Just when everyone thought the industry was done with talk of revamping the North American Free Trade Agreement (NAFTA), President Donald Trump sent official notice to Congress of his intent to renegotiate key parts of the trade deal. A surprise? Not really, since that was one of the tenets that Trump campaigned on. Many, though, thought any redo of NAFTA would be put on the back burner as issues such as tax reform, Obamacare repeal, and immigration dominated the early days of the presidency.
It is timely, then, that McKinsey & Company has recently issued a report on potential impacts within the trucking and rail freight industries in the three countries. The report, “Four forces to watch in trucking and rail freight,” identifies critical structural issues that executives must pay attention to in the immediate future.
The authors, Sal Arora and Scott McConnell, note that surface freight transport (truckload, less-than-truckload, and rail) contributed $309 billion in economic profit to the North American economy in 2015.
“Companies based in the United States earned nearly three-quarters of those revenues, and the sector accounted for over 1% of U.S. GDP, almost 2% of Canada’s, and nearly 6% of Mexico’s,” they write. “These numbers shouldn’t be surprising. From raw materials to finished goods, nearly every product made or sold in North America relies on surface transport at one or several points in its life cycle.”
The report notes that truck and rail growth rates at the borders of the U.S. have exceeded domestic freight growth in the past 15 years. “And trucking’s productivity is up—the industry sold or decommissioned 20% of its fleet during the 2008–10 financial crisis but continues to move as much freight, by tonnage and value alike, as before,” the report notes. “Slow and steady economic growth has raised utilization. Other factors also have contributed, including modal shifts as a result of e-commerce, miniaturization of products and packaging, and more efficient use of trucks and trailers. With utilization now high, the trucking industry has little slack to absorb disruptions or more robust economic growth.”
In a survey of 100 shippers, warehousers and transportation companies for the report, conducted in 2016, McKinsey found that hours of service and electronic logging devices are of great concern.
“Since then, of course, a new U.S. administration has brought the North American Free Trade Agreement into question. Understandably, that’s the issue now dominating discussions in the sector,” the authors note.
The authors advise executives pay close attention to these four trends: nearshoring; infrastructure investment in Canada; e-commerce; and technology.
The realities of nearshoring
Nearshoring – or the process of moving manufacturing back to the U.S. – is not a new trend, but it is a growing trend.
“Over the past few years, many sectors have been nearshoring, but not all sectors are part of this trend and those that are have vastly different reasons,” McKinsey notes. “High-tech companies are embracing the move as a way to bring manufacturing and assembly closer to demand, to reduce total landed costs, to minimize supply-chain disruptions, and to reduce intellectual-property risk. These benefits are particularly significant in a sector that evolves as rapidly and as often as high tech, whose imports from Mexico to the United States increased by $142 billion from 2002 to 2015—243%.”
Auto companies have been moving more manufacturing back to North America, particularly Mexico in recent years. “Like high-tech players, automotive companies have shifted production to Mexico in an effort to make their supply chains faster and more flexible and to access a labor force that’s increasingly skilled and priced competitively against parts of Asia,” the report says. “Mexican automotive exports to the United States via rail and truck rose by $170 billion from 2002 to 2015. Canada too has dramatically increased its automotive imports from Mexico, at a compound annual growth rate of 11.5% since 2006.”
The McKinsey authors note the challenges ahead for nearshoring activities, primarily U.S. policy changes. Indications are of labor cost growth in Mexico mirroring that of the U.S., about 3% annually for the next five years. The value of the peso is also a concern.
Goods moving from Mexico to Canada are of greater concern. “For Canadian companies that want to take advantage of nearshoring, the logistics are even more complicated than they are for U.S. companies: the Canadians must transship not only at the Mexican border but also at the northern one, to a Canadian carrier, as a result of cabotage laws,” the report notes. “The north–south rail network is an alternative—shippers can pack containers in Mexico and move them inbound all the way to Canada, a method the auto sector uses a good deal.
Canadian infrastructure investment
The Canadian government has invested over $50 billion Canadian over the past 10 years to improve its supply chain. The improvements now allow shippers to bypass U.S. ports and border crossings.
“The expansion of the Prince Rupert Port, improved rail and road networks, and inland hubs (such as CentrePort Canada in Winnipeg) are recent investments, and more is on the way with the 10-year $14 billion (Canadian) New Building Canada Fund,” McKinsey says.
Previously, Canadian imports had to move through U.S. ports before going to Canada. In 2015, Canadian imports coming directly from Asia were 23%, up from just 15% in 2001, and imports from the U.S. have dropped from 64% in 2001 to 54%.
“New infrastructure has also opened the door to new transportation strategies for many Canadian companies. … Larger Canadian transport providers, particularly rail companies, may begin to benefit from increased cross-country traffic—a departure from today’s mainly regional services,” McKinsey surmises.
The growth of e-commerce, as has been stated many times, is dramatically altering the supply chain. The desire not only for quick delivery of orders, but for the ability to return online purchases is causing disruption for shipping companies that are now losing efficiencies of scale they spent years building up.
“Returns are accepted much more widely by e-commerce companies than by brick-and-mortar ones. Shoppers buy and return freely—a process that is simple for them, but quite burdensome for logisticians,” McKinsey says. “In response to these shifts, many retailers are increasing their permanent downstream inventories and changing the way they manage them, moving from mega warehouses to smaller, more flexible facilities closer to consumers.
“At one big company, truckload miles per truckload trip have declined by 25%. Less-than-truckload players are also seeing a dramatic effect, but to their benefit: LTL has increased by 9% annually since 2009, and the boom does not appear to be letting up,” the authors write. “E-commerce and growth in reverse logistics have boosted LTL, which in turn has become increasingly efficient at moving freight out of its networks.”
Retailers in both Canada and Mexico are beginning to adopt strategies similar to companies in the U.S. – more warehouses and strong infrastructure investment that will lower cost of shipping. Mexico does have one cause of concern that is holding back online shipping, McKinsey says, and that is low credit card use among citizens.
“Until recently, consumers had to accept passively whatever a shipping service company provided unless they wanted to pay significantly more to expedite. But supply chains are entering a disruptive reality powered by e-commerce and reverse logistics, so companies need to be prepared for continual and unpredictable evolution,” McKinsey says.”
Technology is leveling the playing field
The great equalizer in the modern economy is technology, the firm notes. That is helping smaller freight companies compete with the larger players.
“In the United States, the top ten players control just 12% of it,” McKinsey observes. “In fact, of the more than 551,000 private and for-hire trucking companies and brokers in the country, nearly 90% have 10 or fewer tractors. In Canada, fragmentation is similar, and in Mexico, it is far more pronounced: the top 10 players control just 14% and 3% of their respective markets as measured by power units.”
Technology is now helping smaller carriers gain access to critical data that is improving their service offerings.
“As small carriers increase their ability to exploit available knowledge, they will be able to compete for more opportunities than ever before, in both baseline and peak freight,” McKinsey says. “Freight-matching apps and other technologies will improve connections. And established 3PLs now offer a plethora of fully loaded services (covering activities such as exception handling, document management, third-party interactions, and nearby load alerting) on desktop and mobile platforms. With these new tools, smaller carriers are becoming increasingly able to punch above their weight.”
The driver shortage frequently discussed in the U.S. is also a concern in Canada, where the Canadian Trucking Alliance predicts a shortage of 48,000 drivers by 2024.
“In the United States, this oft-discussed problem is expected to grow starker as older drivers leave the workforce faster than younger drivers enter it. Projections of the driver shortfall vary from 100,000 to 175,000 by 2024,” McKinsey notes. “In Mexico, the executives we spoke with had little concern about a shortage of drivers, but a lack of hard data makes it difficult to know for sure whether or not this is a problem. In any case, any shortfalls in driver capacity will primarily affect larger consolidated-shipping companies. Small, independent trucking companies tend to rely on a limited number of longtime employees and have lower turnover rates, on average.”
McKinsey concludes by suggesting that the freight markets, now having recovered from the Great Recession of 2007-09, remain as unpredictable as ever.
“Over the past several years, Canada and Mexico have rapidly built supply-chain capabilities for more efficient transport, both domestically and abroad,” the firm states. “By embracing e-commerce, U.S. consumers have fundamentally changed the supply chain, pushing inventories further downstream. Other changes are also gathering force, including emerging technologies such as autonomous vehicles, connected devices, alternative fuels, and blockchain, to name a few.”