Logistics costs are rising, but where is the response from shippers in terms of truly changing fundamentals of their distribution center networks?
One basic precept of logistics is that the highest transportation costs will occur between the distribution center and the retail store, the proverbial “last mile.” This is where loads tend to be the smallest, load efficiencies the hardest to achieve and higher-cost less-than-truckload dominates. The last-mile segment is the polar opposite of ocean transportation, where a crew of 14 can operate a ship carrying 8,000 container units.
All else being equal, when direct transport costs such as fuel are rising, a retailer will try to position distribution centers as close to its retail stores as possible. That typically means more but smaller DCs spread out over a wider geographical territory. Yet, despite a range of rising logistics-related costs — everything from foreign sourcing to North American trucking headed higher — there has been no industrywide trend evident this year toward spreading DC networks.
Panelists at last month’s inaugural Journal of Commerce Inland Port Conference in Chicago, said it is unclear when the changes in the economic landscape would trigger deep changes in distribution networks.
“Conceptually, everyone knows that it makes sense when freight costs are going up to have more facilities versus one big, central DC in the middle of the country, but it hasn’t happened,” said Rich Thompson, executive vice president for global real estate services firm Jones Lang LaSalle Americas.
Indeed, at least certain types of logistics costs are experiencing long-term growth that seems separate from cyclical conditions.
Although inbound ocean freight rates are weakening this summer, most expect pricing to be volatile without heading in any definitive direction one way or the other over the long term. But the costs of offshore sourcing are increasingly steadily, and likely permanently, as wages in Chinese coastal areas skyrocket and shippers seek alternative sources of production, whether in the Chinese interior or in other markets in Asia or Latin America. North American trucking costs are almost certain to rise because of a host of factors — hours-of-service and CSA 2010 regulations, as well as what appears to be strict carrier resolve, among them.
And, although fuel has been synonymous with volatility, the long-term trend for diesel is decidedly upward, especially as demand grows in an improving economy.
“Transportation costs are going up,” Thompson said. “I talk with lots of corporate clients and that continues to be validated in my mind by everyone I speak with.”
But rising costs have not led to any wholesale pushing out of DC networks. Although there have been a few transactions, the industry has seen nothing like the response to the record $145-per-barrel crude oil record set in mid-2008, when 3PL warehouse operators saw a surge of interest in their facilities in secondary and tertiary markets.
If anything, companies during the recession and its aftermath have gone in the opposite direction, retrenching by vacating DC space to cut costs in the face of flat or declining retail sales. “During the recession, a lot of people contracted — a lease came up and so they saw an opportunity to cut come costs,” said Tim Feemster, senior vice president and director of global logistics for real estate services and investment firm Grubb & Ellis.
When it will go the other direction is anyone’s guess, but the feeling among industrial real estate figures is there could be a rush toward locating in smaller markets as soon as the economy picks up steam. “When the economy turns, whenever that is, and freight costs continue to escalate, companies are going to start to get active in second-tier markets — Kansas City, Columbus, Ohio, Charlotte, N.C. They are going to be looking at space where they can get closer to their customer,” Thompson said.
When that happens, as long as interest rates remain low, the increased inventory levels needed to support a more far-flung DC network won’t necessarily be an obstacle. “The more DCs you have, the more inventory you have,” Thompson said. “Right now, inventory costs are at an all-time low. Inventory is not the focus today.”
Companies now are making cost-saving moves that are more tactical in nature, such as stressing load optimization, getting more goods into a single container or truck. And from a real estate perspective, there is plenty of lease renewal and new activity in major markets such as Los Angeles and Chicago with larger facilities of 500,000 square feet and above.
Larger market activity is “contradictory to what everyone believes will be the trend,” Thompson said, “but it makes sense because people know they are going to be there. They are doing what they need to do now, because they know that lease costs are going up.”