ future purchase decisions and thus your company’s success.

Given that e-commerce and DTC shipping are here to stay, for many companies the key question is: how do you successfully serve your customer and manage last-mile costs? To navigate this new last-mile paradigm, you can’t just blindly follow market trends. You must deploy an interconnected last-mile strategy to deliver a harmonized, fit-for-purpose solution. As you do so, you can evaluate seven key pillars (see figure 11):

24Change of plans

The job of your interconnected last-mile strategy is to harmonize the expectations involved in your delivery offering with your delivery execution capabilities.

Delivery offering 1. Customer and product segmentation. Rather

than offering the same service levels for all customers and products, perform a needs-based segmentation. You need to understand the expected cost and service levels for each of your customer and product segments.

2. Geographic coverage. Understand your current geographic coverage (for example, urban, rural, or region) and determine which markets are key to win.

3. Service offering. Determine the service offering by segment. For example, different segments of your product-customer portfolio will have vastly different delivery needs (such as one to two hours for urban groceries versus same-day for urban apparel versus five days for rural furniture). Also, which segments are willing to pay for which aspects of delivery? Which cost recovery models (for example, subscriptions, minimum order thresholds, fees for faster delivery) would they embrace? You should evaluate all aspects relating to profitability and customer needs as you craft your service offering.

4. Demand. Understand the shape of demand across your customer-product portfolio. What factors drive it? Can you proactively shape demand in ways that relieve cost pressure and promote profitability while delivering on customer expectations?

Delivery solution 5. Network and fulfillment strategy. Determine

how to fulfill customer orders. To meet the needs of you and your customers, your solution needs to evaluate network design (dark store, fulfill from store, micro-fulfillment center), delivery channel (DTC, buy online pick up in store (BOPIS)), distributed order management (DOM), and fulfillment technology (warehouse management system (WMS), robotics/automation).

6. Delivery strategy and execution. Identify the required delivery capacity levers (in-house fleet, 3PL-operated, crowdsourced), the right supply partners, and routing and delivery technology.

7. Margin and service intelligence. Utilize intelligence resources to track and monitor margin and service performance. What is not tracked cannot be improved. Moreover, as you refine your interconnected last-mile delivery strategy, it’s imperative that you continue to track toward your margin and service North Star.

Overall, the job of your interconnected last-mile strategy is to harmonize the expectations involved in your delivery offering with your delivery execution capabilities. That way you’ll enable profitable growth today while preparing your network for tomorrow.

25Change of plans

Sources: Railroad 10K reports as published on investor relations website; Kearney analysis

Figure 12 Revenue vs. operating ratio

BNSF UP CSX NS

Rail revenues significantly declined in 2020 due to COVID-19… Revenue (Index, 2018 = 100)

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Rail: diverging lines Although the COVID-19 pandemic depressed 2020 rail volumes, leading to decreased revenues and profits, the industry has quickly rebounded. The bigger story is that most Class I railroads are now, effectively, two businesses. Traditionally profitable carload businesses face declining volumes, due primarily to declines in the heavy industries they serve. By contrast, the less profitable intermodal business is doing well—and could be doing much better.

Recently, pension funds and sovereign-wealth funds, which face low interest rates and steady cash flows, have poured money into infrastructure, including railroads. But turning those assets into growth opportunities remains a fascinating challenge. Volumes are likely to continue increasing in inter- modal, given its cost and sustainability advantages over trucking. But to maximize those volumes—and turn them into profits sufficient to cover carload losses—railroads will have to be smart about tech- nology, service innovation, and new market access.

Revenues and profits decline

In 2020, railroad revenues declined sharply compared to 2019 (see figure 12). For example, Burlington Northern Santa Fe (BNSF) revenues decreased by 11 percent, while Union Pacific (UP) was down 10 percent. The pandemic reduced freight volumes, especially early in the year. Declining revenues led to shrinking profits, despite slight improvements in operating ratios.

Carload volume declined massively in automotive, petroleum, chemicals, and coal, which have tradition- ally been the primary drivers of profitability due to their high-value gross ton miles (GTMs) (see figure 13 on page 27). The core carload business suffered greatly through COVID-19, while the intermodal franchise was able to maintain relatively steady 2020 volumes.

However, the intermodal business offers lower margins than carloads, due to the increased handling required (for example, additional lifts, rebuilding trains) and aggressive pricing to compete with trucking. Intermodal holds strategic importance for railroads’ future growth, but it doesn’t currently drive profitability in the same way that carload does.

26Change of plans

Figure 13 Declines in automotive, petroleum, chemicals, and coal drive the decrease in overall railroad volume

North American Class I railroad traffic by commodity type ($ million) Carloads and intermodal units

Sources: AAR weekly rail traffic; Kearney analysis

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–23.7%

–2.2%

Intermodal volumes bounced back strongly in late 2020 and continued to rise in the first half of 2021 as demand surged. Truck tonnage and intermodal rail units have roughly acted as substitutes for each other in past years, as shown in figure 14 on page 28. High prices in competing trucking markets were a big factor in 2020 intermodal volumes not declining further due to COVID-19.

During 2020, railroads struggled to meet the inter- modal demand, given congestion at West Coast ports and network imbalances. To slow volumes, some railroads began applying surcharges of up to $5,000 in the second half of 2020. The surcharges were rescinded in January 2021, only to be followed by hikes in surcharges of up to $1,500 in April 2021.

Operations success

Compared to 2019, carriers improved operating ratios (the ratio of operating expense to revenue, a key efficiency metric) in 2020. After several years of precision scheduled railroading (PSR) initiatives, most now cluster around 60 percent. The better ratios resulted from improved network speeds and reduced dwell times. For example, UP improved train speed by 3 percent, dwell time by 8 percent, and train length by 14 percent (see figure 15 on page 28).

In general, network speed is a significant driver of operating performance, and speeds tend to increase with fewer trains and less congestion in the system. More consolidated merchant cargo due to fewer shippers also allows for longer trains. In short, the same pandemic conditions that hampered volumes also helped operating ratios.

Crews were furloughed during the worst of the pandemic. Railroads are always able to shed labor faster and more efficiently than reactivating it. Although labor proved costly to bring back, in general, railroads managed well to keep their networks moving.

27Change of plans

17.9 19.1

26.1

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+3%

+8%

+1%

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Figure 15 A decline in volumes generally improved key operating metrics for Class I railroads

Average train speed (MPH) Average terminal dwell (hours)

Sources: Railroad 10K reports as published on investor relations website; Kearney analysis

2018 2019 2020

CSX NS UP UPNSCSX

Sources: Intermodal Association of North America, FRED Economic Data Truck Tonnage Index; Kearney analysis

Figure 14 Truck and rail intermodal volumes historically act as substitutes for the alternative mode

Rail intermodal units vs. US truck tonnage Rail intermodal and truck volumes

Rail intermodal units (left axis)

Truck tonnage index (right axis)

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28Change of plans

New merger energy represents new growth opportunities for both railroads and the US economy as a whole.

If intermodal volumes continue to rebound with a post-pandemic recovery, can carriers continue reducing operating expenses? The next generation of productivity improvements will be driven by tech- nology, including automated inspections, mobile reporting and assignment, and predictive mainte- nance. With railroads already slow to adopt technology, the pandemic didn’t speed implementa- tion. Yet the question is of utmost importance to railroads. Technology will not only reduce costs, it will also improve service. Service improvements would allow railroads to increase intermodal pricing, thus boosting margins in this key segment.

Merger energy

The past year has seen a flurry of merger and acquisi- tion (M&A) energy (all of it subject to regulatory approval). Most notably, Canadian National (CN) has won a bidding war for Kansas City Southern (KCS). Also, CSX has acquired the smaller companies Pan Am Railways and Quality Carriers (also known by its parent company name, Quality Distribution (QD)).

The past 20 years have seen little railroad M&A activity, because regulators have been concerned about customer choice and enhancing competition. But declining carload markets may no longer be the best lens through which to view M&A. This new merger energy represents new growth opportunities for both railroads and the US economy as a whole.

Railroads need avenues for growth. Alone, PSR-type efficiency improvements will not fuel a new decade of value creation. Railroads also need to pursue more end-to-end solutions that will reduce costs for shippers. In short, they must grow their multi-modal businesses, in part through improved service levels that can come through more integrated assets and management.

If railroads, their shareholders, and their regulators can see mergers as a way to grow by becoming more competitive on cost and service with long-haul trucking, then other societal benefits also emerge. Intermodal offers more options to shippers. It is also more sustainable than trucking. Shippers, and the nation as a whole, can better achieve climate-change goals by channeling more traffic through existing rail infrastructure. This is not to say that all mergers are good, but that rather than approaching them with a negative view, we should have a neutral view.

For example, the CN-KCS merger creates the first single railroad operator across Canada, the US, and Mexico. CN was able to outbid private equity for KCS because it is using the merger to generate efficien- cies through a seamless service offering. A combined CN-KCS should reduce transit times to provide new options for shippers and new competition for trucks, especially in connecting Mexico with the US heartland region to accelerate the economic benefits of the US–Mexico–Canada Agreement (USMCA). The combined company also promises cost-effective access to east Texas, Gulf Coast, and Mexican markets in ways that can help shippers locate more suppliers closer to domestic operations and drive growth in the North American automotive manufac- turing market. In short, the merger’s value comes from its potential to reconfigure supply chains.

Similarly, CSX’s acquisition of QD, a truck transporter of bulk liquid chemicals, is about extending multi- modal solutions. The combined company can offer shippers a bundled end-to-end proposition. When it comes to mergers of railroads and trucking companies, mistakes may have been made in the past, but today’s conditions are different. Such combinations now offer great promise to reduce shipper logistics costs.

29Change of plans

Sustainable futures

If you think about railroads only in terms of tradition- ally profitable carload businesses, then today’s many threats also include the growing public interest in sustainability. In 2020, North American Class I revenue from coal dropped more than 25 percent, and volume by nearly 24 percent, while total carload and intermodal unit volume was down only 6.7 percent. Coal will continue to decline with the scheduled retirements of coal-fired power plants over the next several years, although these declines will not be as drastic as the pandemic-spurred ones of 2020.

However, if you think about railroads in terms of future growth, sustainability is an opportunity. Intermodal burns far less fossil fuel than trucking. Specifically, railroads are well positioned to expand cold chain logistics, as demand is expected to grow and intermodal service companies are planning to increase their refrigerated fleets. Temperature tracking and GPS technology have addressed spoilage and location tracking issues for railroads. Combine these developments with improved transit times and specialized cargo shipments, and railroads are well positioned if trucking prices remain high.

In general, one of the biggest inhibitors to intermodal growth is service levels. Shippers that might be attracted by lower prices or better environmental performance are turned off by delays as well as the surcharges imposed to alleviate congestion. In past years, railroads have admirably pursued internal operational improvements to reduce delays. But some of the delays and congestion have structural causes, such as the geographic balkanization of railroads around Chicago. The CN-KCS merger creates a trans-Mississippi flow of goods, and additional creative approaches are needed to reduce interchanges and other blockages to efficiency.

Railroads’ intermodal businesses have inherent cost and sustainability advantages. Its carload businesses are less promising. To succeed, railroads will need to think creatively about the very different structures of these two markets.

Water and ports: congestion and high prices Rates for ocean shipping have skyrocketed. In what may be the biggest surprise of the pandemic year, rates were fairly stable in the spring of 2020, then ascended slowly in the summer and steeply in the fall. They have remained at record-high levels ever since (see figure 16 on page 31). These conditions are not reflected in this year’s USBLC figures, which show a 29 percent decline due to methodological reclassifi- cations and reduced volumes and prices in 2020 H1.

Why rates are so high

When COVID-19 first shuttered Chinese manufac- turing in early 2020, some expected ocean carriers to be hurt. But carriers blanked sailings to keep prices steady amid low volumes. Then COVID-19 shut down all sorts of activities around the world—not just factories but also ports, trucks, and many forms of consumer demand. Supply and demand fluctuated unpredictably. By late 2020, as retailers were ready to restock, consumer habits had shifted to goods consumption. (“If we can’t go to the office, gym, restaurants, concerts, we’ll buy goods to consume at home.”) Retailers still haven’t caught up—and neither has ocean shipping (see figure 17 on page 31).

Perhaps the biggest problem is port congestion. Late 2020 and early 2021 brought unprecedented volumes of imports to the ports of Los Angeles, Long Beach, and Oakland—while the pandemic surged among dockworkers. Carriers tried to add capacity, but the ships still faced long wait times to anchor at port. Carriers could try to divert ships to other ports such as Seattle or Tacoma, but the network was overex- tended and fragile everywhere.

30Change of plans

Sources: Drewry; Kearney analysis

Figure 16 Rates have skyrocketed to record levels and show limited signs of easing

Drewry World Container Index, 2018–2021 YTD $ per 40-ft container, monthly

Global composite rate

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18

Note: Represents data for 15 container ports in the US (90+% of domestic throughput). YoY is year-over-year.

Sources: PMSA West Coast Trade Report; Kearney analysis

Figure 17 There have been unprecedented volumes of imports through US ports since the summer of 2020

US loaded inbound container traffic, 2019–2021 YTD Twenty-foot containers (in millions), monthly

21 -F

eb

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an

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1.7 1.6

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–2% –11%–17%–7%

–14%–7% –4%

1.81.8

2.01.9 2.02.0

1.91.9 1.8

1.71.7

2.0

YoY % reduction in volume YoY % increase in volume

31Change of plans

1 Unaudited financial results

Sources: Company annual reports; Kearney analysis

Figure 18 Quarterly EBITDA margin for a selection of top carriers

Profitability of major ocean carriers Q1 2019–Q1 2021

EBITDA margin (%)

Maersk CMA CGM Hapag-Lloyd

0%

5%

10%

15%

20%

25%

30%

35%

Q1-2019 Q3-2020Q2-2020Q2-2019 Q4-2019Q3-2019 Q1-2020 Q4-2020 Q1-20211

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Maersk

CMA CGM

Hapag-Lloyd

2019 EBITDA%

15%

12%

16%

2020 EBITDA%

21%

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% Increase

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58%

31%

The slowdowns forced many carriers to cancel sailings. That meant they lost revenue. They also lost opportunities to reposition empty containers back to China.

Indeed, a container shortage also contributes to continuous high prices. The shortage began in spring 2020, when cancelled sailings meant that containers weren’t in the right places to meet demand. Later in the year, as Asian exports expanded and container demand increased, the situation got worse. Prices for some new containers have nearly doubled. Container manufacturers have added capacity but can’t yet meet demand.

Observers keep hoping that a return to normal conditions would allow supply and demand to sort themselves out. But with weather events, Suez Canal blockages, and who-knows-what’s-next, the new normal is no normal.

Carriers ready to profit

With volumes and prices high, ocean carriers are well positioned for success. Although port delays and container shortages do increase costs, fuel prices remain low. In 2020, carriers such as Maersk, CMA CGM, and Hapag Lloyd increased already-healthy earnings before interest, taxes, depreciation, and amortization (EBITDA) by 30 to 60 percent over the previous year (see figure 18). Results for Q1 2021 look even better.

There is no evidence that demand will cool down anytime soon. But even if it does, carriers have little incentive to lower prices until capacity clearly overshoots. The past year has demonstrated that most shippers can and will pay higher rates. Past consolidation may help carriers enforce price discipline. And competing sectors such as air cargo are also experiencing sky-high rates.

Market variability means that shippers are still very hesitant to sign long-term pricing agreements. If this trend continues, shippers will have to rely on spot rates or some type of hybrid pricing agreement. If spot prices remain high, carriers will remain profitable.

32Change of plans

Historically, ocean markets were cursed with an oversupply of ships. Many countries subsidized carriers because they wanted a strong shipping sector and carriers saw owning ships as an inherently risky proposition. As demand continues to outstrip supply, these protections may be called into question. Of course, if these conditions continue to reduce risks to carrier profitability, no subsidies would be needed.

A congested port story

As noted above, port congestion is the real bottleneck. Eventually, conditions should ease, as dockworkers no longer get sick and consumers shift at least some spending back to services. In early 2021, ports have been increasing throughput, with the result that dwell times are decreasing from autumn’s crisis period. But conditions have not yet returned to equilibrium—an occasion that has been forecast as being just a few months away for almost a year now.

Import volumes remain strong. For example, the port of Los Angeles processed nearly 800,000 twenty-foot equivalent units (TEUs) in February 2021, the strongest February in its history and the seventh straight month of year-over-year growth. If and when consumer demand eases, retailers will likely need to rebuild inventories. They may then choose to carry increased inventories, to accommodate closer-to-consumer last-mile operations. So high port volumes could continue.

West Coast ports are seeing slightly higher volume increases than East Coast ports. However, congestion is far worse on the West Coast. Expanded infrastruc- ture at all ports could help, although the east/west difference could also be related to historical labor conflicts on the West Coast, which have limited both worker productivity and management’s ability to implement automated solutions.

Chaotic conditions

It’s hard to exaggerate just how much chaos the pandemic caused in ocean shipping. As ports backed up, ships had to wait to dock—which meant they weren’t available for their scheduled next trips, causing blank sailings. Ships, containers, chassis, and crews all ended up in the wrong places.

The fate of crews has been especially poignant. With many countries enacting virus restrictions, some crew members were stranded at sea far beyond their employment contracts, often beyond legal limits, sometimes for more than a year. Carriers faced record-high daily crew costs, because the difficulty of relieving and replacing workers sometimes caused them to divert to crew-change-friendly ports, or charter planes to replace crews. Many countries still don’t recognize maritime personnel as key workers, meaning that they cannot get vaccinated until the general population does. Even in April 2021, it was estimated that 200,000 merchant sailors were stuck at sea.

Ocean shipping headlines now regularly fall into the category of “you can’t make this stuff up.” When the price of oil temporarily fell below zero in April 2020, large crude tankers became “floating storage.” More than 3,000 containers were lost at sea in 2020, a seven-year high apparently resulting from bad weather combined with overstacking, the demand- driven practice of building tall towers of containers that become vulnerable to tip-over. By the time the Ever Given got stuck in the Suez Canal for six days in March 2021 ocean shipping had become fodder for comic memes and late-night monologues.

But to logisticians, such chaos is no joke.

How shippers respond

Shippers have explored alternative relationships with carriers and forwarders. Some have committed to rates in a shorter term, with re-bidding at a set cadence. Many are tracking prices on the spot market very closely. And several have devised additional incentives to provide to carriers, such as volume commitments, leveraging prospected growth, or relaxing requirements for key performance indicators (KPIs).

With high prices and chaotic conditions likely to continue, such strategic moves will become only more valuable.

33Change of plans

Note: Weighted average of all-in air freight buy rates paid by forwarders to airlines for standard deferred airport-to-airport air freight services on major

East-West routes. Rates are expressed in $/kg and include three components: the base rate, the fuel surcharge, and the security surcharge.

Sources: Drewry; Kearney analysis

Figure 19 Air freight rates remain elevated since April 2020

Drewry East-West average air freight rate ($ per kg)

2017 2018 2019 2020 2021

2

3

4

5

6

7

DecNovOctSeptAugJulyJuneMayAprMarFebJan

Air freight: tight capacity, more instability The COVID-19 pandemic shook up the global air freight industry as much as any logistics sector. The result: 2020 capacity was hamstrung and demand moved unpredictably. Capacity is recovering, but far more gradually than shippers might hope. Prices remain high. Shippers are trying to be flexible, but the gutting of belly freight capacity is not easy to overcome.

Tight capacity

With about half of all air cargo carried in the bellies of passenger planes, widespread cancellation of passenger flights reduced available cargo capacity. The available total kilometers (ATKs) in widebody passenger bellies dropped 60 percent for the year 2020 versus 2019, according to Boeing. Freighter ATKs increased by 13 percent, but the net result was a 23 percent reduction overall.

The remaining capacity thus increased in price. The Drewry East-West average air freight rate shot up in April and May of 2020 to more than double the consistent average of past years (see figure 19). Although it has since mediated slightly, in historical perspective air cargo rates remain shockingly high. For example, the average spot rate from Shanghai to North America reached a high of $12.78/kg in May 2020. By late March 2021, it had dropped by more than half, to $5.70/kg—but was still about 70 percent higher than the March 2019 rate of $3.30/kg.

As a result, shippers took some drastic steps. For example, Apple chartered more than 200 private jets to ship devices in 2020, a single-year record. (Another high-tech company chartered planes and then resold the capacity it didn’t need.) Apple also shipped some AirPods by sea for the first time, and greatly increased ocean freight for its older iPhone models.

34Change of plans

Notes: CTK is cargo ton kilometers. ACTK is available cargo ton kilometers. YoY is year-over-year.

Sources: IATA report; Kearney analysis

Figure 20 North American air cargo capacity declined less and recovered faster than international air cargo capacity

Available CTK YoY comparison (ACTK of current month as a % of ACTK from the same month of previous year)

North America International

0%

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06/20 02/2102/2001/20 03/20 12/2004/20 05/20 10/2007/20 11/2008/20 09/20 03/2101/21

The dynamics of passenger versus non-passenger cargo also shifted. For example, in 2020, the four Los Angeles–area airports saw a 67 percent plunge in passenger traffic, but a 9.2 percent increase in cargo tons moved.

At the height of the pandemic, North American air cargo capacity declined less than elsewhere in the world, and it subsequently recovered faster (see figure 20). But international markets, especially within Asia, continue to lead air cargo industry growth. So even as capacity recovers worldwide, markets will remain tight.

Factors boosting demand

Reduced air cargo capacity has met continuously strong demand. As consumers shifted from restau- rants and travel to e-commerce, delivery of their items relied on a complex logistics network that certainly included air cargo (although it’s difficult to measure how much). The urgent need to transport medical supplies further boosted demand. And with ocean shipping experiencing delays and inflated prices, some desperate shippers during the pandemic made unprecedented increases in air freight spend.

Volumes were down compared to 2019. Cargo ton kilometers (CTKs) fell by 10.6 percent, according to Boeing. That was a faster decline than for overall global trade of goods, which dropped by six percent—a pattern typical of economic slowdowns. But with capacity reduced far more, higher prices resulted.

35Change of plans

Amid lockdowns in March and April of 2020, many shippers’ inventory accumulated. They didn’t need air carriers to deliver more. But as inventories became depleted later in 2020, businesses needed to rapidly refill stocks to avoid shortages. Furthermore, air cargo played a role in alleviating sudden shortages as logisticians scrambled for stability amid the inconsis- tent restart of supply chains. For example, one large OEM used air cargo for previously ocean-conveyed parts to keep factories running from April to June of 2020. These shifts benefited air cargo carriers, although their performance was still hampered by the capacity shortages. These trends continued to affect the market through H1 2021.

Looking at H2 2021, repercussions of COVID-19 are still playing out. On the pandemic front, vaccine production initially drove high demand for air cargo. With urgent global need and a limited number of production sites, vaccines took much of the available space. Indeed, they sometimes hampered the shippers of general commodities. As more vaccines are approved, and more production sites developed, international air cargo demand should ease. But uncertainty makes it dangerous to predict when and how much.

On the political front, international political tensions could subside, boosting trade. Improvement in US–China relations would probably require conces- sions from China, which seem unlikely. However, the US could rejoin the Trans-Pacific Partnership, or otherwise accelerate an existing trend in which international trade is moving away from China, toward other low-cost countries. For example, consider manufacturing that moves from China to Vietnam. Vietnam has much slower ocean transit times than China (Maersk publishes a 22-day transit time to Los Angeles, versus an 11-day service from Shanghai). Unless shipping lines improve service, such supply chain diversifications could increase demand for air transport.

Pivot to cargo?

Given the capacity issues amid growing demand— and predictions that passenger traffic is unlikely to return to pre-pandemic levels until 2024—passenger airlines may convert some aircraft to all-cargo operations. Indeed, through September 2020, nearly 200 global airlines converted 2,500 passenger airplanes (about 10 percent of global fleets) to cargo operations.

In the short term, airlines have used two methods to convert their main cabins from passenger to cargo transport. Fastening cargo onto seats and covering it with netting is easy to deploy (and un-deploy when passenger demand returns), but doesn’t maximize space. It also risks damage to the seats and their electronics. Conversely, removing the seats avoids those risks but is more costly and time-intensive (two to six days).

Wide-bodied and narrow-bodied planes differ in their potential to be permanently converted to cargo freighters. This conversion involves gutting cabins, modifying cockpits, sealing emergency exits, and installing cargo hatches. The process costs millions of dollars and takes three to four months.

Boeing expects that two-thirds of the 2,430 freighters it delivers by 2039 will be conversions from passenger airplanes. In addition to Boeing, passenger-to-freighter (P2F) conversion companies include Singapore Technologies, Engineering Ltd, Israel Aerospace Industries, and US-based Aeronautical Engineers.

However, a pivot is about more than equipment. It involves routing and scheduling. It involves airport operations, especially for specialized cargoes such as hazardous materials. It involves corporate culture. It involves the need to build relationships with shippers and freight forwarders. And most impor- tantly, it involves business model considerations: will you remain passenger-focused, become more of a wholesaler, or compete with freight forwarders?

These problems can be overcome. And from a passenger carrier’s perspective, even more valuable than utilizing idle planes and crews would be the opportunity to take a larger role in cargo shippers’ value chains.

36Change of plans

Shippers that have learned from the pandemic are restructuring their supply chains to emphasize resilience.

Lessons learned

More than a year into the pandemic, how and when to convert planes to freighters is one lesson that carriers are learning. Another surrounds relationships with large freight forwarders. For example, Ceva purchases dozens of flights every week to guarantee space—an option likely not available to smaller forwarders. As a result, we could see consolidation among forwarders.

On the shipper side, lessons center on the relative permanence of these market shifts. Meaningful capacity growth just can’t return until passengers do, so continued dependency on cargo planes and charters is likely. Shippers are, however, learning how to be flexible among modes. One great example is Thomas Scientific, a laboratory equipment provider. Before the pandemic, it needed only a handful of international shipments per year. When the demand for test kits spiked in 2020, it had to quickly adapt and developed a multimodal strategy including motor, ocean, and air. As the crisis eased, it could shift volumes of testing kits from air to ocean.

The need to be nimble caused shippers to move to digital air freight marketplaces more quickly than was expected a few years ago. As with other forms of e-commerce, e-booking offers convenience and transparency into rates and capacity. Up to 15 percent of global air freight capacity is now available on digital marketplaces. The WebCargo booking platform, which claims 22,000 users, saw a dip during the February–March height of COVID-19, but recovered by June 2020. Likewise, K+N credited digitalization and automation in its booking, invoicing, and documentation processes for an increase in its air cargo volumes despite limited global freight capacities.

All of this uncertainty plays out amid volatile market structures. Shippers that have learned from the pandemic are restructuring their supply chains to emphasize resilience. Will a decrease in just-in-time inventory practices reduce air cargo demand? Or will multiple supply locations and contingency plans increase that demand? These wider questions mean that the industry will likely remain buffeted for years to come.

37Change of plans

1 Represents only warehouse/distribution product

Note: YoY is year-over-year.

Sources: Cushman & Wakefield; Kearney analysis

Figure 21 Despite COVID-19, warehousing growth remained strong, with many industry fundamentals up from a record-setting 2019

5.2% Vacancy rate

$6.76 Asking rent, per square foot

4.6% Rent growth, %

268.4 million Net absorption, square feet

337 million Under construction, square feet1

YoY change (2019–2020)

12-month forecast (2021)

Warehousing: surging growth Despite the turbulence associated with COVID-19, warehousing growth remained strong in 2020. Many industry fundamentals were up from a record-setting 2019 (see figure 21). Net absorption increased 11 percent, to 268 million square feet. Asking rents grew at a faster rate than the previous year, to $6.76 per square foot. The vacancy rate was higher than last year, but still remarkably low.

In short, e-commerce spurred continued high demand for warehousing space. Providers, especially of urban last-mile facilities, hurried to keep pace.

E-commerce continues to drive demand

The pandemic shifted many consumers to online shopping, which boosted needs for warehouse space. This effect outlasted the spring 2020 restric- tions placed on physical retail stores—Q4 2020 warehouse leasing volumes were 26.9 percent higher than 2019. Vaccine distribution added further pressures in early 2021, especially for cold storage. But even as vaccine pressure fades, other demands will keep capacity tight (see figure 22 on page 39).

E-commerce fulfillment centers are a special category of warehouse, ideally featuring high ceilings and multiple mezzanine floors. There’s demand for very large facilities (3+ million square feet) and for downtown urban facilities. There’s demand for technology and for sustainability (discussed in detail in the separate Sustainability chapter).

38Change of plans

Note: MSF is million square feet.

Sources: JLL research; Kearney analysis

Figure 22 E-commerce remains on top in 2020 with demand from 3PL, while logistics and distribution users are also on the rise

E-commerce

Logistics and distribution

3PL

Food and beverage

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Construction materials and

building fixtures

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With e-commerce cutting into traditional retail, there will be accelerating opportunities to convert stores to warehouses in 2021. Indeed, Amazon has converted as many as 25 malls into distribution centers and was on a shopping spree in early 2021, getting approvals for additional conversions in Baton Rouge, La., Knoxville, Tenn., and Worcester, Mass. Given chal- lenges with such conversions in residential areas, however, they are not likely to lead to an oversupply.

A shortage looms of urban infill sites for fast last-mile delivery. The average land price for single-story warehouse development in the US has doubled in the past five years to $30 per buildable square foot. Thus multistory warehouse development is a budding trend in locations with high population density, strong e-commerce penetration, and tight market condi- tions. A drawback is that these facilities have trouble efficiently accommodating the 53-foot trucks commonly used in US logistics. Nevertheless, at least five multistory warehouses are under way or in the pipeline in New York City, Seattle, and San Francisco. If successful, these new projects could set an example for developers in other cities that face similar conditions.

Deliveries continue apace

Developers delivered 352.9 million square feet of warehouse space in 2020, despite construction delays due to stay-at-home orders. That’s an increase of 5.7 percent over 2019 (see figure 23 on page 40). Another 337 million square feet are under construc- tion so far in 2021.

In Q4 2020, only 57.3 percent of industrial space under construction was speculative (as opposed to build-to-suit). This is a much more conservative pipeline ratio than recent quarters. Pre-leasing of speculative space, at just over 42 percent, remained strong. In general, the available pipeline has enough new supply to provide occupiers with additional options for growth but not so much as to drastically shift the vacancy rate, derail rent growth, or undermine asset values.

39Change of plans

Note: SF is square feet. Sources: Cushman & Wakefield; Kearney analysis

Figure 23 Warehouse space increased in 2020 despite construction delays and stay-at-home orders

Million SF

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Top priority: inventory control

With rising e-commerce and a new appreciation of the dangers of supply disruptions, businesses will likely increase safety stock drastically, which will require a greater warehouse footprint. Greater inventory requires both more space and more management oversight.

Many retailers are reconfiguring their value chains for direct-to-consumer fulfillment. As they open micro- fulfillment centers and close stores, warehouse product flows and replenishment become more complicated and labor-intensive.

E-commerce consumers also return more items, which raises the profile of reverse logistics in deter- mining warehouse operational efficiency. The reverse logistics supply chain is expected to be worth $604 billion by 2025, with a compound annual growth rate (CAGR) of 4.6 percent between 2018 and 2025, according to Allied Market Research’s Reverse Logistics Market report. Because up to 30 percent of e-commerce products are returned, compared to 9 percent for typical brick-and-mortar stores, good reverse logistics management is crucial to inventory control, space management, and operational efficiency.

Labor: still tight

The warehousing labor market has been tight for years, and COVID-19 didn’t change its basic charac- teristics, including seasonality. Beyond competitive compensation, warehouses could attract workers by emphasizing safety and flexibility—factors that the pandemic brought to the fore.

Warehouses vary in supplying PPE materials, enforcing enhanced protective measures, and offering flexible scheduling. Enhanced training programs and standard retention strategies (tracking key performance indicators for retention, conducting robust exit surveys, and so on) can also help improve conditions for workers.

40Change of plans

Revenue or optimization?

In some product categories, such as consumer staples, COVID-19 created tailwinds, with soaring demand. Some smart shippers benefiting from these tailwinds are choosing to maximize revenue through increased throughput. They will pay extra for addi- tional capacity and velocity.

When your focus is unlocking capacity and throughput, you can make process adjustments, starting with inbound scheduling. Your processes should prioritize high-value products and potential out-of-stocks. You can increase effective capacity by auditing item measurements, changing storage methods (for example, bulk bags), and altering racking design. You can also tweak your receiving, put-away, and picking processes to operate quickly and effectively.

Automation

The pandemic may serve as a tipping point for warehouse automation. Fast-moving inventory requires more touches, and using robots helps minimize employee interaction that spreads the virus. Amid increased operational complexity, robots reduce losses related to employee turnover. At large warehouses, shuttle systems and massive data analysis can improve productivity and the ability to flex labor. At smaller warehouses, improved tech- nology is reducing the payback period for automated guided vehicles (AGVs) and autonomous mobile robots (AMRs).

The warehouse automation market will grow at a CAGR of 14 percent to reach $30 billion by 2026, according to LogisticsIQ. Start-ups such as Takeoff Technologies, Fabric, Attabotics, Exotec Solutions, and Alert Innovation have received huge investments. And existing players such as Dematic, Swisslog, Knapp, Opex, Muratec, AutoStore, Honeywell Intelligrated, and Toyota Industries are generally thriving.

Warehouses remain interested in using technology to reduce time-to-pick. One way is to bring inventory to the order picker with goods-to-person (GTP) systems such as carousels, vertical lifts, automated storage and retrieval systems (AS/RS), mini-loads, and automated material-carrying vehicles. In general, supporting human activities with AMRs and AGVs can also reduce time-to-pick.

Large warehouses are also interested in sorting at speed. Advanced sortation systems can improve efficiency for high-volume retailers. Although expensive, these systems have matured as solutions and gotten easier to implement.

Shippers and 3PLs are increasingly interested in real-time tracking. They appreciate collaborations with warehouses to improve visibility. The Internet of Things (IoT), along with technologies such as radio frequency identification (RFID), is making such visibility increasingly affordable.

The biggest trend in this space is robotics as a service (RaaS), which is taking over the robotics market. Warehouses are finding higher gains in paying for a robotics solution rather than physical equipment. ABI Research predicts that by 2026 the total RaaS market will have yearly revenues as high as $34 billion.

RaaS helps warehouses shift capex to opex, slashing the upfront cost to deploy a solution. Additionally, RaaS easily scales up and down with seasonal trends or hard-to-predict long-term needs. Because it comes as a solution, RaaS also enables warehouses to reduce technological barriers to adoption.

Finally, RaaS requires little infrastructure compared to traditional robotics solutions. For example, InVia Robotics’ automated picking system comprises robots that are two feet tall by two feet wide, can reach up to eight feet high, and can carry standard totes weighing up to 40 pounds.

41Change of plans

Note: YoY is year-over-year.

Sources: Factiva, DHL annual report, K+N annual report, Expeditors annual report, DSV annual report; Kearney analysis

Figure 24 Freight forwarding growth momentum is expected to make a swift recovery in 2021

YoY revenue growth

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The challenges ahead

Warehousing poses some of the most fascinating strategic challenges in the logistics industry. In a saturated market, demand and inventory mix are shifting. Yet shippers still face incredible pressures to keep costs low. How can warehouses fulfill those conflicting needs?

One answer is more visibility. When will the shipment arrive, so that I can manage labor at my dock? What will be in it, so that I can immediately ship some items without shelving them? Can I simulate alternate scenarios, so that I can handle disruptions such as a viral outbreak among my employees? All sizes of warehouses must now improve on these drivers of efficiency as they seek resilience at lower costs.

Gaining visibility, efficiency, and resilience will require both investments and supplier and customer collabo- ration. Who will absorb these costs? And how will this information be shared? The success factors for warehousing are quickly shifting beyond four-wall efficiency to collaboration among partners in a vast ecosystem.

Freight forwarding: dealing with disruption The wild conditions of 2020 caused overall freight forwarding volumes to contract by 9 percent. Unprecedented disruptions to global supply chains included equipment shortages, high demand, tight space, and soaring rates. Within the freight forwarding market, results varied by company and time of year. The market appears ready to rebound with broader economic conditions.

Although volumes declined, many forwarders increased their annual revenues due to higher rates, especially for air and ocean cargo (see figure 24). In general, forwarders’ revenues dropped in the first half of 2020 but made a comeback at the end of the year. For example, Kuehne + Nagel’s revenues dropped 6 percent in 2020’s first nine months, with a corre- sponding drop in net profit—but it rode a strong fourth quarter to finish the year with only a 3.4 percent total revenue drop, and only a 1.4 percent drop in net profit.

42Change of plans

In another broad 2020 trend, generalists did well while niche companies struggled. In past years, industry wisdom said that you had to be either big or specialized to succeed. But with the pandemic disrupting most niches (medical devices being a notable exception), in 2020 generalists did better. For example, at the smaller Covenant Logistics Group, revenues decreased 5 percent. By contrast, examples of successful generalists included DHL, where group revenues grew 5 percent year-over-year despite a 14 percent volume decline; DSV Panalpina, where revenues grew 23 percent; and CMA CGM, where revenues grew 3.9 percent.

The vanishing difference between forwarders and carriers

Forwarders grew and diversified in 2020 through moderate merger and acquisition (M&A) activity. Activity accelerated in early 2021, especially interna- tionally. SF Holdings acquired Hong Kong’s Kerry Logistics Network to create what it called the biggest logistics group in Asia. Kuehne + Nagel purchased Asian freight forwarder Apex International. Acquisitions by Scan Global Logistics culminated with the air and ocean activities of US trucking giant Werner Enterprises. DSV announced that it was eager to make new acquisitions, especially in air and sea.

All this activity came on the heels of the DSV-Panalpina merger (announced in 2019 but completed in 2020), which made DSV the fourth- largest global freight forwarder. M&A activity is likely to continue, and the emergence of industry giants could accelerate disruption and uncertainty within the sector.

In addition to the precarity of niche markets noted above, M&A activity is driven by increased network, capacity, and clout in price negotiations with carriers. Furthermore, in times of international tensions, customs clearance becomes a valued competency, worth scaling.

The most intriguing aspect of current merger activity is how it’s blurring the line between ocean carriers and freight forwarders. For example, the carrier CMA CGM acquired CEVA Logistics in 2020. Acquiring a forwarder gives an ocean carrier expanded customer relationships—plus guaranteed volumes for its ships. This consolidation poses threats to existing pure freight forwarders, which lack comparable leverage with carriers.

Look who’s digitizing

In recent years, some of the biggest challenges to traditional forwarders have come from digitally savvy start-ups such as Flexport and Freightos. These start-ups continue to grow: Flexport is opening new branches, and global tech-enabled growth includes Sennder, a European digital road forwarder. Richly funded digital players remain strategic wildcards, with the potential to acquire traditional forwarders for their customer base.

However, in general, the incumbents are digitizing just quickly enough to maintain position, given their operational strengths. Indeed, the pandemic is accelerating transitions from paper-based to digital processing. And technological developments such as artificial intelligence (AI) offer a clear path to more efficient and customer-friendly operations.

Digitization also poses risks, in the form of cybersecu- rity threats. In the past three years, the four largest ocean container lines have been attacked; most recently, CMA CGM struggled to restore bookings for almost six days after an attack in September 2020. As forwarders use technology to increase resilience, that technology itself can become a vulnerability.

If digitization of forwarder operations is proceeding somewhat predictably, the digitization of broader society is taking unexpected leaps. As the pandemic increased e-commerce, shopping itself became digitized. The customer base of many forwarders has been shaken up, with restaurants and cruise lines declining and pharmaceuticals and healthcare gaining.

Furthermore, online retail giants such as Amazon and Alibaba have grown enormously. Amazon is expanding into customs clearance. Alibaba’s logistics arm Cainiao is launching an air and sea container booking service. Thus, the digitally savvy competitors to freight forwarders are no longer limited to nimble start-ups—they’re also some of the world’s largest and most powerful companies.

43Change of plans

Freight forwarders are at the center of the next pandemic logistics challenge: global vaccine distribution.

Pandemic aftershocks

In retrospect, everyone can see how the pandemic stopped and rerouted supply chains, reduced logistics capacity, and caused rate volatility. But freight forwarders are also at the center of the next pandemic logistics challenge: global vaccine distribu- tion. “We refer to this as the biggest product launch in the history of mankind,” Neel Jones Shah, Flexport’s head of air freight, told Supply Chain Dive in November 2020. “This is the top end of complexity of anything we’ve ever done before.” Sources of complexity include high volumes, temperature requirements, and the combination of urgency and uncertainty.

Logistics providers have been prioritizing global vaccines. Although forwarders were working with airlines to expand cargo networks, some non-essen- tial cargo will continue to get bumped, with rates increasing. Large shippers and high-value goods will continue to get preferred treatment. Shippers that were not properly prepared for this unprecedented time are expected to face disruptions. And forwarders—who all face the same high prices and tight capacities—will have trouble differentiating themselves.

Meanwhile, other pandemic aftershocks continue to overwhelm global logistics networks. For example, Chinese crew restrictions are creating shortages of truck drivers and air routes. The global container shortage continues. And disruptions to air freight are extending delivery times, even as impatient customers demand the opposite.

The value of freight forwarders

While vaccine distribution poses challenges, it also highlights the value of freight forwarders. Complicated global logistics networks require great coordination. And forwarders are coordinators.

To manage well, forwarders must continue to keep up with a changing environment. They need to keep digitizing. They need to maintain their networks and relationships. They need to keep a general focus, rather than being boxed into unprofitable niches. And they need to defend their space against encroach- ments from both carriers (for example, Maersk) and shippers (for example, Amazon, Alibaba). On the other hand, in the past few years, most forwarders have indeed rapidly innovated and maintained strong customer relationships. The coming years may simply be more of the same—or we may see a widening of the gap between innovators and laggards, leading to consolidation.

The challenges that surround securing capacity make freight forwarders integral to global logistic networks. Capacity was tight in 2020 and will likely remain so through 2021. But more broadly, freight forwarders also show their value as conditions become more cumbersome and volatile. Even beyond the pandem- ic’s aftereffects, as shippers seek resilience in a volatile world, freight forwarders will remain extremely relevant in the value chain, with the best seeking to increase that relevance.

44Change of plans

1 Showing figures for Americas; profit shown is reported EBIT; conversion rate of 1 CHF = 1.11 USD

2 Profit shown is operating income

3 Profit shown is EBIT

Sources: Capital IQ; Kearney analysis

Figure 25 Most 3PLs saw increased revenues, but profitability was mixed

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8 A 3PL is a company—or a division of a larger diversified company—that provides logistics services across multiple modes and nodes. 3PLs are also sometimes referred to as brokers, because brokering deals across segments is key to their success.

Third-party logistics: turbulent times In turbulent times, the deep knowledge and wide network of a third-party logistics provider (3PL) become more valuable.8 Yet turbulent times place increasing pressure on the 3PL to have developed the right strategies in the past and to implement the right insights in the present. In 2020—and moving forward through 2021—3PLs that prioritized resilience will become the dominant leaders in the segment.

Market conditions

Many leading 3PLs experienced higher revenues toward the end of 2020 (see figure 25). Comparing year-over-year, revenues for J.B. Hunt Integrated Capacity Solutions increased by 23.0 percent, Expeditors by 23.7 percent, and UPS Supply Chain Solutions by 13.5 percent. However, some 3PLs struggled to maintain profitability, as the efficiencies they’d built and lanes they were counting on got disrupted. For example, XPO Logistics’ operating margin was down 41.9 percent and Hub Group’s 31.3 percent.

45Change of plans

These results are not surprising amid a pandemic that increased costs as it broke up efficient networks. Cost increases impacted profits, especially early in 2020, as carriers and 3PLs struggled to handle the vari- ability. Most 3PLs satisfied their customer requirements in the clutch. And many were rewarded with fourth-quarter results that were far stronger than yearlong or even 2019 results, reflecting a rebound that has turned the tide in favor of brokers. Projections generally show continued healthy industry growth. For example, Allied Market Research expects a 7.1 percent compound annual growth rate (CAGR) through 2027.

End-to-end visibility with control towers

As 2020 rocked with variability, it highlighted the importance of supply chain resilience. When you think of variability in an end-to-end supply chain, like a force hitting a line of dominos, the last piece is guaranteed to fall. As a shipper or 3PL, if you have upstream visibility—and more importantly, can act on what you see—you can proactively buffer against variability.

From a data perspective, control towers offer the necessary visibility by connecting systems across every aspect of the supply chain. Although end-to-end visibility is a daunting feat, for most shippers, pooling the data is only half the battle. Actually implementing solutions to enact resilience requires expertise, resources, and a network fortified with assets—barriers that seem insurmountable to the average shipper and carrier.

However, 3PLs have a robust network of carriers and warehouses and are used to a plethora of systems. They are thus uniquely positioned to take advantage of scale, assets, and end-to-end infrastructure to provide a control tower solution that will actually realize benefits for their customers. For most shippers, the biggest barriers to building and offering control tower capabilities are in building an expansive network. Because 3PLs have already overcome those barriers, they are best positioned to implement successful control towers. As the world moves toward data-driven decisions, this will become a key strategy for 3PLs.

The e-commerce opportunity

One line of dominos extends upstream from the shipper; another downstream. The rise of e-com- merce has complicated downstream planning—and comprises an increasingly large portion of 3PL revenues (see figure 26 on page 47).

Because e-commerce has razor-thin margins and sky-high expectations, reducing operational costs at high service levels requires more shipper-3PL collaboration than any other type of distribution. A 3PL’s traditional focus on efficient load building and optimized backhauls will not be sufficient. The 3PL also needs to learn how to cocreate the proper dense networks with shippers, as well as other carriers and contractors, such as local and regional last-mile providers.

However, 3PLs are far better positioned for this type of collaboration than other players such as freight carriers. 3PLs have scale, data insight, optimization capabilities, and a wide base of customers. They can come to the table with a full suite of network-shaping capabilities. And they can sell an integrated solution. Shippers often lack the scale of spend to develop and continuously improve the systems, people, and efficient asset utilization to go it alone.

For shippers, building a full network with a 3PL involves inherent risk. But the alternative is bleak: without a collaborative distribution model, efficient e-commerce fulfillment may not be feasible.

46Change of plans

Sources: Armstrong & Associates, Inc.; Kearney analysis

Figure 26 E-commerce is an increasingly large portion of 3PL revenues

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Meeting shippers’ diverging needs

The pandemic produced a dichotomy of shippers: some reeling from success, others reeling from declining demand. The uneven and unexpected spread has created unique situations for 3PLs, as the implications are vastly different on how 3PLs approach these relationships. Both 3PLs and shippers had to make calculated bets on how long-term strategy would play out.

Shippers seeking to meet rising demand don’t have the time or resources to set up an optimal infrastruc- ture. Typically, they’ll turn to 3PLs as one-stop shops that can immediately begin serving increased demand. In addition, pressure to accelerate lead times and provide accelerated delivery options, specifically for e-commerce channels, adds an additional strain for shippers.

To meet these needs, 3PLs must innovate internally or create a network of partners in key areas such as technology, robotics, fulfillment centers, last mile, and returns management to improve their efficiency, increase capacity, and differentiate themselves in a market period where shippers are actively searching for the correct partner.

47Change of plans

Leverage data and analytics

According to the 24th Annual Third-Party Logistics Study, 74 percent of shippers are unsatisfied with 3PLs’ current analytics capabilities. Providing home- grown technological capabilities, especially in terms of leveraging data and analytics to guide insights for shippers, is key for 3PLs to differentiate themselves and create customer stickiness.

For example, XPO recently launched XPO Connect to improve visibility and ease-of-use for its carrier partners. In addition to allowing carriers to find, bid, negotiate, and purchase loads in one easy-to-use platform it offers optimization features such as a tool that locates backhauls home for drivers. Similarly, JB Hunt uses its Marketplace for JB Hunt 360 platform to source capacity and improve service. These types of innovations will be key for 3PLs to ensure their fleet size and efficiency can meet rising demand.

Beyond home-grown platforms, CH Robinson’s Internet of Things (IoT) initiative uses Intel sensors and Microsoft Azure software to improve tracking capabilities for shippers. Besides providing real-time locations for products, the new partnership allows shippers to track metrics for elements such as temperature, light, humidity, and shock.

These metrics are key for high-value, perishable, or hazardous products. Tracking them offers shippers a means to identify improvement opportunities to reduce delays and damaged and lost shipments. As distribution becomes more of a strategic edge for shippers, partnerships and innovations will be crucial for 3PLs to differentiate themselves.

Emergence of warehousing

The trends of rising e-commerce and fluctuating inventory demonstrate the strategic importance of 3PLs’ warehousing functions. Indeed, the $65 billion 3PL warehouse segment is expected to increase to $84 billion in 2024, according to Technavio.

Automation can help 3PLs double down on ware- housing. As noted above, warehouse automation contributes to visibility through the supply chain. It also sets up additional offerings such as inventory control and analyses of inventory velocity.

For example, NFI Industries, a New Jersey-based warehousing 3PL, used autonomous mobile robots (AMRs) to increase picks per hour from 35 to more than 80 in a customer’s 380,000-square-foot e-commerce fulfillment center. Additionally, in terms of warehouse investments, XPO announced in late 2020 plans to roughly double the total number of robots in its warehouses. Indeed, leveraging a network with a solid warehouse footprint will remain crucial to providing a full suite of services for shippers.

A networked future

Like a pendulum, shippers often oscillate from in-house logistics functions to 3PL outsourcing. Yet each time shippers swing back to outsourcing to fill a certain need, they find slightly more advanced and nimbler 3PLs, more adept at solving their new challenges.

Driven by the pandemic, many shippers now see the value of end-to-end visibility and coordination. This trend offers an opportunity for 3PLs, which have traditionally owned such big-picture views. But to capitalize on the trend, 3PLs must meet many challenges. Are they sufficiently invested in warehouse automation? Are they strong in the booming but fragmented heavy goods segment? Do they have enough density to reduce unit costs? Most importantly, are their networks big enough? Through the coming innovations, the key to success for 3PLs will remain the same: more relationships, more flexibility, and more paths to placing the best loads in the best lanes, in ways that benefit shipper and carrier alike.

48Change of plans

Sources: US Energy Information Administration (March 2021); Kearney analysis

Figure 27 Oil consumption is expected to remain below historic levels through 2021

US oil production, consumption, and prices (million barrels per day, $/bbl)

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Pipeline: in the doldrums The COVID-19 pandemic, new Presidential administra- tion, and public shift to green energy led to a topsy-turvy year in pipelines, with little excitement foreseen, following the rapid expansion in the past several years.

Oil afflicted by pandemic

In a boom-and-bust industry, the COVID-19 bust was unprecedented. Traditionally, US oil consumption hovered around 20 million barrels of oil equivalent per day (mmboed). It declined to about 14 mmboed in April 2020 and is expected to remain below historic levels through 2021 (see figure 27). In response, domestic oil production dropped by 2 mmboed during May and June 2020. It is not expected to return to 2019 levels before the end of 2022.

In April 2020, the supply glut famously caused West Texas Intermediate (WTI) futures to temporarily drop below zero. Supply and demand have since rebalanced, but the industry is expected to remain sluggish. Operators are unlikely to invest in new infrastructure.

Unlike oil, gas was largely unaffected by COVID-19 (see figure 28 on page 50). The 2020 consumption and price curves resemble those of 2019. Larger impacts resulted from cold weather in February 2021, which increased demand amid a decline in produc- tion primarily due to wellhead freeze-offs.

In spring 2021, a hack struck the Colonial pipeline, causing a major gasoline supply disruption in the southeast and northeast US. This underscored the vulnerabilities of America’s critical infrastructure, highlighting the importance of pipelines. Demonstrating the need for investment in cybersecurity, the attack prompted the US government to explore new regulations to safeguard this critical infrastructure. Pipeline operators will be forced to adapt to new requirements. They may have to change their operations. Those that have not made consistent investments in the past may struggle to pass future costs on to customers, given the competitive environment.

49Change of plans

Sources: US Energy Information Administration (March 2021); Kearney analysis

Figure 28 Gas was largely unaffected by COVID-19 with the 2020 consumption and price curves resembling those of 2019

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Politics and Keystone

In the first few days of the Biden administration, executive orders targeted oil and gas production, reversing Donald Trump’s fossil fuel–first energy policies. The Biden administration has also vowed to invest $400 billion in clean energy over the next 10 years. Its stated intention is to decarbonize and electrify the power sector, electrify the federal transportation fleet, pour federal dollars into clean energy research, and rejoin multinational climate- change efforts, in addition to the Paris Climate Agreement.

Particularly relevant to pipelines are expected increases in regulations on methane emissions. Methane regulations directly affect gas flaring. In recent years, especially in the Permian Basin, producers have increasingly flared excess gas because volumes have exceeded pipeline capacity. Going forward, Permian gas production may drop with associated oil production. Gas pipeline tariffs likely will remain stable as gas transport replaces oil transport in pipelines.

Much political chatter has also surrounded Biden’s revocation of the construction and operation permit for the Keystone XL oil pipeline, which would have replaced some rail car transport. The pipeline would have delivered 830,000 barrels per day (bpd) from the Western Canada Sedimentary Basin (WCSB) to Midwestern pipelines that transport oil to Gulf Coast refineries. Without Keystone, WCSB will face short- term capacity constraints. However, 370,000 bpd of new WCSB pipeline capacity will be available by the end of 2021, and another 590,000 bpd in 2023.

50Change of plans

Sources: Yahoo Finance; Kearney analysis

Figure 29 The Alerian MLP Index shows a steady downward trend

Alerian MLP Index

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Pre-pandemic, the Alerian Master Limited Partnership Index, which tracks major midstream companies, was on a steady decline (see figure 29). It cratered early in the pandemic and has started to recover, but still trends decidedly downward. MLPs continue to have trouble attracting investors. That means pipeline operators have limited access to capital.

As the green energy movement continues to gain momentum, the pipeline industry future is unclear. Demand for oil transport seems likely to drop. But the February 2021 polar vortex, and associated crises in Texas, demonstrated the value of gas pipelines. With long-term gas prices falling, and plenty of existing infrastructure available to use gas to heat homes and fuel power plants, demand for gas transport appears stable.

Could pipelines be converted for other uses? Historically, oil was more profitable to transport via pipeline than gas. But going forward, the pipelines built for oil may prove more useful for gas, CO2, or hydrogen.

Looking forward, as infrastructure ages, accessibility to capital is limited, and oil usage declines, industry investors and operators need to shift their focus to assessing costs and identifying operational efficien- cies. Over time, existing assets will get older and inspection and repair costs will increase. Recent years in the pipeline industry have seen a shift from expansion to survival. The successful MLPs will be the operators that optimize operations in an effort to reduce operating costs and maintenance costs.

51Change of plans

Logistics trends and outlook: increasing resilience

More than a year in, the logistics sector is still dealing with the ramifications of the COVID-19 pandemic. Like companies in many industries, shippers and carriers are still figuring out how to operate going forward. The pandemic highlighted longstanding deficiencies in many shippers’ supply chains. It also forced carriers, 3PLs, and other logistics companies to revisit the way they have historically operated, becoming even more efficient in the face of tight margins and urgent conditions.

Stay-at-home consumers accelerated their reliance on e-commerce, which is expected to have its first year of trillion-dollar revenues by 2022. That insa- tiable demand forces companies to continue to invest in modernizing and innovating infrastructure and processes. Perhaps ironically, these near-crisis conditions have somewhat simplified the picture when it comes to technological trends.

Visibility and automation Just as the pandemic accelerated existing trends in e-commerce, it also accelerated trends in logistics technology. We’ll talk about two broad categories (although these categories are converging). First, companies have long sought increased visibility across the supply chain, but the need for resilience in the pandemic emphasized the value of that visibility. Information is now paramount. As discussed earlier, some companies are implementing control towers to streamline and centralize their access to information.

Such visibility requires technology. You need widely distributed sensors connected by the Internet of Things (IoT). You need a network to collect all the information they generate. You need artificial intelli- gence (AI) and machine learning (ML) to help analyze all that information. And you need integrated systems to help you execute the decisions you make based on this visibility.

Second, companies have long been interested in automation, but the fragility of human labor in the pandemic highlighted its value. As the pandemic spurred reductions in human interactions, interest grew in robotics and other automated processes. This was true not only across complex warehouse automa- tion systems, but also for simple interactions such as confirmation of delivery, now increasingly accom- plished with a photograph rather than a signature.

Again, it’s not enough to simply have robots in your warehouse, or employees with camera phones. You need technological systems in place to efficiently manage all that information and execute across the supply chain. For example, the new 5G wireless standard can help robots communicate across a vast warehouse. And the emergence of robotics as a service (RaaS) provides an easy way for many companies to implement automation solutions.

52Change of plans

Visibility and automation are becoming synonymous and driving a further blurring of lines between hardware and software. With RaaS, you are buying a hardware-and-software solution. For example, in the RaaS system from Fetch Robotics, the PalletTransport1500, an autonomous mobile robot (AMR), comes fully integrated with a Honeywell warehouse execution system (WES). Suddenly, we can start to imagine what a fully digital warehouse looks like, and the competition to fulfill that vision comes from both hardware and software companies. For example, among your choices for a digital warehouse partner are Tompkins Robotics (expanding from AMRs to complete solutions) and the start-up CognitOps (expanding from a WES to complete solutions). Everybody wants not just a piece of the pie, but the whole pie.

Inevitably with technological trends, there’s uncertainty. But today’s uncertainty—how will these visibility and automation trends evolve, and who will get how much of that pie?—differs considerably from the uncertainty of years past. Back then, the energy was driven by the technologies themselves. For example, there was a lot of buzz about blockchain, so logistics leaders tried to figure out how they could benefit. There were great advances in augmented reality (AR) and virtual reality (VR), so logistics leaders tried to apply them to operations. Today, the energy is driven by clear-cut needs of the logistics companies themselves. The imperatives for visibility and automation are clear. The question is how the technologies can accomplish them.

That’s not to say the answer is obvious, or easy to achieve. Different situations require different approaches. Logistics companies must have a strong vision of what they want, to avoid getting swept up in irrelevant trends. They also need talented people who can understand the applications of evolving tech- nology. But at least the strategic direction is clear: to execute effectively against rising consumer demands, companies must improve supply chain visibility and efficiency across the flow of goods. To do that, they need technology-driven visibility and automation.

Right-shoring Offshoring was the decades-long effort to move manufacturing operations to lower-cost countries (LCCs) abroad. Reshoring was the expected backlash, in which companies would move their operations back to the US, in search of shorter lead times, better communication, tariff avoidance, or other advan- tages. In recent years, attention has shifted to nearshoring, in which companies might favor nearby LCCs such as Mexico over faraway, trade war– constricted China. However, the latest Kearney Reshoring Index shows that reshoring/nearshoring hasn’t yet quite arrived. Indeed, the pandemic’s disruptions have demonstrated that a once-binary choice—offshoring versus reshoring—has evolved into a more complex decision set best described by the word “right-shoring.”

Both the pandemic and 2020’s severe weather events caused significant disruptions to supply chains, demonstrating their vulnerability. In order to avoid overdependence on specific suppliers or geographic regions, companies want to diversify their supply bases and/or ensure access to an appropriate amount of intermediate inventory or safety stock.

The case for reshoring/nearshoring remains sound. Disruptive weather events and pandemics may well recur. The cost of transpacific logistics will also remain high. Trade tensions with China seem likely to continue. Furthermore, a major source of these tensions is increasing Chinese economic strength—a growing middle class, improved capabilities for advanced manufacturing, and a more sophisticated domestic economy—in which it evolves from an LCC to a medium-cost country.

But as the Reshoring Index shows, so far the shift out of China has primarily benefited other Asian countries, rather than North American ones. Vietnam, Thailand, India, and other countries retain the traditional LCC advantages. And it’s hardly a rush to flee China: many companies have deep manufac- turing roots there, and others source its raw materials. While manufacturing could well increase in Mexico and other nearshoring LCCs (assuming the pandemic is largely behind us), the situation is not as clear-cut as the word nearshoring might imply. Manufacturers look at various factors and come to varying results— each chooses the right-shoring opportunity for its particular situation.

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As shippers’ operations become more resilient and option-rich, their logistics demands will become more variable.

The result is likely to pose a complex challenge for logistics. A rush to nearshoring would have resulted in a simple challenge: to reorient logistics networks to North America. But right-shoring means that logistics will become more complicated. Some companies will indeed want improved North American logistics, while others will want routes from Vietnam or India, while potentially also retaining Chinese operations. As shippers’ operations become more resilient and option-rich, their logistics demands will become more variable.

In turn, logistics providers, too, must become more flexible, more customer-focused, better able to foresee change and propose alternative solutions across modes and nodes, and more strategic in taking advantage of opportunities. In short, logistics must become more resilient and resourceful.

The next winners In 2020, logistics merger and acquisition (M&A) activity was driven by pandemic disruptions, e-com- merce spikes, and desires to stabilize supply chains. M&A was particularly strong in warehousing, distribu- tion, and last-mile services. We expect to see this trend continue as logistics players reshuffle capabili- ties. Furthermore, we expect to see a new cycle of partnerships, acquisitions, and investments that may determine the industry’s next lineage of winners and losers.

In warehousing, Amazon remains a fascinating player. It continues to acquire prime warehousing space to house and distribute its wide-ranging portfolio of goods. Private equity firms such as KKR and Blackstone have also purchased significant square footage in anticipation of sustained e-commerce demands. We expect warehousing deals to continue increasing this year as players fight for space on behalf of their respective customers.

In rail, the bidding war between Canadian Pacific and Canadian National for Kansas City Southern counters the longstanding opinion that heavy rail consolidation had run its course. A deal of this size marks an era where companies will get creative and push the boundaries on how they claim and create value in the market as competition rises. No deal may be off limits.

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Shippers need more complete and integrated solutions, so providers are maneuvering to figure out the best ways to serve those needs.

In addition to creative deals, the real driver of coming M&A activity will be creative business model configu- rations. Large logistics players continually seek to integrate across modes and geographies. Given the need to digitize the end-to-end delivery of goods, why not increase ownership across the spectrum of that journey? Given the value of a customer, why not have more services available for cross-selling? Maersk’s investments in digital freight technologies may be the best example of this trend.

Meanwhile, XPO has decided to spin off its global contract logistics business as separate from its trucking and freight brokerage operations, demon- strating the value of focusing capabilities. XPO perceived a “conglomerate discount” in its stock price. Its decision to become two pure-play companies is similarly about finding the best, most creative business model configuration for its situation. We expect such activity to continue: some players will see value in shedding legacy assets, and other players will see value in acquiring those assets for creative new configurations. Large, established players will also seek creative configurations by acquiring companies with strengths in emerging technologies.

The success of these new configurations will likely depend on companies’ ability to integrate newly acquired capabilities. But the motivation is clear: shippers need more complete and integrated solutions, so providers are maneuvering to figure out the best ways to serve those needs.

Adapting to the no normal The pandemic forced logistics functions to become more resilient. As it scrambled supply chains and boosted e-commerce demand, shippers and carriers alike had to adapt quickly to get goods where they were needed. Despite slowdowns, congestion issues, and price increases, efforts were generally remarkably successful, albeit at a higher cost for most shippers.

Yet the crisis also forced shippers to reevaluate their supply chains, and carriers to reexamine their core capabilities. Many companies reconsidered their short- and long-term strategic vision. Some saw accelerated need for diversification, others pondered where they want to be and how they want to operate. One might thus expect continued changes along the same lines as companies adapt to a new normal. But—as we at Kearney like to say—you can’t hope for a new normal, because it can’t be predicted and may never arrive. Instead we live in times of a no normal, a “permanent now” that forces us to live and do business in the moment. The outlook for logistics, as for so much of the economy, calls for strategic and organizational agility to adapt to the no normal.

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Control tower: visibility and control, everywhere

More than ever, global supply chains need connections among formerly siloed elements for better transparency and agility.

If an airport is so complex and fast-paced as to need a control tower, surely a company’s supply chain is too. For decades, shippers have dreamed of seeing all aspects of logistics visible from one place, and thus being able to make smart, quick decisions.

The quest for more resilient networks centers on having optionality at all times, which requires a large number of actors in the play. How do you connect so many diverse players in real time? Yet how do you manage costs and efficiency without such connections?

Why it matters more now The recent development of affordable, user-friendly, cloud-based technology solutions overcomes a big historical problem: how to interface with various platforms. Today’s cloud-based solutions use micro- services architecture with lightweight protocols that make it easier to integrate diverse data. There’s less need to dictate what software your providers use— today’s control towers can grab data from anywhere. It’s now easier to automate the formerly program- ming-intensive task of linking together an enterprise resource planning (ERP) system, order management system (OMS), transportation management system (TMS), warehouse management system (WMS), and freight audit and payment system.

At the same time, increasingly frequent natural and geopolitical disruptions to supply chains have become costlier, and are taking longer to recover from, as recently and best demonstrated by the COVID-19 pandemic. More than ever, global supply chains need connections among formerly siloed elements for better transparency and agility—the exact benefits of a control tower. Meanwhile, increasing consumer pressure to assure shipments has increased shippers’ sense of urgency. In some cases, shippers lose business solely because of an inability to meet service requirements, regardless of product quality or price.

As a supply chain executive at a Fortune 100 consumer product company told us, “In the past we competed on how fast we could move stuff. Now we compete on how fast we can move data.”

These immense challenges for shippers are huge opportunities for third-party logistics providers (3PLs), which are becoming the biggest driving forces for control towers. While both parties need control towers to satisfy their customers, 3PLs can leverage control towers to create synergies across their (shipper) customers and carrier bases, reducing costs to reinforce their core value proposition.

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The size of the prize Activity is surging in the control tower space right now, and for a very good reason: a control tower can help trim 10 to 20 percent of total supply chain costs, depending on the starting point. If done right, the control tower will provide enhanced data transpar- ency and control, in near–real time, across your supply chain.

Most companies thus see the control tower as the ultimate solution for all supply chain pain points. Imagine your sales and operations planning (S&OP) forecasting is no longer a guessing game but is instead driven by the latest inputs from your customers. Imagine that you can track the source of missed on-time-in-full (OTIF) deliveries, because you have clear custody records and time stamps for every milestone activity conducted by your carriers and warehousing providers. Imagine that when you are conducting a full network procurement event with collaborative optimization, it’s easy to consolidate data, because all historical shipment data across geographies is in one place, with the right level of detail, ready for you to download.

Setting the right ambitions Although a well-established control tower would indeed achieve all of these, sometimes grand ambitions can get in their own way. To get there fully and fast, you’d need to take a big bang approach, which would require daunting levels of investment and pose tremendous business continuity risks. Furthermore, the approach would likely underdeliver, as shown by many companies’ dissatisfaction with their big-bang ERP systems.

Part of the problem is the metaphor of a lofty tower from which control surges down. A better approach, at least for early-stage development, might be the hub. Rather than erecting a control tower tall enough for your biggest ambitions, you can start coordinating in one or more hubs. If a hub can generate enough visibility to provide meaningful control, it can serve as a proof of concept and platform for learning, which you can later scale up.

A transformational journey Experimenting with hubs can be a low-cost, non-threatening entry point. You can start within a business unit, a geography, or a collection of plants and distribution centers. Working through individual use cases, these initiatives can demonstrate value and fund their own expansion (see figure 30 on page 58).

The hub concept and use case–driven entry point are widely applied by today’s leading control tower providers. Working with individual clients, they develop customized solutions that address specific supply chain pain points. For instance, partnering with a technology provider, Penske is building a customized ClearChain solution for various clients to address their individual challenges, including optimizing inbound freight to expedite the right parts to plants, and allocating inventory against order in a make-to-order situation.

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Source: Kearney analysis

Figure 30 Path of adoption: start with use cases addressing pain points and demonstrate value, then scale up

Illustrative

Artificial intelligence/machine learning (AI/ML) becomes a key value driver. Capabilities of benchmark-based prediction and automated decision will reduce high-touch human roles.

5. Link to trade partners

— Start connecting elements of own supply chain with those of suppliers and/or customers; scale up to build multi-partner supply chain network.

1. Identify pain points in transportation

— Determine key cost and performance gaps; define “metrics that matter” to drive improvement.

3. Link TMS and WMS

— Standardize WMS and connect digital architecture between platforms leading to a coordinated distribution information system.

2. Streamline TMS process

— Harmonize underlying data processes to support TMS reporting; update operating model and governance to ensure actions.

4. Link distribution with planning

— Establish two-way information exchange to coordinate planning and distribution, aiming to optimize total cost to serve.

No matter where the first hubs are built, successful designs typically include four key elements: metrics that matter, data standardization, digital solutions, and internal capabilities and change management.

1. Metrics that matter. Ten to 15 metrics that truly drive performance are far more effective than hundreds of meaningless tracking records. Figure out what this short list should look like for your business and build your analytic processes to meet those needs. The metrics should enable you to quantitatively demonstrate success to the organization, in order for your initiative to continue garnering credibility and support.

2. Data standardization. No control tower will ever deliver significant benefits until you harmonize the underlying processes it is intended to control. To many organizations with a complex business structure, the biggest bottleneck is data sources that are segregated by physical location and format. The harsh reality: no software can magically solve this problem for you. You have to make your various sources of data compatible first. The good news: you can start small, with the scope of your first hubs, and standardize the in-scope data for your identified metrics that matter.

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3. Digital solutions. For information to flow correctly and efficiently, you must have the right pipes set up. However, for most organizations, this goes beyond the technology level—you need to choose the right partners to support you along the control tower journey. Due to the complex nature of your supply chain, the control tower solution that is right for you will undoubtedly be a customized one. If you currently have robust internal supply chain capabilities across sourcing, operations, analytics, and customer services, you might choose a tech-oriented solution provider. On the other hand, if your journey is more about closing gaps in your own capabilities, you might want to choose a provider with deep supply chain experience and networks.

4. Capabilities and change management. As the control tower automates mundane day-to-day processes, expectations for your supply chain team will increase. Its members will need to solve increasingly crucial and strategic issues. Thus, you must keep your people growth on par with your system growth. No matter what level of outsourcing you adopt on your control tower journey, it always requires the next-level strategic and transformed in-house core capabilities to match up. Furthermore, gaining stakeholder support is harder to achieve than implementing the control tower itself, especially for large, complex organizations. However, you’ve got to win the people, every step of the way. The key is to demonstrate tangible values they care about. Meanwhile, effective support from executive leadership almost always helps. The COVID-19 pandemic has highlighted the importance of supply chain resilience to the executives of most organizations, so now should be a good time to start the conversations, if you haven’t already.

A look ahead Because a control tower connects many data sources, it provides a perfect platform for artificial intelligence (AI) and machine learning (ML). AI/ML will take control towers to a whole new level of efficiency and reduce the cost of the most expensive element of the supply chain—human labor. For example, AI/ ML can do benchmarking based on massive collec- tion of freight rates to predict a market price and the likelihood of tender acceptance, which will enable automatic award decisions. Furthermore, the control tower can use natural language processing to communicate the award, which triggers dispatching. Although shipments of high complexity (for example, fragile, hazmat) might still require human touch, algorithms are being trained to handle more and more complexity beyond the bulk routine.

Meanwhile, as many companies focus on internal control towers that connect a supply chain end to end, technology trends point to a far horizon, a highly coordinated supply chain network across multiple trade partners.

Though still in early stages, platforms aiming at this vision are gaining traction. Because building an end-to-end interconnected supply chain within organizations and across multiple partners does not have to happen sequentially, it’s possible for multiple companies to coordinate on certain aspects of their supply chains at scale.

For instance, if you were a food consumer packaged goods company, you could build customer- driven S&OP. You connect your internal planning functionality with your retailers’ order forecasts, in order to improve your own forecast accuracy, especially when it comes to holidays and ad hoc promotions. On the supply side, you could build touch-less VMI (vendor managed inventory), auto- mating information exchange between your material inventory and your suppliers’ VMI and outbound logistics. The connections between companies might take various shapes and forms to start with, but if the collaborations can demonstrate value and manage risks, multi-partner supply chain networks may arrive faster than you expect.

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Sustainability: from feel-good pledges to business necessity

Shippers, carriers, investors, and customers are all acting in ways that demonstrate the value they place on sustainability.

The transportation sector accounted for 29 percent of America’s 6.6 billion metric tons of 2019 greenhouse gas emissions. Thus, even incremental efficiency improvements in moving goods and people could have huge carbon impacts. For years, statements such as this have come from environmental activists, making moral arguments. In 2021, these sentiments are coming from logisticians, making business arguments.

Shippers, carriers, investors, and customers are all acting in ways that demonstrate the value they place on sustainability. They’re not merely making feel-good statements or pledges. They’re making investments. For example:

— UPS will deploy 6,000 natural-gas-powered trucks over the next three years, aiming at reducing emissions by 12 percent by 2025.

— FedEx is making $2 billion initial investments in vehicle electrification, sustainable energy, and carbon sequestration.

— DHL is investing $8.2 billion in sustainable aviation fuels, electric vehicles (80,000 vehicles, 60 percent of its fleet, by 2030), and carbon-neutral buildings.

— Amazon ordered 100,000 electric delivery vehicles, saying it will power operations with 100 percent renewable energy by 2025.

— JP Morgan Chase aims to finance $2.5 trillion toward sustainability solutions by 2030, Citi $1 trillion, Morgan Stanley $250 billion. Goldman Sachs has already invested $93 billion.

— After Larry Fink’s commitment in a letter to shareholders, BlackRock has made sustainability its new standard for investing—it won’t give you money unless you have a sustainability agenda.

And this is only a sampling of logistics-related companies with publicly announced sustainability investments. Many other shippers and carriers have made aggressive sustainability pledges, including BestBuy, Walmart, XPO, Maersk, and CSX.

Businesses are spending money on sustainability because they understand that for the next 20 years, the fate of logistics companies will be governed by how they meet this challenge. Even amid the pandemic, consumers were increasingly considering environmental impacts in their purchase decisions. As consumers and employees increasingly demand sustainability—and governments support those demands with increasing regulation—reducing your carbon footprint is no longer a by-product to placate the public relations staff. It’s becoming a business necessity.

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What sustainability means The global climate crisis is increasingly apparent in many basic economic consequences. Increasingly large hurricanes and wildfires, and increasingly hot summer temperatures, can hurt and kill people. Extreme weather events can cause delivery disloca- tions, delays, and plant closures that can impact logistics and transportation. At a minimum, logisti- cians must respond to climate change by making their networks more resilient and less vulnerable to shutdowns in coming natural disasters.

Furthermore, the severity of the crisis means that many consumers, employees, and potential business partners would prefer to interact with companies that work to lower carbon emissions, so as to help mitigate or reverse the carbon-fueled trends. This change in public opinion is turning sustainability from a luxury or a moral issue into a growth opportunity.

But how to accomplish it? Many companies are still trying to figure out what sustainability looks like on the ground. Some don’t know exactly what they want to achieve. Furthermore, for decades, companies have viewed their value chains through the lenses of cost, quality, or (recently, for some innovators) resilience. Now they struggle to understand how to apply the lens of sustainability.

The answers will continue to evolve. But the direction of that evolution is increasingly clear. One way that companies can move toward sustainability is to know how and what to measure. Another is to have a framework to identify the right levers for change. A third is to understand the dynamics of a specific industry and situation.

To help manage it, measure it The magical aspect of logistics sustainability is that most logistics cost-saving initiatives are also climate- saving initiatives. Every effort to shorten transit routes reduces fuel consumption and thus carbon impact. Every effort to optimize space in warehouses or trucks can reduce heating or air conditioning needs, and potentially reduce the number of trips required. Every effort to reduce obsolete inventory, or to trim packaging, or to recycle pallets can have a sustainability “side effect” of reducing carbon footprint. Sustainability is all about efficiency, even in incremental steps, and it is more than likely that initiatives already in action will help companies increase their sustainability.

Logisticians have been slow to take sustainability credit for past efficiency initiatives—in part because they don’t know how to measure it. To help, Kearney has built a sustainability calculator to quantify past and current efforts and show the value of future projects. For example, the tool can show the carbon emission impact from cutting miles on deliveries and shipments.

Another tool is SmartWay US, a voluntary public-private program supported by major transpor- tation industry associations, environmental groups, state and local governments, international agencies, and the corporate community. Its system for tracking, documenting, and sharing information about fuel use and freight emissions across supply chains helps companies identify and select more efficient freight carriers, transport modes, equipment, and opera- tional strategies. Werner won two SmartWay Excellence awards in 2019 for reducing its carbon footprint by more than three million tons.

Such awards can be useful ways to demonstrate to customers, investors, and employees that you are committed to sustainability. But more fundamentally, participating in such initiatives gives you measurement tools that help you understand your individual sustainability opportunities and document your successes.

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A framework for sustainability improvements Still, where should you begin your investments? Which are the right levers to pull? Where should you even start to measure? Executives who approach sustainability issues for the first time can find it all a bit daunting. They can benefit from seeing sustain- ability improvements through the framework of three pillars: sustainable operations, service, and supply.

1. Sustainable operations. Can you improve internal efficiencies, using best practices, to increase sustainability across your day-to-day activities? As noted above, this often offers the added benefit of reducing costs.

For a shipper, making your operations more sustainable could involve using technology to measure key performance indicators (KPIs). The advanced analytics you use (or aspire to use) to optimize carrier choice and routes could include carbon impacts as a decision variable. You could also improve the energy efficiency of your warehouse operations through better lighting, temperature control, and gas and water usage monitoring. Finally, you can reduce waste, whether that’s disposable wooden pallets or slow-moving and obsolete (SLOB) inventory.

For a carrier, making your operations more sustainable could involve switching to less carbon- intensive transportation modes—say, from air to ocean, or motor to intermodal. You can also pull levers to reduce carbon impact within each mode, such as moving away from gasoline as fuel, or simply investing in a more modern fleet. A modern semi-truck that averages 7 mpg versus an older model that is in the 5–6 mpg range will reduce your fuel consumption by close to 25 percent, thus making your fleet more sustainable. Companies that wish to do even more can invest in electric vehicles, and although electric vehicles are not fully sustainable until the electricity used to power them comes fully from renewable sources, they do uniquely offer a path to fuller sustainability.

2. Sustainable service. Can your company build a strategic vision for sustainability? This vision can then dictate how you do everything from choosing partners to reducing e-commerce returns.

For a shipper, making your service more sustainable means not only articulating that vision, but also communicating it to partners: suppliers, manufacturing sites, warehouses, carriers, and customer locations. It also means adjusting the mindset of your consumers—for example, around expectations for product delivery and/or returns.

For a carrier, making your service more sustainable could involve reusable containers and packaging, lane optimization to share truckloads with other carriers, and more broadly increasing your asset utilization to limit empty miles.

3. Sustainable supply. Do your external suppliers meet your sustainability vision? Because climate effects are holistic and cumulative, you can’t just offload your carbon footprint to your suppliers. You have to vet those suppliers as legitimate partners that share your sustainability strategy.

For a shipper, making your supply more sustainable centers on transparency. You need to inform all your suppliers about your climate and social goals, and develop in-house auditing teams (as opposed to external certification partners) to monitor performance. You should also make sustainability metrics (for example, for green fuel or electric vehicles) part of your supplier outreach and selection.

For a carrier, making your supply more sustainable centers on fuel and equipment. Where can you use alternative green fuels? And where can you adjust your fleet portfolio to improve efficiency and/or fuel type?

Many of these priorities and initiatives are not new. For example, many shippers have long desired transparency; many carriers have long seen the value of improved asset utilization. Instead, what’s new here is the framework—a way of seeing your value chain through a lens of sustainability, which may put these initiatives in new light.

“Companies should look to a portfolio of solutions, not just plugging it in,” says Erik Neandross, CEO of the clean transportation and energy firm Gladstein Neandross & Associates (GNA). “Finding the right technology for the right application is really critical to achieving economic and environmental sustainability.”

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Sustainability is like profitability— different strategies work in different situations. Various industries and sectors will eventually develop best practices in sustainability.

Examples from various logistics sectors Sustainability is like profitability—different strategies work in different situations. Various industries and sectors will eventually develop best practices in sustainability. But as the topic is new and gaining momentum, you can benefit from learning about the sustainability advances of leaders in your sector. Here is a sample of sustainability trends in various logistics sectors.

The air cargo industry has a high carbon footprint, yet fully electric or hydrogen-powered widebody aircraft are still decades away. In the interim, there’s a sustainable aviation fuel (SAF)—synthetic kerosene. It’s expensive, but some shippers may be willing to pay the expense, because it’s proven. In November 2020, Lufthansa Cargo and DB Schenker used SAF in the first carbon-neutral freighter flight, Frankfurt to Shanghai on a Boeing 777.

Much of today’s aviation biofuel, comparable to high-grade biodiesel, is produced from plants or waste. Consuming resources that could instead be used for food means that it may be carbon-neutral but isn’t fully sustainable. However, power-to-liquid technologies already exist to convert renewably powered electricity to synthetic kerosene.

Advocates for rail note that it moves cargo more efficiently than trucks. For example, a report from the Association of American Railroads says that if 10 percent of the freight shipped by the largest trucks were moved by rail instead, greenhouse gas emissions would fall more than 17 million tons annually. Indeed, a key component of Schneider’s March 2021 sustainability commitment is to double its intermodal size by 2030, reducing carbon emissions by 700 million pounds per year.

To further reduce emissions from rail, in early 2021 BNSF and Wabtec tested a battery-electric locomotive. It ran between two diesel locomotives in revenue service between Barstow and Stockton, California. This diesel-electric hybrid approach reduced both fuel consumption and emissions by more than 11 percent, with more ambitious tests to come. Meanwhile, Canadian National and Canadian Pacific are considering locomotives powered by biodiesel, hydrogen, and electricity.

In the long term, electric vehicles are expected to transform the trucking industry, with potentially huge carbon benefits. Penske has fielded 30 electric trucks in the southern California marketplace as a proof of concept for electrified truck fleets. Drew Cullen, Senior Vice President of Fuels and Facility Services at Penske, says, “Our electric truck efforts at Penske have gone well… we are also proud of the EV charging stations.” Elsewhere, motor transport innovations include green fuel, green mode, and new tractor models with lower carbon emissions.

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Constructing new warehouses closer to inbound ports—or closer to customers— will save energy and emissions on transportation.

Warehousing occupiers will demand more skylights and renewable energy sources. They will also demand sustainable features to provide water savings, recycling capabilities, and eventually charging units for electric trucks. Warehouses can become greener through LED lighting, improved insulation, adjustments in shelves to improve the circulation of heated or cooled air, and the implementation of energy management systems to provide visibility into energy use and performance.

Constructing new warehouses closer to inbound ports—or closer to customers—will save energy and emissions on transportation. In the design phase, right-sizing the warehouse at that location, with computer models to simulate the flow of people and materials, will ensure efficiency and thus sustainability.

Across all three of the sustainability pillars, 3PLs have particular leverage. They already tie together suppliers, shippers, carriers, and end consumers. They can capture sustainability data across the entire supply chain. As they make connections, they can build networks of companies with similar sustain- ability goals. As they provide services at scale, their efficiency improvements can ripple across a wide customer base, giving each more impact than if they achieve it alone.

Traditionally, one big challenge for 3PLs has been to deepen relationships with shippers, so that they don’t always have to compete just on price. Collaborating on sustainability initiatives provides those closer partnerships. For example, XPO and Nestlé in Britain built an environmentally advanced distribution center with ammonia refrigeration, LED lighting, air source heat pumps, and a rainwater harvesting system.

Next steps The sustainability area is not only complex but fast-moving. New technologies emerge; new govern- ment programs offer incentives; new weather events bring new converts. At the same time, all of these new trends are implementations of an old idea: efficiency and cost savings.

During the pandemic, logistics firms demonstrated their ability to pivot, quickly yet calmly, and deliver needed materials from one place to another despite surprising new challenges to traditional ways of doing business. The sustainability pivot may be more permanent and comprehensive, but it presents a similar mix of challenges to traditional approaches and reliance on traditional skills. And though it comes with a similar sense of urgency, logistics firms should see it as less of a surprise.

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Appendix

Estimating USBLC The CSCMP and Kearney strive to maintain maximum transparency and consistency. The assessment of assumptions, data sources, and methodologies that was made last year resulted in a robust research procedure that can be replicated for consecutive years. Because the structure of the supply chain did not significantly change compared to last year, it was deemed appropriate to keep the approach to estimating the USBLC unchanged.

Historical comparability has been preserved and the three main categories of the past have been retained: transportation costs, inventory carrying costs, and other costs (see figure A on page 66).

Transportation costs

Transportation costs are based on Bureau of Economic Analysis (BEA) industry output. BEA US input–output accounts are a primary component of national income and product accounts and GDP. BEA uses the widest variety of available source data as input to the industry accounts. It incorporates domestic and import–export revenues where appli- cable. In other words, it includes any spend attributable to an establishment within the United States. It is rebalanced every five years against US Business Census data.

Our data partner IHS Markit used detailed BEA data, its proprietary databases IHS Markit Transearch™ and IHS Markit Business Market Index, and public company information to categorize subsegments in a way that better reflects how transportation and logistics is purchased and used. Data was thoroughly reviewed to avoid double counting between segments.

In delivery of the 2019 data, we observed abnormally large historical data swings, which resulted from BEA methodological revisions introducing more detailed input and output data, plus North American Industry Classification System (NAICS) updates to industry and commodity definitions. In 2019, conservatively, we applied compensatory factors to ensure consis- tency, both historically and with the 2019 data. In delivery of the 2020 data, it became clear that these changes—particularly evident in water freight, both deep sea/coastal/Great Lakes and inland waterways— were no fluke. Thus we’re here making a one-time change, and refreshing all historical data as noted below.

No changes were made to last year’s segmentation and definitions:

— Motor carriers are segmented into full truckload, less than truckload, and private or dedicated carriers.

— Parcel includes US-based couriers and messengers and the USPS parcel segment, net of purchased transformation. The numbers are based on BEA output, modified to remove duplicate transportation from other modes (arising from, for example, intramode purchases).

— Air freight includes both cargo and air express. Consistent with BEA definitions, it incorporates both domestic and import–export revenues.

— Water includes coastal and Great Lakes, inland waterways, and deep sea. It incorporates domestic and import–export revenues.

— Pipeline reflects all commodity products.

— Freight forwarder is included, net of purchased transportation cost estimates, under carriers’ support activities in the “Other costs” category.

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Figure A Three cost categories are used to determine USBLC

Motor carriers

Transportation costs

Inventory carrying costs

Other costs

Parcel

Rail

— Full truckload — Less-than-truckload — Private or dedicated

— BEA input–output accounts, annual, production of commodities by industry

— IHS Markit TransearchTM

— Courier and messenger — USPS parcel segment

— BEA input–output accounts, annual, production of commodities by industry, gross value

— IHS Markit — FedEx and UPS financial statements — US Bureau of Transportation, Form 41 Air Carrier Reports — USPS financial statements — USPS Cost Segment and Components Report

— Carload — Intermodal

— BEA input–output accounts, annual, production of commodities by industry

— IHS Markit — Association of American Railroads — Surface Transportation Board

Air freight

Water

Pipeline

— Domestic and import—export cargo and express

— BEA input–output accounts, annual, production of commodities by industry

— US Bureau of Transportation, Form 41 Air Carrier Reports — IHS Markit

— Inland — Coastal and Great Lakes — Deep sea: domestic, import–export

— BEA input–output accounts, annual, production of commodities by industry

— IHS Markit

— Crude oil — Natural gas — Other products

— BEA input–output accounts, annual, production of commodities by industry

— IHS Markit

Storage

Weighted average cost of capital

Total business inventory

— BEA input–output accounts, annual, production of commodities by industry

— US warehousing and storage gross output from 2011 to 2020

— Cost of equity, debt, and taxes — Aswath Damodaran, New York University Stern School of Business

— Federal Reserve Bank of St. Louis, Series ID A371RC1Q027SBEA: private inventories, quarterly, seasonally adjusted (from BEA). Private inventories includes manufacturing, retail, and wholesale and represents end-of-month stock and goods available for sale on the last day of the reporting period

Other (obsolescence, shrinkage, insurance, handling, others)

Carriers’ support activities

Weighted average cost of capital

— Shippers’ administrative costs — Kearney estimate based on various internal and external studies

— Gartner

— Freight transportation arrangement — Packing and crating — Marine cargo, port, and other

shipping-related services — All other support services to transportation

— BEA input–output accounts, annual, production of commodities by industry

— Public company financial statements — IHS Markit Business Market Index

— Wages — Benefits — IT costs

— BLS, occupational employment statistics, occupation by industry sector

— BLS, employer costs for employee compensation, private workers

— NYU

Data element Sub-elements Source

Note: USBLC is United States business logistics costs.

Source: Kearney analysis

66Change of plans

Historical comparisons To facilitate comparisons with the historical series, the USBLC table has been recalculated back to 2011 using current sources and methodologies (see figure B on page 68). As noted above, due to a significant update of the Industry Economic Accounts (IEAs) and the resulting impact on BEA data releases, a compre- hensive refresh and recalculation of historical USBLC figures was conducted for this year’s report. Other government data has also been revised or updated, so some figures, including GDP and inventory, may differ from previous reports.

Inventory carrying costs

Inventory carrying costs are calculated from the bottom up using the sum of their three subcompo- nents: storage, financial costs, and other. Financial costs estimates the weighted average cost of capital for all US public companies and multiplies it by the value of total business inventory. The value for “other” is calculated as a proportion of the overall inventory carrying cost. This proportion is smaller than the other two subsegments and is based on consensus estimates from various sources.

Other costs

We use the same definitions as last year.

Carriers’ support activities reflect a broad range of services that support shipping. Examples include freight transportation arrangement (freight forwarders and brokers), customs services, packing or crating, port handling, and other freight yard management, container leasing, navigation services, and a number of other related activities. In the case of freight transportation arrangement (forwarders and brokers), purchased transportation has been estimated and removed to eliminate duplicate counting of freight.

Shippers’ administrative costs are built on two specific cost areas: labor and logistics IT. Labor costs are calculated using a weighted average of mean annual wages for manufacturing, retail, and wholesale industries for logistics-related occupations plus the estimated value of total benefits paid to employees in addition to wages. Logistics IT spend is based on industry reports of the supply chain management software market for the United States.

67Change of plans

Figure B Ten-year summary of USBLC

UnitsMetric

15,542.6

2,247.4

16.3%

763.9

365.7

74.4

1,204.1

7.7%

14.5%

4.9%

2.4%

100.0

100.0

100.0

100.0

16,197.0

2,337.9

16.4%

794.7

382.7

79.3

1,256.7

7.8%

14.4%

4.9%

2.4%

99.8

99.8

100.4

100.2

16,784.9

2,395.4

16.6%

817.1

398.8

82.2

1,298.1

7.7%

14.3%

4.9%

2.4%

98.7

99.0

101.0

99.8

17,521.7

2,524.4

15.0%

884.5

377.5

89.4

1,351.4

7.7%

14.4%

5.0%

2.2%

99.6

102.7

91.6

99.6

18,219.3

2,520.7

15.8%

890.3

397.9

94.7

1,382.9

7.6%

13.8%

4.9%

2.2%

95.7

99.4

92.8

98.0

18,707.2

2,536.7

15.3%

886.9

389.1

100.6

1,376.7

7.4%

13.6%

4.7%

2.1%

93.8

96.5

88.4

95.0

19,543.0

2,637.4

15.5%

935.5

409.1

107.7

1,452.3

7.4%

13.5%

4.8%

2.1%

93.3

97.4

88.9

95.9

20,611.9

2,775.5

17.2%

1,023.2

476.4

113.9

1,613.5

7.8%

13.5%

5.0%

2.3%

93.1

101.0

98.2

101.0

21,433.2

2,858.8

15.7%

1,050.5

449.0

122.9

1,622.4

7.6%

13.3%

4.9%

2.1%

92.2

99.7

89.0

97.7

20,936.6

2,778.5

13.7%

1,059.0

381.6

116.9

1,557.5

7.4%

13.3%

5.1%

1.8%

91.8

102.9

77.4

96.0

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

$ billion

$ billion

%

$ billion

$ billion

$ billion

$ billion

%

%

%

%

base 100

base 100

base 100

base 100

Nominal GDP

Total business inventory

Inventory carrying rate

Transportation costs

Inventory carrying costs (ICC)

Other costs

Total USBLC

Total USBLC as % of nominal GDP

Total business inventory as % of nominal GDP

Transportation as % of nominal GDP

ICC as % of nominal GDP

Total business inventory as % of nominal GDP (2011=100)

Transportation as % of nominal GDP (2011 = 100)

ICC as % of nominal GDP (2011 = 100)

Total USBLC as % of nominal GDP (2011 = 100)

Note: USBLC is United States business logistics costs.

Source: Kearney analysis

68Change of plans

Michael Zimmerman Partner, New York [email protected]

Alberto Oca Partner, Atlanta [email protected]

Balika Sonthalia Partner, Chicago [email protected]

Arsenio Martinez-Simon Partner, Washington, D.C. [email protected]

Authors

Korhan Acar Principal, Chicago [email protected]

Yan Sun Principal, Chicago [email protected]

69Change of plans

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