Riding the Third Wave

Riding the Third Wave

Copyright 2004, Traffic World, Inc.

Fueled by consolidation, new technology and the growing importance of midmarket customers, a third wave of contract logistics is reshaping the logistics market.

Large Fortune 500 companies such as General Motors generated the first wave in the early 1990s by shedding "noncore" logistics activities. A second wave followed driven by new technology as companies sought to harness new capabilities for transportation management, warehousing management, shipment tracking and tracing, and international trade management.

In 2004, three forces working together are driving a third wave:

-- First, logistics and transport companies are consolidating across modes and regions in response to customer demand for one-stop shopping.

-- Second, web-based, pay-as-you-go technologies finally are being adopted and proving their value in managing supply chains.

-- Third, midsized logistics companies are emerging as the major growth story of 2004.

The consolidation that is changing the shape of contract logistics rises from the industry''s fragmentation.

The logistics industry has several segments: value-added warehousing, air/ocean freight forwarding, asset-light transportation management and asset-based dedicated contract carriage. Each segment has grown 15 to 25 percent annually over the past decade, a growth rate likely to continue. Each segment also is highly fragmented. In all cases, more than 30 percent of the market share is divided by small companies (defined as those not among the top 50 in their segments) and in the case of warehousing it is more than 75 percent.

In short, this is a highly fragmented, fast growing industry. Contract logistics has three notable features:

-- A fragmented market; no one company controls more than 6 percent of the total $65 billion logistics outsourcing market.

-- Lack of a clearly dominant player within any one segment.

-- The "silo" effect - no one company ranks in the top two within more than one segment.

Since 2000, we have witnessed a wave of acquisitions across modes and geographies, as fragmentation gives way to consolidation. A good example is UTi Worldwide''s acquisition of Standard Logistics in October 2002, in an ongoing quest to transform from the company''s freight forwarding roots into multiservice contract logistics leadership. Other major examples include UPS''s purchase of the Fritz Cos., Exel''s buy of Mark VII, Deutsche Post''s acquisition of both Danzas and AEI, APL''s buy of GATX and Keuhne & Nagel''s purchase of USCO Logistics.

In 2004 we can expect to see three major trends:

-- An acceleration of the consolidation in the marketplace.

-- Increased adoption of web-based technologies.

-- Midmarket success stories.

As Fortune 500 companies seek to reduce the number of their suppliers, they will continue to lean on 3PLs and logistics outsourcing companies to consolidate across modes and territories.

Second, as web-based logistics providers continue to increase their functionality, logistics users are gaining comfort with the application service provider model. Software experts believe that in the coming decade a full 50 percent of all supply-chain software sales will be in the form of web-based, "pay-as-you-go" services rather than traditional installed systems.

The upside of these web-based technologies is significant.

Companies can gain quicker payback due to shorter implementation cycles.

Users also gain the flexibility of being able to upgrade or change systems more easily. Finally, web-based technology offers dramatic cost savings and productivity improvements - as high as 80 percent - compared with a traditional, phone/fax environment.

Third, the midmarket will emerge as a source of major growth potential for contract logistic companies. More than 70 percent of Fortune 100 companies already use outsourced logistics services, compared with only 20 percent of the Fortune 401-500. The Fortune 100 are likely to increase outsourced logistics spending only 8 percent while Fortune 401-500 companies are likely to increase outsourced logistics spending 20 percent annually.

This is a market more open to the second- and third-tier logistics players.

Who will the winners of 2004 be? Logistics firms that are leaders in niche markets are likely to be successful.

One winning strategy revolves around vertical solutions. On the surface this may appear counter-intuitive since many companies focus on different vertical markets. However, the true giants of value creation in logistics have developed highly differentiated offerings tailored to specific markets.

For instance, USCO Logistics was slightly better than breakeven in profitability in 1996. When new CEO Bob Auray came on board the following year, he molded the business around the high-tech and telecom sectors, developing tailored technologies and business services for clients such as Sun Microsystems and Nortel.

Within four years, USCO shot up to close to $40 million in cash flow or EBITDA, before selling to Kuehne & Nagel for approximately 10 times EBITDA.

Cross-border services are poised for growth. Last year more than 10 million trucks crossed the U.S.-Canadian border as the U.S. imported $211 billion from Canada and exported $161 billion. Similarly, truck crossings on the U.S.-Mexico border grew from 2.8 million in 1995 to 4.4 million in 2002, as both exports to and imports from Mexico more than doubled.

As U.S. companies expand trade with NAFTA neighbors, and as security regulations increase the complexity of trade, cross-border services will provide expanding opportunities for innovative logistics companies.

Another important niche is built around the U.S. Postal Service and services offered around its traditional parcel operations. The USPS designed a workshare initiative in the mid-1990s to better manage high volume direct mail.

It sought partners that would handle linehaul transportation of mail freight, letting the postal service focus on the final mile. This outsourcing shift created an enormous market opportunity for creative transportation companies.

SmartMail Services, founded in 1996, responded with an innovative business model, offering delivery services for catalogs, flat-size mail pieces and parcel packages. The company built 16 processing centers nationwide and designed each facility to quickly and efficiently process mail pieces in a highly secure environment.

SmartMail now has more than 1,200 customers and $200 million in revenue, and is likely to continue to expand.

-- Gordon is Managing Director of BG Strategic Advisors. The firm provides investment banking and strategy consulting services to companies in the logistics and supply-chain industry. For more information, please visit www. BGStrategicAdvisors.com, e-mail Ben@BGStrategicAdvisors.com, or contact Gordon at (617) 864-4966.